Quaker Chemical Corp. (KWR) Q1 2020 earnings call dated May 12, 2020
Corporate Participants:
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Mary Dean Hall — Senior Vice President, Chief Financial Officer, and Treasurer
Robert T. Traub — Senior Vice President, General Counsel, and Corporate Secretary
Shane W. Hostetter — Vice President, Finance and Chief Accounting Officer
Analysts:
Dan Rizzo — Jefferies & Company, Inc. — Analyst
Brendan Popson — CJS Securities — Analyst
Michael Harrison — Seaport Global Securities — Analyst
Presentation:
Operator
Greetings. Welcome to the Quaker Houghton First Quarter 2020 Results Conference Call. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Michael Barry, Chairman, Executive — Chief Executive Officer and President for Quaker Houghton. Thank you, Mr. Barry. You may begin.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Good morning, everyone. Joining me virtually today, as we are all working from home, are Mary Hall, our CFO; Robert Traub, our General Counsel; and Shane Hostetter, our Head of Finance and Chief Accounting Officer. We have slides for our conference call. You can find them in the Investor Relations section of our website at www.quakerhoughton.com. A great deal has changed in the world with the COVID-19 pandemic since our last quarter’s conference call. For us, our top priority is to protect the health and safety of our employees and our customers, while ensuring our business continuity to meet our customers’ needs. All of our 34 plants around the world are operating and we are meeting our customers’ needs. I am very proud of what the Quaker Houghton team has done to continuing servicing our customers as well as continuing with our integration, which has not missed a beat.
In our last conference call, we knew China was being impacted by COVID-19, which really started impacting us in February. But in the second half of March, we began experiencing impacts everywhere around the world. And towards the end of March, many of our customers had significantly reduced production or shut down altogether, especially in the automotive sector. Overall, we estimate that COVID-19 impacted our sales by about 4% in the first quarter. We were also impacted by Boeing temporary halting the 737 MAX production, which impacted sales by approximately 1%. These were the two main drivers of our volume decline in our pro forma comparisons. We have gone through a customer-by-customer analysis to see what our gains and losses and market share were at the customer and product levels. This analysis continues to show that we took share in the marketplace as we estimate total organic volume growth due to net share gains was approximately 2% in the first quarter of this year versus the first quarter of last year.
Concerning gross margins, you may recall from our comments in the past that the combined gross margins of Quaker Houghton were expected to be about 1% lower than standalone Quaker. In the first quarter comparison, you can see this difference is only 0.5 percentage point. This is indicative of our raw material savings from our integration starting to come through. While crude was also decreasing during this period, we do not see any material benefits from this as of yet, as our raw material costs were relatively stable.
So overall, the first quarter results were somewhat better than expected when considering the COVID-19 impact. Our first quarter pro forma adjusted EBITDA grew 10% versus last year due to our integration savings, the impact of the Norman Hay acquisition last quarter, and the additional cost control measures we put in place to combat the global effect of COVID-19 on our volumes.
This event has been similar in many ways to what we went through in late 2008. Just like then, we took fast action to save cost in numerous ways. Essentially, all discretionary expenses have been eliminated. We stopped new hires, executive pay cuts were implemented, some positions were furloughed, and our planned capital expenditures have been cut by over 30%. And very importantly, we reviewed our integration’s synergy plans in light of this situation and took additional actions as well as accelerated other synergies where possible. We have now increased our guidance on synergy achievement. For 2020, our new estimate is $53 million of cost synergies achieved versus our previous estimate of $35 million. And the total synergies that we estimate will be achieved by 2022 have been raised from $60 million to $75 million.
One question we have been asked about is if this pandemic has impacted our integration. And the answer is that it really hasn’t negatively impacted our integration in any way, especially in the timing. I give our people a tremendous amount of credit for being able to do plant shutdowns, product manufacturing site transfers, and ERP implementations during these challenging work conditions that we’re currently operating under. For instance, we successfully implemented our [Indecipherable] at two sites recently and has done such all remotely due to the current working conditions. Our two years of planning are paying off and we’re fortunate that we had this integration execution ongoing during this period of time to help us offset the volume impacts that we’re experiencing. Even with these additional cost synergies, we have not done anything that will impact our business execution or strategic initiatives, including our ability to service our customers well, continue to grow above the market into the future, and further develop and execute on our strategic platform.
Looking forward to the rest of the year, we expect the second quarter to be the most challenging quarter. Many of our customers has significantly reduced production or shut down. For example, our April revenues were down in the order of 30%. We do anticipate that in the second half of the year, we will begin to see a gradual sequential improvement in business through the rest of the year. However, we do not expect our business to return to the levels expected pre-COVID-19 by the end of the year.
Given how clouded the economic environment is to the COVID- 19, we will not be providing specific guidance at this time. However, in order to try to give some direction for the remainder of the year, I can say that we’re currently see that the second quarter’s adjusted EBITDA could be down by nearly half of the first quarter’s adjusted EBITDA. For the full year, we expect our adjusted EBITDA to be more than $200 million. And we do not expect to have any liquidity or bank covenant issues.
Overall, our higher expected synergies, additional cost saving actions, the improvement in our gross margins, and the expected release in cash via working capital reductions are expected to continue to help us during this period of time when our volumes are down. And if we look forward to 2021 and 2022, I continue to be optimistic in our future, and I do expect us to achieve significant increases in our adjusted EBITDA, as we complete our integration cost synergies, continue to take share in the marketplace, and benefit from a projected gradual rebound in demand in our end markets over this period of time.
In closing, I want to thank all of our colleagues at Quaker Houghton, whose dedication and expertise helps to create value for our customers and shareholders and differentiate us in the marketplace. I am so proud of how our team has performed in servicing our customers, meeting their needs, and successfully continuing on with our execution of our integration, which is so critical for us this year. People are everything in our business and by far our most valuable asset, and ensuring their safety and well-being is and will continue to be a priority for us. I’m very happy with our Quaker Houghton team and what we have and will be able to accomplish for our customers, both now and going forward.
And that concludes my prepared remarks. I will now hand it over to Mary so that she can review some of the key financials for you for the quarter. Mary?
Mary Dean Hall — Senior Vice President, Chief Financial Officer, and Treasurer
Yes. Thank you, Mike, and good morning all. Before I begin, let me remind you that comments made during this call include forward-looking statements, which are based on current expectations, estimates, projections and assumptions that are subject to risks and uncertainties, which may cause actual results to differ materially. For a discussion of these risks, please review the cautionary statements regarding forward-looking statements included in our earnings release and then our 2019 Form 10-K filed with the SEC. These are available on our website. Please also note that we updated the risk factors in yesterday’s first quarter 10-Q to address COVID-19-related issues and these risk factors should be reviewed along with those in our 2019 Form 10-K.
In our press release and in this presentation, we provided certain information, including non-GAAP earnings per diluted share, non-GAAP operating income, and adjusted EBITDA as well as certain pro forma items in an effort to provide shareholders with better visibility into the Company’s core operations, excluding certain items, which we believe do not reflect our core operating performance. Reconciliations are provided in the appendix of this investor deck.
We followed a similar review format for this deck as the one we used for our last couple of calls post Combination, where our comparison periods show actual and non-GAAP results as well as pro forma sales and pro forma adjusted EBITDA as if we’ve been combined with Houghton throughout the periods presented. So please see Slides 6 and 7 and also the chart on Slide 8, while I review some highlights.
When we had our Q4 earnings call in early March, we noted that we continued to face strong headwinds from global automotive and general industrial weakness that surfaced the latter half of 2019, as well as a stronger U.S. dollar. COVID-19 at that point was generally considered a China issue. As March unfolded, COVID-19 became a global pandemic as Mike noted, significantly exacerbating the auto and industrial weakness already seen. So, while our actual sales are up significantly to $378.6 million in Q1, this is due to the inclusion of Houghton and Norman Hay. On a pro forma basis, as if Houghton was also in Q1 of 2019, net sales were down 3%, which reflects negative impacts from lower volumes and foreign exchange, partially offset by additional sales from Norman Hay.
Despite the challenges we faced in Q1, the Company generated good cash flow and adjusted EBITDA, which was up 10% on a pro forma basis and non-GAAP EPS of $1.38 was well above consensus of $1. Gross margin of 35.4% for Q1 was down from 35.9% Q1 of last year, which is in line with our expectations and communication. We previously noted that somewhat lower gross margins in the legacy Houghton business due in part to the accounting treatment for Fluidcare, the chemical management business. If Houghton was included in the prior year, we estimate that our prior year gross margin would have been approximately 1% lower. This indicates improvement in the current quarter’s gross margin, which largely reflects the procurement savings related to the combination that Mike mentioned.
In the table on Slide 8, you can see a reported operating loss of $12.4 million in the GAAP section but in non-GAAP operating income of $36 million in the middle section. The main non-GAAP adjustments are combination and restructuring charges totaling about $10 million and a $38 million non-cash impairment charge in Q1 to reflect the write-down of our Houghton trademark indefinite-lived intangible assets to their estimated fair value. These were recorded at fair value at close of the Combination on August 1, 2019 and tested for impairment during the fourth quarter of 2019. However, given the recent changes in business conditions as a result of COVID-19, we determined that these assets needed to be tested again and confirm their carrying value exceeded their current estimated fair value by approximately $38 million. As we noted in our 10-Q, as business conditions evolve, we will continue to re-evaluate all our long-lived assets as necessary.
In non-operating items, we reported a non-cash charge of $22.7 million for final settlement and termination of legacy Quaker’s U.S. defined benefit pension plan, a process we previously disclosed. The offset is reflected in the accumulated other comprehensive income/loss account in the equity section of the balance sheet. Concurrent with this termination, the Company paid approximately $1.8 million, subject to final adjustment.
Our reported effective tax rate was a benefit of 31.1% in Q1 2020 versus an expense of 26.8% in Q1 of last year. Adjusting for all one-time charges and benefits, we estimate our ETR would have been 22% this Q1 and 24% in Q1 last year. We currently expect our full-year ETR, excluding all one-time charges and benefits, to be between 22% and 24%. Our non-GAAP EPS of $1.38 is down from $1.41 in Q1 last year, due primarily to the additional shares issued in the Combination, partially offset by the inclusion of Houghton and Norman Hay. Sequentially, non-GAAP earnings per share is up from $1.34 in Q4 of 2019, which included Houghton and Norman Hay and the additional shares.
On Slide 9, we show the trend in pro forma trailing 12 months adjusted EBITDA, which reached $239 million as of Q1, up from $234 million at the end of 2019. This increase reflects the strong adjusted EBITDA performance in Q1 of $60 million, up 10% from pro forma Q1 last year of $55 million due to the inclusion of Norman Hay and the benefits of cost savings realized in the quarter from the Combination.
On Slide 10, we provide an update on our leverage and liquidity. Please note that we drew down most of the available liquidity on our revolving credit facility in March in an abundance of caution as COVID-19 went global and created significant uncertainty and volatility in all global markets. This drop was leverage neutral as the additional cash in our balance sheet is a direct offset to our debt. In fact, our reported net debt to adjusted EBITDA declined to 3.40 times from our year-end level of 3.47 times as a result of good cash flow and the cost savings mentioned earlier. Our bank covenant ratio also improved from about 2.94 at year-end to 2.76 at the end of this quarter per the definitions in our borrowing agreement. We expect to continue to be in compliance with our bank covenants and we have strong liquidity to support these uncertain times. Our capital allocation decisions reflect these priorities, including an approximately 30% reduction in previously-planned capex.
As you know, we have a very asset-light business model and we also expect a release of working capital at sales decline to generate good cash flow similar to the global crisis in 2008/2009. Our cost of debt continues to benefit from declining interest rates and was estimated at approximately 2.4% at March 31 versus about 3% at year-end. As Mike mentioned, we’re encouraged by the additional cost synergies realized to date and expected to be achieved overall. The increase in expected realized synergies this year from $35 million to $53 million in addition to the cost reduction actions we have taken to address the global crisis and our history of generating good cash flow in downturn all give us confidence in our ability to weather this storm.
Thank you for your interest in Quaker Houghton, and now back over to you, Mike.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Thanks, Mary. We will now open it up for questions.
Questions and Answers:
Operator
Thank you. [Operator Instructions] Our first question is from Laurence Alexander with Jefferies. Please proceed.
Dan Rizzo — Jefferies & Company, Inc. — Analyst
Good morning. It’s Dan Rizzo on for Laurence. How are you guys doing?
Robert T. Traub — Senior Vice President, General Counsel, and Corporate Secretary
Good.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Good morning, Dan.
Shane W. Hostetter — Vice President, Finance and Chief Accounting Officer
Good, thank you.
Mary Dean Hall — Senior Vice President, Chief Financial Officer, and Treasurer
Good morning, Dan.
Dan Rizzo — Jefferies & Company, Inc. — Analyst
Good morning. I was just wondering, just given everything is going on in the volatility, have you been able to gain staff from competitors who might be in more disarray?
Michael Barry — Chairman of the Board, Chief Executive Officer and President
No, we’ve just really trying to control expenses at this point with keeping — given the current situation. So we’re not actively looking out there for new people at this point and we’re continuing a lot of our overall cost reduction programs due to our integration plan as well.
Dan Rizzo — Jefferies & Company, Inc. — Analyst
And has social distancing affected your sales — your typical sales process because that was kind of more hands on? I was wondering if it’s changed at all.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
It’s a really good question. It’s forced us to obviously keeping contact with customers in different ways at times. So sometimes we cannot go into a customer’s facility. There are times we’re still in a customer’s facility. For example, even in Wuhan, where kind of — COVID-19 kind of started, we have a number of customers there and during that time period, our people actually just stayed in Wuhan and were there every day at our customers’ facilities. And we still have different places where people still visiting customers where permitted, but definitely there is a different shift. There are some customers who might not want to see us at this point or kind of they’re closed down. But you’ve got to stay in touch and focus with other ways and having meetings, technical meetings, having discussions with the various teams between the customers and our people, things we could do for them, just has to be done in a different way.
Dan Rizzo — Jefferies & Company, Inc. — Analyst
Okay. And then finally, how will the higher cost inventories affect decremental margins in Q2?
Michael Barry — Chairman of the Board, Chief Executive Officer and President
It’s hard to — it’s really hard to give an exact number on that. If you — you kind of see our operating margins are more in that, let’s say, 10%, 11% range dependent upon how our volumes are going to be. And then, of course, you have our gross margins in that 35%, 36% range. So, in general, it’s somewhere kind of halfway in between that, I would say.
Dan Rizzo — Jefferies & Company, Inc. — Analyst
Okay. Okay. That’s pretty helpful. And then, I’m sorry, one final question. The tax rate was a little lower in Q1. Have you given an outlook of what it’s going to be for all of 2020 or how it’s going to move?
Mary Dean Hall — Senior Vice President, Chief Financial Officer, and Treasurer
Yeah. Dan, what we’re saying is that excluding any one-time charges and adjustments, we’re looking at a tax — effective tax rate this year between 22% and 24%.
Dan Rizzo — Jefferies & Company, Inc. — Analyst
Okay. Sorry.
Mary Dean Hall — Senior Vice President, Chief Financial Officer, and Treasurer
For full year.
Dan Rizzo — Jefferies & Company, Inc. — Analyst
I may have missed that. All right. Thank you very much.
Mary Dean Hall — Senior Vice President, Chief Financial Officer, and Treasurer
Yup.
Operator
Our next question is from Jon Tanwanteng with CJS Securities. Please proceed.
Brendan Popson — CJS Securities — Analyst
Hi. Good morning. This is Brendan Popson on for Jon. So, I want to ask real quick just about — and you actually touched on this already in your prepared comments about gaining share. Do you see, with everything going on, pressures in your competitors and base — obviously, there are some pressures, but did you — how is the difference between larger and smaller competitors? Are smaller competitors going to be cash traps very quickly and give you an opportunity or what do you guys seeing competitively?
Michael Barry — Chairman of the Board, Chief Executive Officer and President
So I really don’t think of it too differently because of this event. I do think we’ll be very successful competitively and continue to take share with the kind of cross-selling synergies that we have and just our size and breadth of our product portfolio and especially in the combined company at this stage, but not so much because smaller versus larger from this event, the COVID-19 event, because these kind of businesses that we’re in are generally pretty good cash flow generating businesses. So we don’t necessarily see a lot of competitors hurting at this point. But we do think just our scale and everything that we’re doing with the Combination will give us a natural competitive and increase our competitive differentiation and we’ll get share that way.
Brendan Popson — CJS Securities — Analyst
Okay. Makes sense. And then with — looking at aerospace, you talked about how the Boeing was a 1% hit. Can you just reiterate again how much as a percent of revenue and your margin is from aerospace and how you think about going forward? And given — everything seems to keep getting pushed out and I think there is some commentary even this morning from Boeing about kind of damping down expectations for ramping that with just air travel and how long that might take to ramp back up again.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Yeah. I mean you could see the kind of impact that had in the first quarter of this year. I think that those kind of impacts will continue. We would expect to see some increase in the second half of the year, because right now, they haven’t been producing any 737 MAXs and that’s the impact that we shared with the 1%. But in the second half of the year, we do expect it to be something and we’ve taken down our internal estimates. They haven’t really given specific guidance, but we’re not — we’re projecting way lower production levels than, let’s say, we did — that we expected coming into this year back in December. So we have adjusted. So any forecast numbers that we’ve kind of projected is kind of building that in already a much — very muted amount of builds coming in for the 737 MAX.
Brendan Popson — CJS Securities — Analyst
Okay. And lastly, cost savings expected and — to generate 2020 on top of any additional synergies and how much of it would be a temporary reduction versus like a fixed cost reduction?
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Sure. So anything we’ve — it’s a really good question, Brendan. I think anything we’ve quoted from a perspective of increasing our integration savings and cost synergies, those are structural in nature. In addition, we are taking a lot of other actions that I mentioned to reduce our cost structure from — on a temporary basis, whether it’s T&E expenses and so forth for those, pay cuts that kind of furloughs. So we haven’t — we don’t have — we’re not giving guidance on what that amount is but that’s built into our estimates. And — but anything you see in the integration is structural in nature. So those increases that we’re projecting, for example, $35 million — going from $35 million original projection this year to $53 million, that additional $18 million is structural in nature. Some of it is due to additional things we found along the way. For example, we’re finding more raw material type synergies than we had originally projected in summer due to additional actions we’re taking, because of the current situation of COVID-19 that we’re in.
Brendan Popson — CJS Securities — Analyst
Great. Thank you.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Thank you.
Operator
Our next question is from Mike Harrison with Seaport Global Securities. Please proceed.
Michael Harrison — Seaport Global Securities — Analyst
Hi, good morning.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Good morning, Mike.
Michael Harrison — Seaport Global Securities — Analyst
Mike, I was wondering if you could talk about the expected pace of raw material benefits. It sounds like there was some margin relief that happened in Q1. Is there going to be some more that comes in Q2 with the decline that we’ve seen in crude? Or should we think about maybe your purchases are depressed right now because of lower demand and it becomes more of a second half driver where we see that benefit coming through?
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Sure. Yeah, there is a lot going on in the raw materials. So, as I kind of just mentioned, we are expecting on an ongoing basis to have more raw material savings due to the integration than we originally had projected. So that’s one aspect and that’s going to come in throughout the year. It’s not like it’s all in now. It should be a benefit as we go through the year. And then you have this other effects that you mentioned of lower raw material costs in general anyway because of crude and that — we haven’t seen that — we’re just starting to see the effects of that at this point, but it’s really not been material and anything we’ve seen so far, but we do expect our raw materials to define that way, that will be an added benefit temporarily because a lot of then prices eventually adjust, but there is generally a lag between our pricing and the raw material costs. So that could be a potential benefit for a period of time.
And then — but then there is this also third effect that you kind of mentioned that when our volumes are down, then that — that’s a negative effect on some of the other savings that we’ve seen.
When you put all that together, we still expect the overall cost savings to be more than we have expected this year, that’s for sure.
Michael Harrison — Seaport Global Securities — Analyst
Got it, got it. And then in terms of the margin performance that you showed in the Asia-Pacific business, really didn’t deviate a whole lot from where you were in the fourth quarter even though I’m sure that customer operating rates were quite a bit lower. Can you talk about some of the actions that you took in Asia-Pacific to preserve margin in that region? And is that to some extent providing a playbook for how you’re managing the impact of COVID and the related downturn in other regions?
Michael Barry — Chairman of the Board, Chief Executive Officer and President
One thing — it’s a really insightful question. The — one thing that happened in China that was different, I would say, in different parts of the world now that we’re experiencing is that in China, we were — we took down our facility for a period of time, but in China, we were not allowed to produce product for a while. So the savings of having that kind of planned shutdown was helpful in our overall margins in the first quarter, wherein the rest of the world and China for since that time, everywhere else, we’re up and running. So — and I would say, we did see certainly material impacts in our volumes in China due to COVID, but we are, just as a general statement, I think we’re seeing China starting to rebound nicely in the volumes. So hopefully that will be consistent with the rest of the world. But so far what we’re seeing in China looks positive.
Michael Harrison — Seaport Global Securities — Analyst
All right. And then the last question I had is just about your Primary Metals business. We’re in an environment now where there are some steel mill customers that you have that are probably still running fairly hard. Some of them are running at reduced rates and some of them may be shut down. I’m just trying to get a sense of how your sales move. Should we think about your sales as being a 100% driven by wherever your customers’ production rate is or is there some base component to it such that your revenues end up being a little bit more resilient than the underlying production rate or operating rate of your customer?
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Yeah. For the most part, I mean, I think it is kind of proportional to their production. There can be a little bit of this — no matter what the production is, there might be a little bit more because of that. But I guess as a simple rule of thumb, I just tend to think that it’s more kind of directly correlated to the production, and I would say, in general, our Primary Metals business has — it’s definitely been impacted and it’s definitely been because of the reasons you stated, cutback versus where it was, but maybe not to this exact same extent that other things that we’ve been impacted with likes, for example, automotive.
Michael Harrison — Seaport Global Securities — Analyst
All right. Thanks very much.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Thanks, Mike.
Operator
We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing comments.
Michael Barry — Chairman of the Board, Chief Executive Officer and President
Okay. Given there are no other questions, we will end our conference call now, and I want to thank all of you for your interest today. Our next conference call for the next quarter will be in early August, and if you have any questions in the meantime, please feel free to contact Mary or myself. Thanks again for your interest in Quaker Houghton.
Operator
[Operator Closing Remarks]