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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings, and welcome to the Quaker Houghton Fourth Quarter and Full Year 2019 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 your host, Michael Barry, Chairman, Chief Executive Officer and President for Quaker Houghton. Thank you. Mr. Barry, you may begin.
Good morning, everyone. Joining me today 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.quackerhouhgton.com.
We've recently passed the 7 month mark of completing our combination and certainly has been very eventful period of time. Since August we have seen our end markets continue to be challenged with certainly some impacts from the trade war as we enter 2020 we expect that these market challenges to begin to turn around and now there are two new specific challenges the Corona virus and the temporary halt of the Boeing 737 Max production which will be headwinds for us in 2020. However, on the things we can control like margins, achieving synergies, integrating well, taking market share and investing in our strategic initiatives, we are doing well and they are also helping us to more than overcome these market challenges.
So let me start it off now with some remarks about the fourth quarter results and then I'll get into our outlook for 2020. Overall, our results came in somewhat over the high end of our previous guidance. This improvement was largely driven by faster achievement of synergies as we achieve $7 million versus the $5 million projected. However, the real story of the fourth quarter was the poor too bad in most of our end markets and most of our geographies. We experienced a 9% decline in our pro-forma sales volumes for the quarter. This was due to weak automotive markets and generally weaker industrial markets throughout the world.
Also we continue to face significant inventory corrections by our customers throughout the world. So a logical question based on these declines is where we losing market share. We have gone through a customer by customer analysis to see what our gains and losses in the market place were at the customer and product level. This analysis continues to show that we took share in the marketplace as we estimate total organic volume growth due to net share gains in the fourth quarter versus fourth quarter of ‘18 was approximately 1% which is consistent with what we expected in the first year of the combination, now that we’re twice the size.
As I mentioned before there are other positives in the quarter as well. We continue to perform well in the areas that we have more control which help offset market challenges including keeping our gross margins at appropriate target levels, controlling our operating expenses, completing the purchase of Norman Hay and executing on our cost synergies. Doing all this enables us to have a fourth quarter pro forma adjusted EBITDA of $60.6 million, which is a 4% increase from the fourth quarter of last year despite the decline in volume.
Looking forward to 2020 there are two items which came up early in the year that will impact us. One is the Corona virus and the second is the temporary production halt of the Boeing 737 Max.
Let me now talk about both of these. The Corona virus has main impact on us so far has been in China which makes up approximately 15% of sales. We have tried to estimate the impact of the Corona virus, knowing of course, that there's still a great deal of uncertainty surrounding its duration and magnitude. Based on our current knowledge, we estimate that sales in China will be down in 2020 by approximately 9% from where they would have been otherwise due to the Corona virus.
This translates into an approximate $10 million negative impact on adjusted EBITDA. Our estimate assumes production returns to normal in China in the second half of the year. It does not include any negative impact in other countries due to the virus and it does not include lower overall global production due to the virus possibly causing overall global demand to be negatively impacted.
Now let's discuss the temporary production halt of the Boeing 737 Max. Quaker Houghton makes chemical milling maskants that get used in the production of new aircraft including the 737 Max. We historically haven't talked too much about this business because it's been so steady as aircraft builds rarely show dramatic increases or decreases. Even last year production remained normal despite the 737 Max being restricted from flying for the majority of the year.
However, Boeing essentially held the production in January for the 737 Max. At the end of January we learnt through our main supplier Spirit, that they estimate their production of fuselages and components for 216 737 Maxs this year compared to over 600 last year, with the vast majority of the production happening in the second half.
We estimate this will negatively impact our adjusted EBITDA by approximately $6 million. So in total, we forecast these two items to impact our 2020 adjusted EBITDA by approximately $16 million and possibly more. However, we still expect 2020 to be a good year for us. We expect the benefit from having Norman Hay for a full year. We expect to achieve our projected costs synergies and we expect to continue to take market share including some cross selling opportunities from the combination. When we put all this together we still expect to see an increase of approximately $30 million or more in our adjusted EBITDA this year.
As far as performance by quarter, we expect the first quarter to be our weakest quarter for the reasons mentioned previously. We then expect sequential improvement in each subsequent quarter as a negative impact from the Corona virus and the 737 Max production become less and we continue of course to achieve our projected cost synergies.
Also I like to affirm all the two-year projections we mentioned during the last call. By August 2021, we expect our adjusted EBITDA to be over $300 million on a going-forward basis. Our net debt to EBITDA to be 2.5 times or under and we expect to be growing above the market by 2% to 4% on our entire revenue base.
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. A special thanks for everyone for the excellent job they have done during the integration process. People are everything in our business and by far our most valuable asset and I am very happy with our Quaker Houghton team and what they have and will be able to accomplish for our customers going forward.
That concludes my prepared remarks. I will now hand it over to Mary so that she can review the key financials for you.
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 in our 2018 Form 10-K filed with the SEC. These are available on our website. Please also note that updated risk factors will be included in our 2019 form 10-K which we will file before the extension deadline of March 17. As we disclosed in our press release furnished last night and the subsequent form 12B 25 of filing submitted to the SEC the company is filed for the 15 calendar day extension permitted by the SEC to allow its time to complete our year-end procedures and file our annual report on Form 10-K, which we will do no later than March 17. Therefore, all 2019 numbers we are presenting are preliminary, unaudited and subject to change as the number of regular audit and control procedures remain open.
That said management believes that the financial statements included in our press release and the results discussed during this call will not change materially if at all when our Form 10-K is filed.
In our press release and in this presentation we have provided certain information including non-GAAP earnings per diluted share, non-GAAP operating earnings 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 charts 15 to 24 of this investor deck and some are in the press release as well. We followed a similar review format for this deck as the one we used for our Q3 call where our comparison periods show actual and non-GAAP results and also pro forma sales and adjusted EBITDA as if we had been combined with Houghton throughout the periods presented. For this deck we have those views for both Q4 and full-year.
Please see slide 6 and 7 as I begin the review of Q4 which includes Houghton as the combination was completed August 1 of last year.
As Mike discussed and similar to our discussion in Q3, we continue to face strong headwinds from global automotive and general industrial weakness as well as a stronger U.S. dollar. So while our reported net sales are up Q4 versus Q4 last year this is due to the inclusion of Houghton and Norman Hay, excluding them net sales declined 10% due primarily to lower volumes of 9% and negative effects impact of 1%.
On a pro forma basis as if Houghton was also in Q4 of 2018 net sales were down 2%, which also reflects the impacts from lower volumes and negative effects partially offset by the acquisition of Norman Hay.
For the full year as shown on slides 8 and 9, we see a similar story with reported net sales increasing due to Houghton in Norman Hay but excluding them sales are down 6% due to lower volumes of 3% and a negative effects impact of 3% as well due primarily to a weaker Euro versus the dollar.
On a pro forma basis sales are also down 6% due to similar impacts from volume and foreign exchange. Gross margin of 34.8% for Q4 reflects $0.5 million of accelerated depreciation and a $1.5 million inventory adjustment related to purchase accounting for Norman Hay. Excluding these items our gross margin would have been about 35.3% versus 35.4% last year.
On a full-year basis gross margin was 34.6% including similar purchase accounting adjustments for both Norman Hay and Houghton. Excluding these items our gross margin was about 35.7% versus 36% last year. This is in line with our expectations and prior guidance reflecting the somewhat lower gross margins in the legacy housing business due in part to the accounting treatment for FLUIDCARE, the chemical management business as we discussed in Q3.
Please refer now to slide 10 for a snapshot of certain key financial measures. Here you can see that our reported operating income of $20.3 million is up slightly compared to Q4 last year but on a non-GAAP basis Q4 operating income increased to $37.6 million compared to $24.3 million last year. Full year non-GAAP operating income increased to $121.9 million versus $104.4 million last year. Our operating margins in Q4 and for the full year declined driven primarily by the additional depreciation and amortization acquired with Houghton and Norman Hay on the decreases in sales.
Our reported effective tax rate with the benefit of 18.2% in Q4 of ‘19 versus an expense of 59.8% in Q4 of ‘18. This current quarter's rate includes a one-time benefit from transferring certain intangible assets between non-U.S. subsidiaries and the prior year's rate reflects additional one-time expense related to U.S. tax reform. Excluding these items and various other acquisition related and non-core items, our Q4 ETRs would have been approximately 24% and 17% respectively.
For the full year, we estimate that our effective tax rate excluding non-core and one-time items would have been approximately 22% in both periods in line with our guidance of 22% to 24% which we updated in Q3.
Our non-GAAP EPS of $1.34 for Q4 and $5.83 for the full-year declined compared to a $1.54 and $6.17 last year primarily as a result of the additional 4.3 million shares issued at close of the combination.
On slide 11, we show the trend in our pro forma adjusted EBITDA. While our $234 million of adjusted EBITDA declined slightly from $236 million in 2018, it exceeded our guidance in October. In fact our adjusted EBITDA margins improved for both the quarter and the full year. Our pro forma adjusted EBITDA margin for Q4 15.5% was up versus 15% last year. On a full-year basis our adjusted EBITDA margin increased approximately 1% to 15% versus 14% last year. The improved margins are primarily due to the inclusion of Norman Hay and the initial cost savings benefits we have realized from the combination.
On slide 12, we provide an update on our leverage and liquidity. As noted, we finished the year with net debt to adjusted EBITDA of 3.47 times, up only 0.05 times since the combination closed despite significant cash outlays in Q4, which included the acquisition of Norman Hay for approximately $95 million, CapEx of about $5 million and dividends paid of approximately $7 million. This reflects our good operating cash flow in Q4, which also allowed us to end the year with cash and cash equivalents of $124 million. Our cash balances combined with undrawn portion of our revolving credit facility of about $221 million provide ample liquidity to the company.
Our cost of debt in Q4 was approximately 3.1% and about 2.9% at year-end reflecting the declining interest rates. In Q4 we fixed about 20 % of the interest cost on our debt at approximately 3.1% through interest rate swaps and we continue to focus on managing our balance sheet and debt prudently. We affirm our commitment to reducing leverage to less than 2.5 times within two years post close of the combination and currently expect our leverage ratio to be at or below 3 times by the end of 2020.
In summary, Quaker Houghton continues to deliver on its commitments despite the very challenging market conditions we faced in 2019. As we head into 2020 the crystal ball is murky reflecting a volatile and unpredictable global environment particularly with the unique challenges posed by the Corona virus outbreak. However, we focus on what we can control. Our integration, execution and synergy capture are on track and in fact a bit ahead of schedule and we are confident in our ability to continue to drive market share gains.
Specifically we currently estimate that we will realize total integration cost synergies of approximately $35 million in 2020, that our gross margin will be in the 36 % area for the full year, that our full-year effective tax rate will be in the range of 22% to 24 %.
We also continue to estimate that our one-time costs to achieve the total $60 million plus of integration cost synergies will be approximately 1 time the synergies realized. So when we put it all together even with a $16 million negative impact from the Corona virus and the 737 Max issues, we believe we will show significant growth in our adjusted EBITDA as we expect to achieve approximately $264 million or more in 2020; a 13% increase compared to $234 million in 2019 and we expect to reduce our leverage to 3 times or less by year-end as I mentioned.
As we discussed at our Investor Day in December, we believe Quaker Houghton is well-positioned for growth and we are focused on delivering long term value for our shareholders.
Thank you for your interest in Quaker Houghton and now I'll turn it back over to you Mike.
Thanks Mary. We will now open it up for questions.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.
Good morning. Thank you for taking my questions, also nice job in the quarter.
Thanks John.
Mike or Mary can you comment on what you're seeing from customers who are in Italy and South Korea and Japan and if you're seeing any slowdown or fears from -- due to Corona virus there at all?
Italy, we have not seen any impact so far. It doesn't mean there won't be but so far so good there. Japan is with a joint venture with us. We haven't really heard any incidence or anything there that gives us any cause or concern not a big monitoring movement saying for us anyway there and then China is really the area that we've been impacted by far the most. That's for sure.
Okay. Got it. Any inflow in South Korea at all?
South Korea not that so far from what we heard things are continuing to progress there but as things get worse it could happen but so far everything's fine.
Okay. Great. And then just helping to bridge between this year's pro forma – or excuse me 2019s pro forma EBITDA and the outlook for this year. So you're gaining, call it $35 million in synergy realizations. You're seeing a $16 million headwind but a net increase of $30 million year-over-year, I assume the rest is market share, gains and growth. Is that right and –
Yes. Norman Hay as well in there right. So the incremental EBITDA for Norman Hay maybe 10-ish million but just one thing clarity, just one point I want to clarify when Mary mentioned about the $35 million of synergies that was the cumulative synergies to date that we would expect to have in the full year. So the incremental amount there would be $28 million.
Okay. Great. Thanks. That's helpful and then I'm just on the synergies themselves, did you realize more than expected or was it just a faster pace than expected and it's still the same amount of total synergies and maybe were there any revenue synergies in the mix at all just heading out of the year?
Yes. There were some certainly, not there's no revenue synergies included in any those numbers that we reflected. That’s just built into our business. In fact – and certainly we've had some relatively small at this point but we've had some cross-selling synergies that have already taken place and we expect more next year and then what was the other part of your question.
Just was it faster than expected or [indiscernible] more --
Yes. So the faster, yes. I mean that’s a good question, I mean, I think we are keeping our guidance where it is right now. So we're kind of saying we got in the first year, we expected 5, we got 7 that's really just acceleration of some of the synergies that we did.
We're keeping to our overall guidance that we've already had. So that shows the $35 million for example by the end of 2021 or 2020 rather and then -- so we're keeping that guidance. Doesn't mean we're not trying and we certainly have plans in place to exceed.
This is just a really big year in our integration and our achieving of cost synergies. So as we go through the year we can probably try to give you more updates but being where we are in this point of the year we're just continuing with our previous guidance.
Okay. Got it. And just a quick one what amount of global steel and auto production are you assuming this year in your EBITDA outlook?
I would say the latest forecast that we've seen -- certainly before the Corona virus steel was 1.5% to 2% in that kind of range and now what I've seen lately is global steel may be closer to 1% growth and then from an automotive perspective some of the forecasts I saw before the Corona virus is negative 1% and now it's certainly going to be knocked down another percent or two from that, but who knows exactly? But that is a negative even was negative before Corona virus.
Okay. Great. Thanks guys. Great job.
Thank you.
Thank you.
Thank you. Our next question comes from the line of Laurence Alexander with Jefferies. Please proceed with your question.
Hi guys, this is Dan Rizzo for Lawrence. How are you?
Hi Dan.
Good morning.
Just following up on your assumptions for this year, if global growth was cut by say 50 basis points, is there -- what is the rule of thumb of how your business will respond? I mean this is a third as much of that? What should we think about it?
I mean, we don't know if we have a rule of thumb because so things can be very indifferent how we can react and how fast we can react to instances, so but I mean it's surprise as good as any. I don't really have a specific answer for you on that.
Okay. And then I'm sorry if I miss this but obviously we're talking about the effect of the Corona virus but with that oil prices are falling? I was just wondering your outlook is for raw materials for 2020?
We expect our gross margins throughout the year to be come up in general just because of the cost synergies. You might recall that raw material savings in general are a significant part of what we're trying to achieve. Over the full integration period, we expect our gross margins to increase by approximately 2% because of not only the cost synergies, the raw material synergies as well as the manufacturing.
So having said that, our projection this year is around that 36 % range as Mary mentioned and certainly we haven't seen much really happening in the raw material front so far. It takes a little while to kind of hit us and as things fall as we said in the past that can be a tailwind a little bit for us. Before things adjust on the pricing side of things this tends three tends to be six month live period with pricing so, but right now we're just counting on something in that 36 % range for gross margins for this year.
All right. Thank you very much.
Thanks Dan.
Thank you. [Operator Instructions] There are no further questions at this time. I'd like to turn the call back over to Mr. Barry for any closing remarks.
Okay. Given there 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 first quarter will be in early May 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.
Thank You. This concludes today's teleconference. You may disconnect your lines at this time and have a nice day.