Greetings, and welcome to the Quaker Chemical Corporation Third Quarter 2018 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 Chemical Corporation. Thank you. Mr. Barry, you may begin.

Thank you. Good morning, everyone. Joining me today are Mary Hall, our CFO; and Robert Traub, our General Counsel. After my comments, Mary will provide details around the financials, and then we'll address any questions that you have. We also have slides for the conference call, and you can find them in the Investor Relations section of our website at www.quakerchem.com. I'll start off now with some remarks about the third quarter. I'm pleased we have delivered another strong quarter despite some market challenges. The quarter's results were largely driven by 2 major themes: the first being sales increases and the second was gross margin improvement. Let me start with our margins. Since mid-2016, we've been in a generally rising raw material cost environment. And as we've discussed in the past, with the raw materials, there is a lag effect between the changes in our raw material cost and adjustments to our product pricing. On the last conference call, our expectation was that our gross margin will be in the low to mid-36% range. I'm pleased to report that it came in at the high end of the expectation as our recent pricing initiatives continue to offset new raw material cost increases. However, we also experienced raw material cost increases in the third quarter and they are continuing into the fourth quarter, which we are addressing with additional price increases where necessary. How exactly this all plays out in the fourth quarter is hard to predict in a precise manner, but our best estimate is that gross margins will be in the low to mid-36% range. And going forward, we still expect our gross margins to get back to our target 37% once raw material cost increases subside. Let me now move on to sales. Our sales increased 4% versus…

Thank you, Mike, and good morning all. Before I begin, please remember 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 the risk factors included in our 2017 Form 10-K filed with the SEC. These are available on our website. Please refer now to Charts 4 and 5 as I review our financial performance. Q3 performance was similar to our strong Q2. For Q3, Quaker reported a 21% increase in non-GAAP earnings per share to $1.60 as a result of strong operating performance, which also drove a 12% increase in adjusted EBITDA to $33 million. Our operating performance year-over-year benefited from good sales growth, improved gross margins and continued good cost discipline. We delivered strong earnings despite a negative impact on earnings of 6% from foreign exchange. Our net sales were up 4% to about $222 million versus Q3 last year, with volume growth of 4% and price mix improvement of 3%, partially offset by the negative impact of foreign exchange of about 3%. We saw a stronger U.S. dollar across our footprint year-over-year, with the main drivers of the negative impact being the Brazilian real down about 25%, the Indian rupee down about 9%, the Chinese RMB and the Euro, each down about 2% and the Mexican peso down about 6%. Gross margin for Q3 of 36.5% is up from 35.1% in Q3 of last year and flat sequentially, despite rising raw material costs. In addition, Quaker continued to show good cost discipline. Please note that our GAAP operating income and operating margin include…

Thank you, Mary. At this stage, we'd like to address any questions from any of the participants on the conference call.

[Operator Instructions] Our first question comes from the line of Mike Harrison with Seaport Global Securities. Please proceed with your question.

I was wondering if you could give us a little bit more detail on what you're seeing in raw material trends. You mentioned -- obviously, we've been in an inflationary environment for a couple of years now. But you mentioned that things seem to tick higher during Q3 and into Q4. And any detail on what specific raws or baskets that you're seeing move right now and maybe the magnitude of those increases.

The main driver at this point in time has been mineral oils. There's also some other things like we buy poly oils or other additives that get put into our -- that are increasing as well. The, I would say, general range of increasing that we're seeing lately is in that maybe 1% to 2% of our overall raw material mix.

And in terms of how much additional pricing is necessary, I guess just compared to the 3% price mix number you reported in the third quarter. Should we expect that to tick higher in Q4 and into Q1? Or is that probably a good assumption for the next couple of quarters?

It's hard to say precisely the timing exactly what our price increases are. I'd rather not kind of give specific guidance around that price mix number. All we do is kind of commit that. We want to put our price increases in place. So that will eventually get these and well set the raw material increases.

Or you feel pretty confident in your ability to capture pricing where you need it?

Yes.

And then in terms of the North America volume growth rate, that 9% number was pretty impressive. Is that related at all to some of the tariff, maybe benefits to manufacturers or steel makers because of tariffs? Just trying to get a sense of the sustainability of that type of number.

Certainly, steel production increased in the United States, and that's part of it. But it's not really, I would say, then the major driver. So it's -- tariffs are certainly part of it, but it's -- a major driver really in the U.S. for us is pretty broad-based market share gains. We saw them in our primary metals business, we saw them in our automotive business, our tube and pipe business, our grease business our AC products. And it was very broad-based, and it's just really continued to, as I said, use our baseball analogy, hit a number of singles and continue to grow and take share in the marketplace.

And then the last question for me for now is just an update on Houghton. Obviously, everybody is focused on the timing. I was wondering if you could give us any update on what kind of progress they've made on their sales and earnings. I think the last number that we have was a 2016 number of $767 million of revenue and $120 million of EBITDA and also that $690 million of net debt. Can you provide updates on any of those numbers?

I'm sorry, we can't. Houghton is a private company at this point. We've chosen and said that we'll do that once we kind of close the combination. I think the only guidance we've given over time is that what we put in our proxy relative to their borderline performance is pretty close. It's not inconsistent of what's been happening. So it's -- no surprises on our end.

Our next question comes from the line of Jon Tanwanteng with CJS Securities.

My first one is, do you expect to see the same magnitude of currency impact going forward in your earnings? It looks like it was little -- it hit your earnings a little bit more than it hit your revenue this quarter. Is that a onetime situation? How do you see that going forward?

Yes, I think from a top line perspective, we're going to continue to see something of that magnitude or so. It's going to be a pretty good hit. The -- hopefully, the bottom line will be twice as much what the top line was this time.

That was due to a year-over-year transaction flip from gains to losses. So we believe that, that won't repeat to that magnitude, Jon.

And then just any commentary on end market demand? I think you addressed North America earlier. What are you seeing worldwide in terms of steel and autos, aerospace, any slowdowns or pockets of strength or resistance? And any details on that would be appreciated.

Sure. As I think about the year, and I think about our overall demand, I, kind of, put the year into two parts. There's the first half of the year and the second half of the year. First half of the year, we saw our end markets of steel and automotive to be very strong. And that's -- I would say, those end markets were growing on the range of 2% or 3%. And then starting in the second half of the year, we've seen kind of, what I consider, more of a step change down, more modest growth of 1%. So that's kind of what we estimate our markets were growing in the third quarter. We estimate that it's going to be some of that close to low modest growth in the fourth quarter. And actually kind of even going into next year, what we read in our publications or services that we get relative to the auto market or steel markets is that modest growth like in that 1% range or so is expected for these type of markets globally. And of course, globally is what we are generally concerned about because we tend to have relatively equal shares in these global markets, auto and steel everywhere around the world. That's the main -- that's kind of how we view things right now.

Our next question comes from the line of Laurence Alexander with Jefferies.

Dan Rizzo on for Laurence. Has the lag from cost increases, the price, like, shortened at all? It just seems that this cycle things are a lot more manageable than it has been in the past, I was just wondering what's changed?

It really hasn't changed. I think what happens is when the magnitude of some of these increases earlier were larger, and then we started catching up and catching it in the second quarter of the year. And then the magnitude of the increases between the second quarter and the third quarter were relatively modest. So things we have then put in place there was able to offset some of those modest increases. But now, as I said earlier, kind of we're starting to see another -- because the crude is going up and mineral oils and so forth, we're starting to see more increases coming to our raw materials and we'll be going out with price increases. But in general, we don't see -- we still expect to see a 3- to 6-month lag in our capturing raw material increases.

Okay. And then you mentioned -- you made it that there was some weakness in the quarter due to some timing issues or -- I was just wondering if that would imply that's going to be some sort of catch up or a partial catch up in the fourth quarter?

Yes, we would expect that the beginning in the quarter some of these orders hit that we expect than more at the end of the quarter. It just -- we'll see how that plays out for the whole quarter. But yes, we have seen that at least early on.

[Operator Instructions] Our next question comes from the line of Mike Gyure with Janney.

You touched a little bit on the market share gains you guys think you're capturing. Can you talk about, I guess, your labor situation, your associate base? Has that really grown to capture those market share benefits? Or I guess how are you looking at labor for the rest of the year?

Well, sure. We have grown in number of people over the years. I think about where we were -- 2009, we were like 1,200 people and now we're little over 2,000 people, some of that through acquisitions and things that we've made as well. But nothing from a manpower perspective. This year has been relatively flat. We feel we have resources in place to drive our current growth initiatives. A lot of the new technologies that we brought in the Company and we want to spread out globally. We -- a number of years ago, we had to go out and try to hire those expertise in different parts of the world, so to help drive them, but they are in place at this point. So it's a relatively steady labor environment for us right now.

Okay. And then maybe on the Houghton integration or at least thinking about the integration. Can you talk a little bit about, I guess, how you guys are preparing maybe your current site or your infrastructure or your personnel, it's getting, I guess, sort of assuming you're going to close the Houghton early next year or the end of this year from that perspective?

Sure. Yes, one thing at least this prolonged regulatory approval period has given us the ability to plan effectively, and it's also helped that the two companies' headquarters are 10 miles far. So we were able to do a lot. We hired McKenzie to help us with the integration planning. We have a lot of flog. We have a lot of playbooks in place right now, so that once we closed, we can kind of hit the ground running here. From the perspective of our organization and design of the organization, it's given us a lot of time to very thoughtfully assess the talent in the organization. And so I think we're much further ahead than we normally would be under a normal acquisition perspective. So that I'm very optimistic once we close, we can at least get started relatively quickly here.

Our next question comes from the line of Edward Marshall with Sidoti & Company.

I wanted to ask, if we talk about the market growth of 1%. I think you guys have been saying 4% to 5% for some time. I'm just curious as we kind of look at price to offset some of the higher raw materials, do you think these markets are strong enough to accept more price? And two, on a volume perspective, do think that slowdowns related to inflation, currency, maybe some uncertainties geopolitically. Maybe what's your view for maybe 2019, if you could share those?

Sure. Yes, I mean, like I said earlier, I think, Ed, we did see in the first half of the year. We never thought it was really 4% or 5%, but we thought it was in that 2% to 3% range for both steel and for automotive. And we've seen that kind of drop to this 1% type of level in the third quarter. We kind of expect that for the foreseeable future based on things that we have read relative to these markets. And for the same reasons that you hear, whether it's the impacts of the tariff, things hanging over the people's heads or slowdown in China automotive or things like that. But when you put it all together, we expect to see somewhat of a more modest growth of that 1%.

And on the price discussions. How -- I mean, the markets...

Yes, I don't really connect them to be honest. I think we have a number of contracts of customers that are based on indices that can go up or down and then the rest are more negotiated things, and we negotiate when prices go up or down on raw materials. So I would expect us to continue to be able to achieve what we've done in the past and try to keep our margins in the right place.

And so as I think about switching gears over to the acquisition in the letter of commitments that's been extended. I'm curious first, I'm assuming that can be extended further if necessary? And second, when I think about the commitment to the shareholders of Houghton, is there a reason or would -- is it foreseeable that you could actually increase the number of shares based on -- and [Technical Difficulty] that in global equity. I'm just kind of trying to get a sense as to how you might be thinking about that?

So let me take that with that, Ed. With respect to financing commitment, we do clearly expect that if we need to extend that, there won't be a problem. We have discussions with the bank group. They're fully aware of the situation and the time line. So we have had and expect to have good support there. With respect to the number of shares that are part of the purchase consideration for -- or the transaction, the Hindujas get 24.5% stake in NewCo. And that will be basically a formula off of whatever the outstanding shares are of Quaker Chemical close to the time of close. So no intention to renegotiate that. It really is a formula that's embedded in the contract and we don't have any plans to change that at this point in time.

Our next question comes from the line of Garo Norian with Palisade Capital Management. Please proceed with your question.

I want to just get a little bit more better understanding around the North American volume strength. I think if I go back in my notes, the last year's third quarter was a little weaker on volumes owing to some auto shutdowns. I wanted to see if the comp from that was somewhat beneficial in the 9% for this year?

Sure, it can be part of that. But we've also seen just really good market share gains in that area as well.

And then just on the European Commission. The original date that they put out was 27th of November and then it went to December 11th. Do you have any understanding of what changed there?

Sure. There's a number of filings that you make with European Commission. And when you put the first filing in, it goes to something where there is 25 business days and that was kind of the first day. And then when you kind of have a subsequent filing a few days after that, that pushes it out automatically in additional 10 days. So we have always had this 35-business day time frame in our head. So we -- I know what they put out, but we've always expected once we put in the October 19th submission that it would be December 11th or somewhere around there.

Our next question is a follow-up from the line of Mike Harrison with Seaport Global Securities.

Just a couple of additional questions. First of all, you mentioned that we've heard from a number of other companies that there was slowing in auto sales in China. You don't seem to have shown much impact in your numbers in the quarter, but can you just talk a little bit about the potential for seeing some impact from slowing auto production as we get into Q4?

Yes. I mean, again, we would expect that there will be some slowdown in China. We've actually started to experience that in the third quarter. So it's -- but -- so we don't see too much of additional in our -- it's not going to like for what we see any way and from our customer base, it's going to be soft, but again, it's one part of our global perspective on automotive. And when we put everything together, we continue to expect to see relatively modest growth in automotive in the fourth quarter.

And then with regard to the financing for Houghton, interest rates are obviously higher than where they were when you first announced the deal. Can you maybe update your view on the rate that you expect to pay on the financing there?

Mike, I think we believe it's in the queue there. We are holding to our 3.5% to 3.75% based on current rates. We have seen movement. Obviously, upward movement in the LIBOR rates in the U.S. But remember that we have 2 tranches anticipated for debt, 1 in the U.S., 1 in Europe. Europe tranche will benefit from the lower rates there. So when you blend the 2, we're still comfortable saying that that's the range at the current rates that we would expect.

And then last question for me is the Europe. You mentioned a product line or a customer that had low probability that you stopped selling to. Can you give any detail there on how large that product line is, and maybe what it was?

Yes, I would just say it is -- probably, it was in some close to 2% of the sales of Europe in that quarter and that was a really nonstrategic. It wasn't a whole product line we exited, it was really just more of a customer thing and had very low profitability on it. So it actually does not impact our bottom line that much, but it was more of an impact towards that.

Mr. Barry, there are no further questions. At this time, I'll turn the floor back to you for any final comments.

Okay, thank you. Given there's no other questions, we'll end our conference call now, and I want to thank you all for your interest today. We are pleased with our results for the third quarter, and we continue to be confident in the future of Quaker Chemical. Our next conference call for the fourth quarter and full year 2018 results will be in late February or early March. And if you have any questions in the meantime, please feel free to contact Mary or myself. Thanks, again, for your interest in Quaker Chemical.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.