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Edited Transcript of KWR earnings conference call or presentation 2-Aug-19 11:30am GMT

Q2 2019 Quaker Chemical Corp Earnings Release and Combination Close Conference Call

CONSHOHOCKEN Aug 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Quaker Chemical Corp earnings conference call or presentation Friday, August 2, 2019 at 11:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Mary Dean Hall

Quaker Chemical Corporation - CFO, VP & Treasurer

* Michael F. Barry

Quaker Chemical Corporation - Chairman of the Board, CEO & President

* Shane W. Hostetter

Quaker Chemical Corporation - Global Controller & Principal Accounting Officer

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Conference Call Participants

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* Edward James Marshall

Sidoti & Company, LLC - Senior Equity Research Analyst

* Jonathan E. Tanwanteng

CJS Securities, Inc. - MD

* Laurence Alexander

Jefferies LLC, Research Division - VP & Equity Research Analyst

* Michael Joseph Harrison

Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Quaker Chemical Corporation Second Quarter 2019 Results and Combination Close Conference Call. (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.

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [2]

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Good morning, everyone. Joining me today are Mary Hall, our CFO; Robert Traub, our General Counsel, Joe Berquist, our Chief Strategy Officer as well as our Head of Global Specialty Business; Shane Hostetter, our Head of Finance and Chief Accounting Officer. We will have a longer than normal conference call today. I am very excited to be able to finally talk in more detail about the combination with Houghton International, since that has been over 2 years since our original announcement. And of course, the prospect of this combination goes back many years. When I entered Quaker 21 years ago, we had a project called Project MIH. This was of our code name for our project to combine with Houghton. The MIH stands for Made In Heaven, and I'm pleased that we're finally able to make this combination happen.

In structuring this conference call, I thought it'd be best if we talked about the second quarter for Quaker Chemical first, take your questions on the quarter, and then we can move into a discussion of the Houghton combination where we have some prepared remarks, and then we'll take any additional questions that you may have. In this regard, we also have 2 sets of slides for the conference call. You can find them in the Investor Relations section of our website, and our new website is www.quakerhoughton.com, but also our old website of quakerchem.com also has the slides.

I'll start it off now with some remarks about the second quarter. The quarter was challenging, and you could see this most clearly in the 7% drop in net sales. There were 2 main drivers to this decline: one was foreign exchange, which had a 3% negative impact; and the other was our volumes, which were also down 3%. The drop in volumes was caused primarily by 2 factors. The first is weakness in the global automotive markets. The IHS numbers for the second quarter showed an 7.5% decline in global automotive production with each region showing less builds in the second quarter of 2019 compared to the prior year. The biggest declines in auto production occurred in China, which was down 16% and Europe, which is down 7%.

The other major factor impacting our volumes were production reductions in June by a number of our global customers in order to correct inventory issues. We saw this with our steel customers, especially in North America, South America and China.

When looking at our volumes by region, we saw declines in North America and Europe of 4% and in South America of 5%, while Asia Pacific was essentially flat year-over-year. I also want to note that in our second quarter 2018 conference call, we mentioned that, that was a very strong quarter for us, and we did mention that there was some timing elements in sales of North America and Asia Pacific, which had unusually high volumes.

Overall, for this quarter, we estimate that our industrial end markets declined more than our business did as we were able to continue to achieve market share gains in many of our markets. For example, on Asia Pacific, our overall volumes were essentially flat, despite the significant decline in China automotive.

In summary, it was a tough quarter for each of our regions given what happened in the global markets, but we were able to mitigate some of the market share gains across the globe. On the plus side, our second quarter gross margins were where we expected them to be, which was 36.5%, which was an incremental improvement over the 35.9% in the first quarter.

In addition, we had good SG&A control in the quarter, and this helped to mitigate the declines in our volumes as well. Overall, we were down 2% in non-GAAP earnings and adjusted EBITDA with foreign exchange negatively impacting both of them by an estimated 3%.

So in summary, this is not the type of quarter we're accustomed to delivering, but we did mitigate some of the decline in the global markets and the foreign exchange headwinds we faced through our market share gains and improved gross margins and good SG&A control.

Looking to the second half of the year, we don't expect our markets to dramatically change, however, we do expect year-over-year comparisons to improve because our markets weakened in the second half of last year as did foreign exchange rates versus the U.S. dollar. Overall, we don't expect the negative impacts we faced in the second quarter to have the same magnitude into the second half comparisons.

For legacy Quaker Chemical, our forecast indicated that our full year results are expected to show year-over-year improvement in non-GAAP earnings and EBITDA, which means we're projecting positive comparisons in our legacy company's second half performance to 2018.

And that concludes my prepared remarks for the second quarter. I'll now hand it over to Mary Hall, so that she can give you some of the -- more details around the financials for the quarter.

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Mary Dean Hall, Quaker Chemical Corporation - CFO, VP & Treasurer [3]

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Thank you, Mike. And good morning all. As Mike noted, this earnings discussion pertains solely to the second quarter earnings performance of Quaker Chemical.

Before I begin, please remember that comments made during this call includes 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 in Form 10-Q and the risk factors included in our 2018 Form 10-K filed with the SEC. These are available on our website.

In addition, please note that we provide certain information, including non-GAAP earnings per diluted share and adjusted EBITDA in an effort to provide shareholders with better visibility into core operations, excluding certain items that we believe do not reflect our core operating performance. Reconciliations are provided in charts 10 through 13 of this investor deck, and they're also in yesterday's earnings release and Form 10-Q.

So in Q2, Quaker continued to face headwinds from a stronger dollar across most of our markets and continuing weakness in automotive, which also negatively impacted cold-rolled steel production globally in Q2. In the face of these challenges, we continued to show sequential improvement in our gross margins and good cost control as Mike mentioned. As a result, Quaker's non-GAAP earnings per diluted share were up 11% sequentially, but down 2% year-over-year, reflecting the negative impact of foreign exchange on earnings of approximately $0.04 per diluted share or 3% compared to last year.

Please refer now to Charts 4 and 5 as I review our Q2 financial performance in more detail. Net sales of $205.9 million, were down 7% compared to Q2 last year due to the negative impacts from foreign exchange of 3%, a decrease in volume of 3% and lower price/mix of 1%. A stronger U.S. dollar was the primary driver of the negative foreign exchange impact, specifically versus the euro, which depreciated 6% versus the dollar, the Chinese RMB down 7% versus the dollar, the Brazilian real down 9% and the Indian rupee down 4% versus the dollar.

Our gross margin of 36.5% in Q2 is consistent with Q2 of last year and with the expectations we shared in our earnings call last quarter.

Our non-GAAP operating income declined due to lower sales. However, excluding acquisition-related expenses, our non-GAAP operating margin improved slightly compared to the prior year due to the good cost control in our SG&A, which decreased 8% year-over-year.

Similar to our non-GAAP operating income, adjusted EBITDA was down slightly to $31.4 million compared to $32.2 million last year due to the lower sales, but our adjusted EBITDA margin improved to 15.3% compared to 14.5% in the prior year.

Our effective tax rate of 24.2% in Q2 is up versus 16.8% in Q2 of last year. Both rates include the impact of certain nondeductible Houghton expenses and other non-GAAP items, but Q2 of last year also included a U.S. transition tax adjustment of $1.2 million in Q2 of last year, which positively impacted the rate. Excluding all non-GAAP items for both periods, we estimate the effective tax rates would have been approximately 22% and 21% in this Q2 and Q2 of last year, respectively. For the rest of the year, post close of our combination with Houghton, we estimate our effective tax rate will be between 25% and 27% in Q3 and between 19% and 21% in Q4. These ranges reflect our expectation of receiving a concessionary tax rate of 15% versus the statutory rate of 25% in one of our non-U. S. subsidiaries toward the end of this year. For the full year, we continue to expect that our effective tax rate will be in the range of 22% to 24%, excluding all non-GAAP items.

Turning now to Chart 6. Here you can see the decline in volumes I mentioned earlier, down 3% year-over-year and down 2% sequentially as market conditions weakened particularly in June.

On Chart 7, we see the continued sequential improvement in gross margin to 36.5%, which is consistent with Q2 last year.

Chart 8 shows our positive trend in adjusted EBITDA over time, which we expect to continue going forward.

Chart 9 shows our continued improvement and our net cash position, which was about $74 million at the end of Q2, reflecting our balance sheet disciplines and strong liquidity.

In summary, Quaker delivered a solid quarter despite significant market challenges. We're excited to finally close the Houghton combination and are ready to move forward in executing the next chapter of our growth story. One thing that doesn't change is our focus on delivering the solid and consistent performance our shareholders expect. And now I'll turn it back to you, Mike.

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [4]

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We will now open it up for questions. I would ask if you have -- if you keep your questions at this point just to Quaker Chemical's performance only and in the second quarter. And then after this round of questions, we'll begin our remarks around the combination we have another slide deck around that, and then we will open it up to questions again.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question here is from Jon Tanwanteng from CJS Securities.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [2]

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Congratulations on closing the deal.

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [3]

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Thank you, Jon.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [4]

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For Quaker, can you talk about the June slowdown? And if you could -- if you see that trend extended into July? And how much of the FX headwind do you see also in the second half compared to last year?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [5]

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We still see overall foreign exchange being a slight headwind, but it's going to be a lot less than it was -- that we've seen in the first half of this year that's for sure. So it's more just a slight thing at this point based on our estimates. And then on the June production issue, we feel a lot of it was more onetime in nature, but certainly, our markets are generally weaker, but we have gotten some indications and some of these customers that this slowdown that -- in certain parts of that -- in the world, they would be coming back as we go through the third quarter, fourth quarter type of thing. So I don't think it's a prolonged thing. In addition, of course, we have our initiatives to continue to gain share in the market and so forth. So -- and continue to grow above the market, so that's sort of comfort and confidence as well.

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Operator [6]

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Our next question is from Mike Harrison from Seaport Global Securities.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [7]

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Was just kind of piggybacking on that last question regarding the slowdown and maybe some crude auction curtailment. We've also heard that there is some facilities that are taking early downtime typically you would shut down for a portion of August that's typically a European thing. But that some of them have taken early downtime or extended holiday downtime around August. Are you hearing about that? And so maybe as we think about regionally, could we think that maybe Europe is going to be maybe a little bit slower to come back? Or any thoughts around kind of typical holiday shutdowns?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [8]

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In general, when the markets are weaker, you can get some of that. I haven't heard anything too specific around that in Europe in particular, in some of our major customers. But certainly, that's certain -- that can certainly happen.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [9]

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All right. And then it sounds like you're talking about an inventory correction that is customer managing their finished product inventory. But I was just wondering are customers holding significant inventories of your products aside what's kind of already in the system or in the webs? Just wondering if you feel like you're at risk if customers decide to pull back on levels of your products or stock that they might be holding in inventory?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [10]

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No. Our customers -- they keep a very low level of our products, 1, 2 week kind of thing, generally.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [11]

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All right. And then the last question for now is just related to the pricing declines that you saw in Europe and Asia. Wondering if we should expect to see further price declines? Maybe how you feel about your ability to hold pricing even if raw materials are maybe moving a little bit lower?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [12]

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Yes. A lot of what you're seeing there really wasn't, let's say, price decline as much as product mix there. So prices have been relatively, in general, stable in our raw material environment right now, the -- in general as a statement is stable.

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Operator [13]

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Next question comes Edward Marshall from Sidoti & Company.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [14]

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I was focusing on the Asia Pacific, specifically the margin, you've given some good commentary on the sales line there. As you look at the decline on the margin, I'm curious if that had anything to -- can you kind of bifurcate maybe volume versus currency there are on the margin side? And then follow-up, the weakness in the sales, can you discuss maybe the trade impact versus overall market weakness?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [15]

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Yes. I mean well, trade impact to us, it's not a thing that really has a significant impact on us because it can impact us in a couple different ways, our raw materials to get higher cost if we were shipping, for example, China raw materials onto the U.S. or vice versa. But we tried to mitigate that as much as possible that's not a material thing for us. And then on the side of -- like steel production, for example and trade, we have equal shares around the world. And with that, it doesn't really matter where steel is made, so we tend to be kind of protected.

I would say the trade though is more of an issue around -- this brings down the economies or makes people a maybe weaker global environment. So from that perspective, that's how I feel it really impacts us.

And then concerning your question on margins, Shane, do you want to comment on that?

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Shane W. Hostetter, Quaker Chemical Corporation - Global Controller & Principal Accounting Officer [16]

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Yes. So in -- just in general, as you think about margins from a product mix perspective, some of the impacts on the automotive decline, there is some heavier margin products on that side compared to some of the steel. So as you look at the mix on the given period, there isn't a mix issue that happened in Asia and Europe. So you see some of the volume mix on, what I would call, the probably metal side versus the metalworking side is really contributing to the decline.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [17]

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Got it. And do you think the same formula of outpacing market growth with market share gains continues in Asia Pacific and specifically to China? I guess one of the themes we're hearing this second quarter in some of the calls is about an initiative to buy local. I'm just curious if you're seeing any of that at all.

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [18]

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Yes. We have not experienced that phenomena. We continue to believe that we will continue to grow above the market. I think like I pointed here, China itself with the severe decline in autos, we were still in our Asia Pacific region flat. So we have been getting good market share gains that kind of offset that. So yes, we still expect to see very good things for us in Asia Pacific.

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Operator [19]

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Our next question is Laurence Alexander from Jefferies.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [20]

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Could you touch on 2 things? One, since we've had a chance to stress test the operating culture and -- does the ability to grow ahead of the market, has it expanded or contracted in the markets that were softer? That is a pro or countercyclical. And did that show you anything about the way the sales force is working that needs to be fixed? And then secondly, can you just characterize trends on raw materials and how should we think about back half of the year?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [21]

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Sure, Laurence. On the raw material front, I -- that's relatively stable, it's pretty good environment right now. We haven't seen much change from the previous quarter, and we don't expect to see much changes in the quarter upcoming here. So it's pretty stable environment. And then on your first question, which was the -- oh, about -- pardon me?

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Mary Dean Hall, Quaker Chemical Corporation - CFO, VP & Treasurer [22]

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Operations. Operating culture. Yes, well, Laurence, could you rephrase that first part of your question?

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [23]

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Sure. I mean I guess, over the years, we've characterized the spread versus the end markets, but I guess what I'm asking about is, as the market softens does the ability -- pace of share gains accelerate or do the customers become more resistant to new product launches and so it slows down?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [24]

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Sure. Actually, I think it's kind of independent. We -- the things that we're doing to gain share on the marketplace are generally things we've been -- the things we're gaining today are relative things we've been working on for a while with the customer. And so in some ways, I view it almost independent of the environment that we're operating under.

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Operator [25]

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We would like to turn the floor back to Mr. Barry.

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Presentation

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [1]

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Okay. Good. Thank you for your questions on the quarter. Now I will provide my remarks on our combination with Houghton, which was closed yesterday. I would ask if you could go to the slides that we put into the Investor Relations section of our website, so that you can kind of better follow along with my remarks. We've put a good number of slides into this deck. My intent this morning is not to go through all of these slides in detail, instead I'll briefly comment on some slides and spend some more time on others. But please note, we do have a good deal of information here to kind of better describe the many aspects of our combination.

So I'll start on Slide 4. Here is some information about the terms of the deal, governance, financing and updated synergies. I'll just mention 2 things now that are not covered elsewhere in my remarks. The net debt that Houghton had at closing was $660 million versus the $690 million when we announced the deal. This is one of the contributors to our net debt-to-EBITDA at close being 3.4x versus the 3.7x we estimated at announcement over the -- about 2 years ago.

So second item is that we've added 3 independent former Houghton directors to the Board, and you can see those in the press release as well.

On Slide 5, you could see the financing for the deal, it's all bank debt, which provides us attractive rates and flexible payoff terms as we generate cash flow. And the undrawn portion provides us with a good liquidity. Also I appreciate the Fed's actions on Wednesday, which will help keep our rates at an attractive 3.4% to 3.6% range. And I do want to thank our bank group for being very supportive through this long process.

On Slide 6, we summarize the strategic rationale for doing the combination. There are so many great features about this combination. But to me some of the major highlights include, one, gaining talent. I always say people are our greatest asset, and we really have a tremendous talent pool in our combined company that will enable us to service our customers better. Two, provides us an avenue to continue our ability to grow above the market, like the 2% to 4% we have done historically, even if now we're double the size. Three, we expect to achieve good cross synergies, which enable us to be much more efficient given now that we're twice the size. And four, better R&D capabilities. I'm truly excited about the ability to take our 2 companies' different approaches to developing products for our customers and put them together. I believe this will allow us to develop better products in the future than either company could have done alone.

On Slide 7, our key priorities. Here, I like to point out that our customers are our #1 priority. We want them to be well served over this time of integration and see no disruption with our supply of products and services. Another key priority is to create a strong culture and engagement in our people, again, our most valuable asset as we come together as 2 companies. Both companies have a similar customer focus culture, but we'll be putting a lot of focus to ensure that we create a strong and consistent culture for our company going forward.

We also have been -- will be increasing our efforts around ESG also known as CSR or sustainability by some, which we strongly believe in for the safety of our people, making our communities better and helping our customers be more sustainable, which is important for them.

On Slide 9, this combination creates the leading global supplier of industrial fluids. Our global scope in terms of customers, people, manufacturing locations, R&D locations and countries we do business with has dramatically increased in the last 2 days.

On Slide 10, this is our new leadership team, which is a combination of existing leaders from Quaker and Houghton. I believe one of the key differentiators from some of our competitors is the experience level of our leaders, especially leaders that have led businesses directly in our industry and really understand our customers' needs and our business model, which is critical to our success. We have over 130 years of business leadership experience in our industry from this leadership group.

On Slide 11, we have a summary of our expansion across multiple fronts, whether it's customer, markets, products or geography. This increase in size and scale provides us with more opportunities and less risk. Over the next set of slides, I'll touch on each one of these.

On Slide 12, we talk about our customers and the dramatic increase in the number of customers going from 3,500 to 15,000. Also, the customer bases are very complementary with not as much overlap as maybe one would think, and that is really due to the different strengths each company has in different markets. Overall, our customer concentration is now reduced as we combine our 2 companies. For example, our largest customer is now 4% of sales versus 8% before.

On Slide 13, we're comparing Quaker in the past to Quaker Houghton now. While our presence in all key markets increased, you can see our metalworking presence has more than doubled as we are now in more end markets within the area. But even with this near doubling size, our overall market share in this industrial fluids market is still well less than 20%.

The next slide, Slide 14, shows the different addressable markets that we have a good presence in. We have color-coded them, so that you can see which company has a stronger presence in which market as well as the ones where both companies have a good presence. The overall takeaway is that we now have stronger positions in more addressable markets because of the combination.

On Slide 15, we take things a step further and look at the key market positions and what the combination did to increase the leadership position in each end market. On the top part of the chart, you can see a significant increase in our leadership position in many of our chosen markets. The more dots the better in this chart, and you could see the increase in dots for many of the end markets. The bottom part of the chart reflects, which capabilities are enhanced by the combination to increase these leadership positions. While I won't go more into the chart now, it just does provide a good deal of information that you may want to look at more when you have time.

Next on Slide 16, we have a similar chart as the last one, but this one is around product lines. You can see the increase in dots in many of the product lines that the combination strengthened our product portfolio and made it broader. We now have a strong basket of products that are well positioned to service our customers' needs in many markets. As I mentioned earlier, I am also excited that with the addition of -- the ability to combine our R&D organizations and develop better products in the future because of different approaches each company takes to formulating products.

One additional area of expansion I'd like to talk now is in Slide 17, where it shows our additional strength we have geographically. Now being combined, our presence in several areas has been significantly improved such as Mexico, South America, Germany, India, Thailand and South Korea. Overall, our company now does business in 115 countries.

The next Slide 18 will be a familiar slide to the people who have seen our investor presentations in the past. And despite this combination, nothing has really changed with our growth strategy. We believe our markets will be growing over time although modestly like in the 1% to 2 % range. And we will continue to grow above the market by 2% to 4% over time for a differentiated customer business model and our cross-selling opportunities. We have done this consistently in the past 10 years and believe this will continue. The cross-selling opportunities will come from selling products that one company has that the other doesn't or maybe it's even a weaker product and selling that to the other customer base, which remember is very complementary.

We'll also continue to expect benefits from the past acquisitions that each company has made and has not -- and those products maybe are not completely rolled out yet. And of course, acquisitions will continue to be a core part of what we do as well. I believe these are very good ways of creating shareholder value. In the short term, we will concentrate on paying down debt, but we will still look for smaller bolt-on acquisitions as opportunities arise after we reach our targeted net debt-to-adjusted EBITDA ratio in 2 years, we will look for larger opportunities.

On Slide 19, we have provided more detail around our cost synergies. As you could see, we have broken down the synergy realization by time both by calendar year and by years from today. Some key points are that we now expect to achieve $60 million of synergies versus our previous estimate of $45 million. All of these synergies will be achieved by the end of year 2, so on year 3, we will see the full effect. We are providing a breakdown of the type of synergies which are very broad-based in nature and come from many sources such as supply chain optimization, extra production, raw material purchasing and operational efficiencies.

If there was one benefit for the long period of trying to get regulatory approvals it was that we were able to plan thoughtfully and in a detailed manner how to fully achieve these synergies. Now we are ready to hit the ground running and achieve them.

On Slide 20, we provide more detail around the divested businesses. We had to divest certain product lines in Houghton's aluminum and steel businesses in North America and Europe. The revenue impact was consistent with our original expectation of 3% of the combined company. The adjusted EBITDA impact mentioned here of $11 million is more of the variable impact that we get hit with day 1. But over time, that impact is less as we will reduce the related manufacturing and SG&A costs that remain with the company.

Okay. Let's move on to Slide 22. One of the more frequent questions that I've been asked over the past 2 years is, how is Houghton doing? We were not permitted to share this information until now. The short answer is that, Houghton's performance has been very consistent with the projections that were provided in our July 2017 proxy for the shareholder vote. You can see this by comparing the actual adjusted EBITDAs to the projected adjusted EBITDAs in the boxes right below them. So all in all, very consistent and a close match.

You can also see that Houghton had more variability than Quaker over this time period. On the right-hand side, we try to list out some of the key factors impacting their performance from 2016 to the last trailing 12 months, so comparing the 2 last bar columns there. And there were 2 major drivers: their Korean joint venture; and their offshore business performances, both of which showed decline. We believe these businesses are likely at their lowest point currently, and there is more upside than downside going forward.

Fortunately, the Houghton businesses that have been the core part of Houghton, have been performing well and grew adjusted EBITDA by $8 million over this 2.5-year period. Another item to point out is that there's been a decline in the combined company's adjusted EBITDA between 2018 and the trailing 12 months. This decline is really primarily due to foreign exchange rates.

On the next slide, Slide 23, we are taking the same data as the previous page and adjusting it on a pro forma basis, which included the divestments and some other minor adjustments. Today, our trailing 12 months adjusted EBITDA is $230 million. Just like that previous chart, it's down from 2018 primarily due to foreign exchange. However, we are projecting our full year 2019 pro forma number will be somewhat over 2018, despite being down on the trailing 12 months. While we don't expect our markets to dramatically change in the second half of the year, we do expect to have our year-over-year comparisons to improve because our markets weakened in the second half of last year as the foreign exchange rates versus the U.S. dollar.

Overall, we don't expect the negative impacts we faced in the second quarter to have the same magnitude in our second half comparisons, and our forecast indicates some year-over-year improvement in our adjusted EBITDA for the second half.

In addition, we'll also begin to see synergy improvements, which we estimate will be approximately $5 million over the next 5 months and that will be back loaded into the fourth quarter.

On Slide 24, this provides an indicative picture what happens now that we're combined and then after we achieve the cost synergies. As you can see, our adjusted EBITDA run rate goes to $290 million, and by the time we get to this point, which will be 2 years from now, we believe our growth will also generate additional EBITDA, and we will be over $300 million, which is quite a change from Quaker's trailing 12 months adjusted EBITDA of $124 million.

A couple other points on the slide. The gross margin of the combined company will be 35%, which is our estimate what is currently, which is not on the slide. And we expect that to increase to about 37% once the cost synergies are achieved. Also, we expect to expand our adjusted EBITDA margin by 4 percentage points to 18% once the cost synergies are achieved at the end of year 2.

On Slide 25, we have given some additional information that may be helpful as people model our performance going forward.

And Slide 26 provides our capital allocation priorities. We will be focusing on paying down debt, our long-term debt to adjusted EBITDA target is 2 to 2.5x, we believe we will be below 2.5x 2 years from now. We will also continue to pay a dividend like we have consistently done over the past 47 years. And as I mentioned earlier, we will continue to look at our acquisition opportunities going forward, although on the short term, they will be small in nature.

On Slide 29, I make my concluding remarks, and I'm really pleased we're at this point, and we can begin our journey as Quaker Houghton. Two years from now, we will be a company that has achieved the synergies, and we will be a $300 million plus adjusted EBITDA company that is well positioned for above-market growth and has a balance sheet in its targeted debt range and is well positioned to make future acquisitions

So with that, I'd like to open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) First question from Jon Tanwanteng from CJS Securities.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [2]

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Mike, you mentioned in over $300 million EBITDA goal in 2 years assuming that's September 2021. And you have a -- maybe between $235 million and $240 million goal for this year pro forma, can you tell us what your goal is by the end of 2020 kind of in between those 2 data points? Or even 2021, if you can see that far with the full synergies?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [3]

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Well, as you know, we don't kind of give really specific guidance per years and stuff like that. But one thing I just want to clarify on the $300 million that was on a -- by the time we reach that's going to be on a going-forward basis. But I think Jon, if you can -- you could see, that synergy achievement in that one chart, and that's a big component of certainly going from the $230 million today to the $300 million. I think if you can model in those year-by-year, calendar year synergies, you get a pretty good idea of where we're going to be.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [4]

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Okay. Got it. And maybe just to get it another way, what is your expectations for EBITDA growth in 2020 organically before synergies, I guess? Is it going to be approaching that historical between, call it, high-single digit rate that you've done traditionally?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [5]

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Well, one of the things we said is certainly the 2% to 4%, we always -- long term, we expect to be 2% to 4% over -- if you read some of the comments we had in the press release. We see the first year here is really going to be concentrating on the integration, stabilizing customers, focusing on them, retention and so forth, making sure everything is very stable. I wouldn't be surprised if our volumes might not achieve that 2% to 4% in that first year, but I said in the press release that it would get back to that in the second year. So I still think we'll have growth, but it depends, of course, what our end markets are doing at that time. But it may be a little bit more modest than the -- in the interim period here.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [6]

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Okay. Fair enough. And then you mentioned Korea being a sore point for Houghton. What is that JV doing? And kind of what is the outlook going forward for it?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [7]

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Sure. I mean that's a -- it's a very significant JV. And it has a very large business. We're very happy to be honest because we had -- as Quaker, we didn't have a large presence in Korea. And really this really happened and if we kind of looked at their performance over time, and we certainly don't -- don't have that information, but you would see that 2016 was kind of a -- in some ways, an outlier a little bit and how high their performance was. And then some things that happened since then is really just some of the slowdowns in the Asian markets. They obviously sell a lot to the Korean OEMs.

So where they have slowed down there and maybe even in other parts of the world like China, for example, that's what we're seeing there. So we don't really -- the best guidance we've gotten from the Houghton team is that it's likely that we're at a kind of the trough at this point with that JV. So...

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [8]

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Okay. Any hope for improvement in the near-term or just plateauing at this trough level?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [9]

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Well, we haven't had like a lot of detailed discussions with our joint venture partner on that yet, so I can't really comment on that. But again, whatever we've been told by the Houghton team, they feel there's more upside than downside going forward with that entity.

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Jonathan E. Tanwanteng, CJS Securities, Inc. - MD [10]

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Okay. Great. And then just a final on the strategic side, what is your appetite for smaller bolt-on and M&A deals between now and getting to your target leverage? Is there an active pipeline or have you been too busy to focus on that? And what does the market look like?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [11]

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Well, mainly our approaches with M&A is like we're kind of not actively going out right now and looking for things. But as opportunities arise and they come up and people want to sell, then we have to kind of react to that. So from that perspective, we're continuing to look at opportunities, and we are interested and still making these smaller type of acquisitions that we feel can create good shareholder value.

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Operator [12]

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Our next question is from Mike Harrison from Seaport Global.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [13]

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Congratulations. I've been waiting 2 years to ask these questions, and I don't know what to ask first. Mike, can -- you mentioned that this transaction has been around for quite a long time kind of kicking around as an internal project within Quaker. Can you talk about kind of how this transaction has evolved over time? Maybe why it took so long for you guys to move forward in the deal with Houghton? And why is the timing right now? Is it just as simple as having a willing seller? Or is there more to it?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [14]

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Yes. I think it's really as simple as that. I mean certainly, the history of Houghton has been that they were a private company up to 2007, they were sold to AEA. At the time, when they were sold, we were allowed to participate in that process -- we were not allowed to participate in that process because there is -- the owner wasn't a big fan of Quaker, the family owner there. So he didn't want to allow Quaker into the process. And then the AEA, the private equity owner of Houghton owned it for 5 years sold it in 2012. Even in that process, it didn't make sense for AEA to include us in that process because they were trying to sell before the capital gains treatment change, and they wanted to take advantage of that, so they didn't want to get stuck into any kind of regulatory review. And therefore, we were not part of that process. So when the Hinduja Group bought in 2012, then we started to have discussions with them and then it finally culminated to having an agreement in place in April 2017.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [15]

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All right. And then, wanted to ask also about this larger customer base moving from 3,500 customers to 15,000, are there going to be some opportunities to shed some low-margin business among those customers? There have to be some that aren't great or might be better served through distributors. Just wondering if you have thoughts on that. And do you have tools in place from, I guess, an ERP or an IT perspective? Are there tools to identify and take actions like that on a customer-by-customer basis?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [16]

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Our approach right now is to kind of keep everything we have and stabilize, get everything integrated and -- but then we will start to do things like we normally do Mike, when we take an EVA approach to business, we analyze where we make money, whether it's in certain product lines or certain customers. And maybe out of that exercise, some things change, but we don't have any information to lead us to -- because we haven't been privy to that kind of information since we've been competitors and so forth, we don't have any customer-related type of information. So I hope that gives you more flavor. It could happen, some could happen down the line, but right now, everything is going to stay the same.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [17]

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Okay. And then the last one from me right now is, it seems like really one of the most impressive opportunities you have here with this combination is the strong position that Quaker Houghton is going to have in metalworking, obviously, the broadest portfolio in the industry. And market-leading share yet it's still relatively low in terms of the combined total market. Was wondering if you could talk about how you're going to be approaching that metalworking market? How long is the selling cycle? And do you win big chunks of business after that selling cycle is complete? Or do you get little pieces at a time? Just trying to think of how the share gain opportunity could evolve.

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [18]

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No. It's a good question. First of all, the way you summed it up, I totally agree by the way, did a really good job with that and couldn't said it better because I do believe that's a big opportunity. And I still believe we even have good opportunities within our other markets as well in metals market. But generally, how we're going to go about, we have these cross-sellings, we think they're going to be significant, it's going to take a while. As you know, we've made a number of acquisitions over time and the sales cycles for these things takes a while as you get new technologies that you want to sell to your customer bases. So in this case, we have products that, let's say, Houghton has -- that Quaker never had. And we're very excited about those and trying to sell those to our existing customer base.

Likewise, we have the opposite situation. Quaker has products that Houghton doesn't have and because the customer bases are so complementary in nature and that we believe there is good opportunity here, we haven't given any specific guidance around the speed at which this can happen and -- other than we think it's really going to first become visible in the second year. So it's going to take a while, there is a run rate, but we have programs around it. And we're very -- we are very excited about it to make it happen.

And the other question I think you kind of had was around the size of customers and -- yes, metal -- the metalworking, generally, it's a smaller sales amount of quantity products that you sell to a customer at a specific location generally then maybe in the metals market. So many more customers.

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Operator [19]

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Your next question is from Laurence Alexander from Jefferies.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [20]

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So I guess first of all, just looking at some sort of the end market breakdowns that you've given, how important for you is specialty greases as a longer term opportunity?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [21]

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Longer term, we still like specialty greases because it's -- it fits kind of right in and expands our portfolio. The size of the specialty grease market is a huge market itself. So it increases the addressable market for our company. And as you know, we've made 3 smaller acquisitions in grease over the past 10 years in this area. And we're -- even in the Quaker portfolio things, we're still rolling that out globally trying to penetrate into our existing customer base with specialty grease. And now we will have that same opportunity to do that with the customers that Houghton has.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [22]

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Can you break out for the combined company the pro forma, the percentage of sales that is tied into the metals, the industrial and the automotive markets and aerospace, I mean, the big 4?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [23]

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We don't have -- I don't have anything specifically in this, but I would just say the one thing I could say is automotive, we think continues to be something that's probably in the order of magnitude about 1/3 of the company. And then the -- but all these other markets I think we're much more diverse now than these other metalworking markets, Houghton was much more diversified in how they go about at these other industrial markets. So we are planning to probably show some additional slides around that to kind of give a better flavor of that as we go forward with our investor presentations.

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Mary Dean Hall, Quaker Chemical Corporation - CFO, VP & Treasurer [24]

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And even on the automotive side, as we've talked about before, again, Quaker tended to focus more on the large OEMs. Houghton, much more diversified automotive focus Tier 1, Tier 2. So even though the combined company is still in roughly that 1/3 to automotive, it's a much broader automotive footprint.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [25]

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Can you give a sense for the relative size of your larger competitors? I mean what's your sizes of the multiple of your next largest competitor or some kind of metric like that for market density?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [26]

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There's -- I don't have perfect information on that, Laurence, so I don't want to kind of throw the numbers. We believe in our space, what we call in our space, we are the market leader, I would just say the next 2 people or companies down from that would be Fuchs and Castrol.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [27]

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And then just lastly, I guess, we haven't really touched on the difference in the operating cultures. Can you give us a sense for what you think Quaker can learn from Houghton and what Houghton can learn from Quaker? And what you are itching to fix?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [28]

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Yes. I don't know -- yes, it's a really great question. I think our cultures, in general, by the way are pretty similar. We had a lot of time here, 28 months to plan our integration. And because we're only 10 miles apart, we got to deal almost on daily basis with each other around planning for integration issues. So we feel really good about the relationships that that's developed, the cultures of the company and the focus on the customer. So from that aspect, we feel really good.

They -- there is different things that each company is focused on, like I think the -- for example, Houghton has been farther ahead than we have been in putting equipment in with customers to automate kind of monitoring things, and we're excited to learn and do more of that around our customer bases.

I think certainly -- we have certain practices that I mentioned earlier like taking the EVA approach to company analyzing where we make our money, where we don't, by customer, by product line, just understanding better again because we felt that has really helped the legacy Quaker business a lot improving profitability. And Houghton hasn't done that historically, but so we think doing something like that over time will help optimize the profitability of our businesses.

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Operator [29]

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Our next question is from Edward Marshall from Sidoti & Company.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [30]

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The combined D&A that you provided in the press release allows you to kind of to back into some EBIT margins for Houghton. And I'm curious has the deal accounting been finalized yet? And -- or are you still going through those metrics and that's subject to change?

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Unidentified Company Representative, [31]

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Yes. The latter, the deal accounting has not been of concluded. This is just reflective of our estimates as of now. We're obviously engaged with valuation experts, but this is very much preliminary.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [32]

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Okay. It looks like it might be a little bit lower on a kind of mid-single-digit kind of EBIT basis, but it does look like the synergies make that recover relatively quickly. Just want to be clear that the synergies, the $60 million, how much of that would be cash versus how much of that might be noncash through D&A takeout, et cetera?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [33]

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It's all cash.

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Mary Dean Hall, Quaker Chemical Corporation - CFO, VP & Treasurer [34]

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Cash, yes.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [35]

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Yes. Okay. The second question I want to talk about was the -- oh, in the $11 million from the divestiture, is that also included in the $60 million? Or is that in excess of that $60 million?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [36]

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Yes. So if you can see kind of in that one chart where we kind of had a walk-through, you have Quaker, Houghton and then you have the $60 million of synergies, you have the $11 million taken off for divestitures. So there are 2 separate items.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [37]

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And then finally, if I look at the number of customers that Houghton has versus number of customers that Quaker has, I think one of the key elements about Quaker is about the customer intimacy and the model, and I'm just curious with that many customers, how do you stay close to your customer with that kind of market breadth?

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [38]

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Sure. It's a good question. They do have a very customer sentiment approach. And if you look at, for example, their -- they call -- they have a business called FLUIDCARE business, which is the same kind of business we call our chemical management services business. They actually have a lot more people involved in that business where they have people at the plants day in, day out at a number of their larger customers. So they do put a lot and they have a lot more people than Quaker does kind of out there servicing customers on the street. So they have more customers, but they also have more people as well servicing. So again, we find that a very attractive feature of our approaches for combining our 2 companies.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [39]

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Excellent. So a lot of my other questions have been already -- already asked.

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Operator [40]

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This concludes the question-and-answer session. I'd like to turn the floor back to management for any closing comments.

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Michael F. Barry, Quaker Chemical Corporation - Chairman of the Board, CEO & President [41]

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Okay. Given there are no other questions, we'll end the conference call now, and I really want to thank all of you today for your interest today. We are pleased with the finalization of our combination with Houghton. And I am confident in the future of Quaker Houghton. Our next conference call for the third quarter will be in late October or early November. And if you have any questions in the meantime, please feel to contact Mary or myself. Thanks again for your interest in Quaker Houghton.

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Operator [42]

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