Greetings, and welcome to the Quaker Houghton Second Quarter 2022 Earnings Conference Call. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Jeffrey Schnell, Senior Director of Investor Relations. Mr. Schnell, you may begin.

Thank you, David. Good morning, everyone. Welcome to Quaker Houghton's second quarter 2022 earnings conference call. Joining us on the call today are Andy Tometich, our Chief Executive Officer and President; and Shane Hostetter, our Senior Vice President and Chief Financial Officer; and Robert Traub, our General Counsel. Our comments relate to the financial information released after the close of U.S. markets yesterday, August 4th, 2022. Our press release and accompanying slides can be found on our investor website. Both the prepared commentary and discussion during this call may contain forward-looking statements reflecting the company's current view of future events and their potential effect on Quaker Houghton's operating and financial performance. These statements involve uncertainties and risks, which may cause actual results to differ. The company is under no obligation to provide subsequent updates to these forward-looking statements. This presentation also contains certain non-GAAP financial measures, and the company has provided reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures in the appendix of the presentation materials which are available on our website. For more information, please refer to our filings with the SEC. Now it's my pleasure to hand the call over to Andy.

Thank you, Jeff, and good morning, everyone. The second quarter was another record sales quarter for Quaker Houghton as we delivered double-digit growth led by strong and broad price increases. We continue to execute on items within our control. This includes making progress offsetting the significant and persistent inflationary pressures on our business, investing in our future and delivering on our customer commitments. In the quarter, we achieved strong sales growth as we continue to address our top business priority of offsetting inflation while we also manage through various challenges that impacted our production and demand. These challenges not only include the significant inflationary pressures on our costs, but also raw material availability, COVID-19 disruptions in China, the ongoing war in Ukraine, supply chain and logistics challenges, unfavorable currency translation and the continuation of soft demand in certain end markets like automotive. Notwithstanding the complexities of the operating environment, the company continued to execute, delivering $58 million of adjusted EBITDA and adjusted diluted earnings of $1.32 per share. These second quarter results can be summarized by strong sales growth driven by increased selling prices and relatively stable volume sequentially, while continuing to outpace our underlying markets. Also, we achieved consistent gross margins in the face of approximately 10% sequential increase in our raw material cost. Compared to the second quarter of 2021, total sales growth was 13%. This was driven by a 22% increase from price and mix partially offset by 6% unfavorable impact from foreign currency translation, 4% lower organic sales volumes and 1% contribution from M&A. We delivered another quarter with volumes ahead of the underlying market growth rates, which we estimate declined by a low to mid single-digit percentage in the quarter. This was a strong result given we were able to continue to win new business,…

Thanks, Andy, and good morning, everyone. We delivered another record quarter of net sales of $492 million, which increased 13%, compared to the prior year. The increase in net sales was driven by a 22% increase in price and mix and a 1% growth from acquisitions partially offset by an unfavorable impact from foreign exchange of 6% and a 4% decline in organic sales volumes. Consistent with recent quarters, we experienced a strong increase in net sales directly related to our strategic price initiatives. These were implemented across all our businesses in response to the significant global raw material increases that began last year and have continued into this year. While our volumes declined 4% year-over-year, this decline can be explained by the reduction of volumes in Russia due to the ongoing conflict, as well as the tolling volumes for products we divested as part of the combination. Without these two impacts, our volumes would have been approximately flat year-over-year, compared to a market that we estimate declined in the low to mid single-digit range. This above-market result was driven by net new business wins of almost 3% year-over-year, which was a strong result considering we have lost some volume due to our strategic pricing initiatives, as well as the macroeconomic and geopolitical factors that have negatively impacted our markets in the quarter. Sequentially, net sales increased approximately 4%. This was driven by an additional 7% of price and product mix in the quarter, which was partially offset by unfavorable foreign currency impacts of 2% and a slight decline in volumes of 1%. We estimate our markets declined in the low single-digit percentages sequentially, and we were also impacted by the COVID-19 disruptions in China, which we estimate reduced our total volumes by approximately 2%. This continues to highlight our…

Thank you, Shane. Before we address your questions, I want to recognize and thank all of our associates for their performance towards our objectives and for their unwavering commitment to our Live Safe core value. We've made considerable steps on our safety journey, and I'm pleased with the performance, which shows continued improvement again in the quarter on a global basis. It is evident that we are ending the second quarter with positive momentum. We're managing our business to overcome the short-term challenges we've encountered, while also investing to position the company for long-term success regardless of the macro challenges that arise. With that, we'd be happy to address your questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from David Begleiter with Deutsche Bank.

Thank you. Good morning. Andy, can you just where you are seeing some demand weakness, particularly what end markets right now, and how your order books look heading into the last few months of the quarter?

Yes. Well, thanks for the question, David. I think it's -- there's some well-publicized information out there about the automotive market continuing to lag driven by some of the supply chain chip shortages. Steel has been a little bit variable as we've moved through the year. And it's a little early to tell any changes going forward in the quarter. We continue to be focused on net new business wins with our customers. I think we've proven that over multiple segments here. And so regardless of our underlying markets, our goal is to continue to outperform them. We've shown that we can do that, and that's our intention going forward.

Very good. And just on raw materials, where are you still seeing increases? And where have you seen maybe some relief recently?

Yes, I think broadly, David, there are still increases. I think the way we'd characterize it is we're seeing maybe some signals that it could be a slowing of the increases, but still increases. It's more anecdotal at this stage, not broad-based, and you know we have a pretty diversified portfolio. So obviously, we're watching that very closely and anticipating as we move to the year that there will be some deceleration of the increases.

Thank you very much.

Thanks, David.

Our next question is from Jon Tanwanteng with CJS Securities.

Hi, good morning. It's Pete Lukas for Jon.

Hi, Pete.

Hi, good morning. You gave us a lot of detailed information regarding volumes and do appreciate that. Just wondering if you can talk on how much volume you've lost due to pricing and customer management. And do you think those come back at some point?

Yes, Pete. That's a great question. I talked about in my script, approximately 3% of share -- of new net business wins in the quarter, and that's inclusive of the volumes we lost with the strategic pricing initiatives. We estimate that was roughly 1% to 2% in the quarter. And in your latter part of that question, the example I always give is, with our total cost of ownership approach and how close we are with our customers, we tend to get back to those customers over the period of time. So I think that's in line with our past history and trend.

Very helpful. Thanks. And how should we think about energy availability and restrictions in the EU and how might that impact EU and impact demand?

Yes. Well, first of all, with respect to our operations in the EU, we're not a heavy natural gas user in our operations, so no direct impact on us. Obviously, there could be impacts to some of our customers, and I think those are well publicized. And that's going to depend on geography as well and the consumption in the different countries. It looks like from everything that's out there that Germany might be one of those countries that is heavily impacted. We're not oversubscribed in the German market. It's a relatively low percentage of our overall revenues in Europe. And so we're watching very closely, but again, what's great about it is, as customers are dealing with us, they're very much focused on their productivity, their energy consumption, making sure they don't have downtime or waste, which fits perfectly into what we provide to those customers and the value that they see with us.

Great. And just last one for me. In terms of the comments you made regarding leverage at about 3.2 times now, did you say working towards the goal of 2.5 times by the end of this year or like getting to that goal by the end of the year or just working towards it by this year?

I characterize it as working towards that goal. As we think about our cash flow characteristics this year, we've had pretty significant working capital outflow in the first half, and we do consider that to on go. That said, I do believe we will have positive operating cash flow. So with that in mind, you can scale that side to get in the 2 times range.

Very helpful. Thank you.

Thank you.

Thanks, Pete.

Our next question is from Mike Harrison with Seaport Research.

Hi, good morning.

Good morning, Mike.

I was hoping we could talk a little bit about Asia. Very impressive performance there. I think on your call, you were expecting that China could be down as much as 50%, and it looks like you guys managed through the COVID restrictions very well. So wondering if you could give some detail on how you manage that situation. And then I think I'm specifically interested in the margin performance, which was up sequentially despite these COVID headwinds. So can you maybe give us a sense of where that operating margin could go at least directionally in the second half compared to that 22% segment margin level that you had in Q2?

Thanks, Mike. Great question. I'm going to start off here by highlighting I think the differentiator for us is really the commitment of our employees. Very heroic efforts by our team with individuals going to live on site for multiple weeks so that we were able to get back to production more quickly. And then that put us in a great position as customers were ready to fulfill their demand. Again, reinforcing our value proposition of being there and being ready to serve our customers as they need and keep them uninterrupted, so I think a great evidence of how we implement this customer intimate model. We did see a pickup as we went through the second quarter. There was some unevenness. I think as you can imagine, the supply chain refilling itself, there's some slack in there, and so we're not sure if that's completely smoothed out yet, but things are certainly in the right direction. And I'd also like to highlight that because of our scale and our presence in the balance of Asia, we actually had overperformance in some of those markets with some opportunities coming that way. So it was the total of those two things that really allowed us to perform better than we were anticipating in the Asia Pacific region and I think just reinforces the value of our model and our scale.

Yes. Just to add on to what Andy was talking about and kind of address your latter part of your question there, Mike, one thing as well is, obviously, we have pricing initiatives that went into place across the board from Asia Pacific as well. That said, we did see some impact to some fixed cost absorption on the gross margin side. So if you think about that 22% you were referencing, we also got a benefit from an SG&A perspective given people were not traveling as much and, obviously, on the lesser side from getting out due to the quarantines. But that said, looking ahead, we continue to put price in across the board in Asia as well, as I talked about, and now we have put price in Q3. And I believe the gross margins there will expand as well as people continue to start traveling, as they get out of quarantine. So I like that 22% and think we could expand.

All right. Thank you for that. And then in terms of just your commentary on margin improvement sequentially as we get through the second half, presumably, there's going to be continued price/cost recovery driving that. But I wanted to get to the -- there's really no numbers around this. Analysts like numbers, and I wanted to specifically ask about your EBITDA commentary. Better in the second half versus prior year suggests that you would do at least $127 million of EBITDA in the second half. Consensus is currently in like the high $140 million range. And I'm just curious if you're willing to put any precision around that number. I'm thinking that the realistic guidance number is probably somewhere between that $127 million and where consensus is at around $147 million.

Yes. Thanks Mike. So I'll start off by just reminding everybody, we're still on the strategic pricing journey that we've been talking about for multiple quarters. As inflation started to be significant last year, the primary focus was on covering the dollars and making sure that we were recovering that and our value with customers. As we indicated, as we were going to move through 2023, we expected to start to recover the margins as we were pricing even over above the anticipated inflation levels. What happened, was not in that foresight, was the disturbance in Ukraine with the war and the China lockdowns, which gave us a little bit of a delay in that. But we're still moving forward with our strategic pricing. And as Shane indicated in his comments, we believe the momentum of what we've already put in place and what we're still doing is going to benefit us for expansion in the second half. Shane, if you want to add?

Yes, just to give kind of some step thoughts around where our earnings are going as the drivers from that perspective, we talked about our raw material costs still going up but at a decelerated level. From that perspective, we are consistently talking about price above those raw material costs. So you can expect increases in gross margin sequentially from Q3 as well as Q4. With that, that should drop down to the EBITDA percentages growing in Q3 and Q4 as well. And so we're committed to that price. As I look at other things, we will be negatively impacted by foreign exchange, specifically the euro, as it gets to parity as well as we have kind of an uncertain demand outlook, but we will continue to go above the market with net new business wins. So all in all, I think it's going to be a strong second half and committed to our guidance that it's going to be above sequential as well as prior year.

Yes. Just one thing to add there, Shane too, I think all of those things are true. And our assumption is that the macro environment we'll have some stability, but we all know there's some uncertainty in that. So that is the balance to the comments there.

All fair points. Thank you very much for the color.

Thanks, Mike.

Thanks, Mike.

Our next question is from Laurence Alexander with Jefferies.

HI, guys. It's Dan Rizzo on for Laurence. Thank you for taking my question. You mentioned in your comments about sustainability and using, I think, renewable oils. I was just wondering how large you would characterize the market for renewable oils and -- I mean, and what the growth rate is or how we should expect it to grow over the next -- in the coming years.

Yes, Dan, thanks for the question. I think it's hard to pin down. Sustainability has been one of those challenging topics where everybody agrees that the trend is coming and that there will be a need to focus not only on operations, but also on the materials being used. First, I'd like to highlight that kind of at the core of our business model is helping customers be sustainable, and it always has been even if we didn't label it that way. As we help them to maintain their uptime, reduce their waste, make sure their energy consumption is going down, redeploying their valuable labor on other activities, those are things we do and fall right within that sustainability. So it's at the heart of who we are and how we operate. If we're thinking more specifically though about materials and sustainable materials going forward, I think we're starting to see an inflection point with customers, because of some of the sustainability goals that they have. So it's hard to predict exactly where that ramp will go, which is why we are focused on developing and investing in the capabilities to be ready as those customers move forward. So definitely a growth area for us, and this SK story is a reinforcement that, that trend is going positively and we're in a great position to go along with it.

Just along the same line, should we think about like just with sustainability and renewable use, products moving more from petroleum-based oils to vegetable oils. Is that even possible like technologically, and is that how we, I mean, kind of how to frame it?

I think there will be some movement between petroleum based and more natural and/or renewable sources. The beauty of our technical capability and expertise is we know how to work with both categories. And so we're in a great position to be able to do that with customers. Obviously, it will be driven by what makes sense for each one of those customers. But again, there will likely be some reformulation towards more natural or renewable materials, and we're in a great position to do that.

Thank you very much.

Thanks, Dan.

Thanks, Dan.

Our next question is from [David Silva] (ph) with CL King.

Yes, hi. Good morning. Thanks for taking my question.

Good morning, David.

Yes. Good morning, thanks. I had a couple of maybe a bigger picture question then a smaller bore one. But first one, maybe this is for Shane, but there's a lot of impact in your results here about FX. And I think of your company with its global network but with a lot of in-country serving local markets. And I'm just wondering, from your perspective, from Conshohocken's view, is there any desire or is there any thought about maybe a more formal kind of global currency hedging program, in other words, maybe to mitigate the significant direct FX translation of your foreign operations on the dollar-based results? You talked at a couple of points about, gee, if it wasn't for currency, the comparisons would have been much better. My opinion is the dollar is going to remain strong, so I'm just wondering if that makes any sense in this environment.

Yes, thanks for the question, David. I'm going to start and then let Shane pick up specifically. But I want to highlight where you started, which is the uniqueness of our customer intimate model where we plan, make, source and deliver locally. That's primarily what we do. That allows us to really be in the best position to serve our customers, add value by uninterrupted supplies, and that's really critical. So I wanted to highlight that, yes, you are absolutely right, that is at the heart of our model.

Yes, David, obviously, this isn't the first time we've experienced significant changes in flux on foreign exchange given the translation side. I would emphasize, as Andy just talked about, this is on the translation of our P&L and balance sheet. We do not transact cross borders, very minimal, given we source and use locally. And the overall answer to your question is we look at anything that I believe will help improve and de-risk the uncertainty in the markets, as well as uncertainty and fluctuation on our income statement and balance sheet. I've looked at it in the past, and I'll continue to look at it. And if it serves right for the right cost, then we may trigger -- may pull something to that extent. But for now, I believe the translation is something that is going to be here.

Okay. Thank you for that. Next question, I guess this is more related to kind of trade-offs that I'm wondering about. But Andy, you've discussed at length the customer-centric model that you're implementing and the strategic elements there. On the current call, I've also heard a lot of discussion about the need to get full price recovery to restore margins. And I'm just wondering if you are seeing any or if you do have to kind of maybe combat or deal with certain conflicts there, where maybe customers that are more strategic or more resistant to the price increases force you or force the company to make some choices there, which customers to keep, which ones to push a little bit harder on pricing. So I'm just wondering how you assess that maybe potential trade-off in the current market. And in particular, who makes the decision? Is that a local market decision or is that something that is decided at a more headquarters level?

Yes, David, thanks for the question. I mean I think you're getting at the heart of the elasticity of our model and how it works. And the way I would characterize it is, because we are so highly service-focused with the customer intimacy, our relationships with customers are pretty sticky. And therefore, there's a lot of inertia to overcome because we are in there helping our customers because we are adding value. And so our pricing discussions are driven around that value that we're adding to them. Obviously, our costs and inflation are a component of that, but we very much focus in on the value we're providing to the customer and the legitimacy of continuing to work with us to keep that continuity. I think as we strategically price, where we see limited amounts of pressure is where we may not have as broad of an offering to a customer or a particular application may not be as valuable to them. But as Shane indicated, we even find in those circumstances that often when a customer tries an alternative, they run into problems, and we find that they come back to us and much more convinced of our value. So I think our model works relatively well. I'm not going to tell you that pricing conversations are fun and that people want to have those conversations, but I believe our customers do really believe in what we provide to them. As far as trade-offs go, we -- or how we do that, we, of course, have guidelines that are set based upon product lines and market segments and application understanding with our experts across our network who understand that. We then provide that to the individuals in the areas to be able to react quickly and to implement against that. So it is a combination of pricing strategy.

Interesting. It gives me a lot more confidence or I understand how you are feeling about the second half now, so very good. I appreciate the color.

Thanks, David.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and there are no more questions at this time. I would like to turn the call back to Andy Tometich for closing comments.

Yes, thank you very much. I mean I think it's clear that we executed well within those items that are in our control. We continue to do that despite some of the macro challenges going forward and some of the uncertainties. The future of Quaker Houghton is bright. We are executing on our priorities, and we're committing to delivering and generating value for our stakeholders. And I really want to thank you for your continued interest in Quaker Houghton. And please reach out to Jeff with any follow-up questions.

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