Greetings, and welcome to the Quaker Houghton Third 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, Head of Investor Relations. Mr. Schnell, you may begin.

Thank you, Paul. Good morning, everyone. Welcome to Quaker Houghton's third 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, November 3rd, 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. In the third quarter, we delivered double digit growth led by strong price realization. We continue to execute on items within our control, countering softer market conditions, continued supply chain and raw material challenges and significant foreign currency translation. We are making further progress addressing our overall margins by offsetting the significant and persistent inflationary pressures on our business. Throughout the quarter, the team remain focused on our objectives. This includes taking steps to optimize our business and control costs, while balancing investments to support and accelerate our long term growth initiatives. All, while we continue to prioritize delivering value for customers in a highly complex operating environment. As we expected, the end market environment was uneven in the third quarter. While we performed in line with our markets, we are not immune to the lower underlying market activity impacting our customers and in turn our volumes, specifically activity in Europe and China softened throughout the quarter. Whereas demand in the Americas and our global specialties business remain healthy leading to our record sales and earnings performance in those segments during the third quarter. Despite the complexities of the operating environment, we delivered $70 million of adjusted EBITDA and adjusted diluted earnings of $1.74 per share. In short, strong price driven sales growth and cost management more than offset continued raw material inflation in a softer market environment. The progress on our strategic pricing initiatives drove an improvement in our gross margins, which we expect to continue in the quarters to come. Pricing in the third quarter increased 25% year-over-year as a result of our ongoing value based pricing initiatives, but was partially offset by lower sales volumes and foreign exchange headwinds. We estimate underlying market growth rates declined by mid single digit…

Thanks, Andy. And good morning, everyone. The third quarter was another strong quarter for the company delivering net sales of $492 million, which was a 10% increase compared to the prior year. This was driven by a 25% increase in pricing mix, which was partially offset by an 8% decline in total sales volumes and 7% unfavorable impact from foreign exchange. Consistent with recent quarters, we experienced a strong increase in net sales directly related to our strategic pricing initiatives. These were measured across all our businesses in response to the significant raw material increases that began last year and have continued into this year. We've maintained this pricing momentum, as we prioritize these new initiatives, and on a sequential basis, realizing pricing of another 8%. While their volumes declined 8% year-over-year, this includes a reduction due to the ongoing conflicts between Russia and Ukraine, as well as lower volumes related to previous totally on divested volumes as part of the combination. Without these two impacts, we estimate our volumes declined approximately 5%, which was largely aligned with our underlying markets, but with regional differences. New profitable business wins continue to be a focus for the company. In the quarter, we estimate that new business wins attribute approximately 3% to volumes compared to the prior year. This was a strong result [ph] and driven by the team's continued focus on driving higher value products and services to our customers, which in turn, increases their productivity and profitability. During the quarter, our value based pricing initiatives resulted in lower volumes, which did offset our new business wins on a volume basis. That said, we anticipated this outcome as we work with customers to offset the inflationary pressures that are currently impacting our business and our cost to serve. Further, we will…

Thank you, Shane. Before we address your questions, I want to once again thank our team who has executed well this year and has stayed focused on our objectives. Their commitment to our customers and our company reinforces our core values, and underscores our ability to prepare for and execute in any environment we may face. With that, we'd be happy to address your questions.

Thank you. We will now be conducting a question and answer session. [Operator Instructions] Thank you. Our first question is from Mike Harrison with Seaport Research Partners. Please proceed with your question.

Hi, good morning, and congratulations on a nice quarter in the challenging environment.

Mike, thanks,

Andy, I was wondering if you could talk a little bit about the Americas business and the nice sequential improvement you saw in the margins there. Just curious if there were any one time drivers that helped the margin performance? Or if you feel like that getting toward that mid 20s level or just sustainable margin level?

Yes. Thanks, Mike. First of all, thanks for recognizing that. The leadership teams really have been doing a great job as we move through the year. It's not a single factor, they're working on improving the mix, deepening customer relationships and the value we add in various solutions. There have been new product introductions, as well as taking advantage of sober [ph] innovation. So it's a myriad of things. And again, we want to build on that, additionally, within Europe and take a cue from that in some of our other segments as well.

And then, looking over at Asia Pacific, I was a little bit surprised to see the volumes, they're down 20%. Definitely worse than last quarter when we were expecting lockdowns to have the most severe impact. And we had also heard that auto production in Asia was improving. So maybe just a little more color on what's going on there? And what your expectations might be for volumes in Asia Pacific as we get into Q4?

Again, thanks, thanks for that, Mike. I mean, as we've signaled for multiple quarters now there's an unevenness in China that we're still experiencing. There are still direct, as well as indirect impacts with the zero COVID policy and the lock downs that have come as a result of that. Within our business as well, there's also variation in customer order patterns that plays into it. I might also highlight that, like we're doing in all regions, we're using strategic pricing, testing elasticity. And the net result of that is the profitability and the -- of the mix of business we have is very healthy and has improved. We're expecting some of the unevenness to continue, there does not appear to be a movement away from the lockdown policies. And then the fourth quarter as well, we typically have some seasonality. But beyond that, I think we feel like we're well positioned and what we've been doing with the business there and will be in great shape as the recovery does come.

Yes. Mike, just add on to that. You mentioned some of the indicators were at auto and some of the KPIs. We estimate our markets were down high single digits. Honestly, we just did not see. What we see the auto indicators there. And I think it's been publicized in the market. We're seeing a little bit more weakness compared to what the auto indicators see.

Interesting. Okay. Thanks for the color there. And then my last question for now is just on the Q4 outlook, in terms of revenue and margin, I guess any further detail you can provide there? The math that I did, suggest that you're seeing kind of like the $57 million EBITDA level as kind of a floor for Q4. But I'm looking at where consensus numbers are. And it looks like they're kind of smack between the $60 million you did last year and the $70 million that you just did in this quarter and was wondering if you could comment on how you feel about where that consensus number is for Q4? Thank you.

Mike, let me start and kick it off. And then I'll ask Shane to add some color. But I mean, first of all, just a reminder, we continue to execute on the things we can control. And there's still significant macro challenges and the uneven demand as well as some of the seasonality that I mentioned. Sequentially, we are continuing to work on value based pricing, as we continue our paths for margin recovery as we move forward. We're also working very hard on new business wins and continuing that as we've done all year. And that will help us as we move forward, as well as we look to control our costs to make sure that we're as efficient as possible. With that, Shane, maybe you want add a little additional color.

Yes. Thanks. Well, it impacted a little bit, like I'm not going to get into specific numbers. But as Andy just talked about, the overall environments pretty uncertain. As you think about the percent decline we had on a rolling from Q2 to Q3, we see that continuing. However, we do see some additional, probably volume declines due to seasonality in Q4, normal seasonality that we impact. Another headwind we'll see is the strong U.S. dollar from an investor perspective. But on the bright side, like Andy talked about, we will continue to operate with what we control. I indicated in my script we will price above where our raw material costs are going again, and we indicated that will show another uptick in gross margin percentage in the fourth quarter compared to the third quarter. And then, this should drive higher EBITDA expansion as well. And then from there, free cash flow should be positive in the fourth quarter, as we unlock working capital and work on some of those efficiencies, as well as improving in our cash version.

All right. Thanks very much.

Yes. Mike, apologies. One clarification, as I said, I just want to emphasize, its EBITDA margin not EBITDA.

Right. Understood.

Thanks.

Thank you. Our next question is from David Begleiter with Deutsche Bank. Please proceed with your question.

Hi. This [Indiscernible] for Dave. I guess first, did you seen destocking impact in Q3? And if so, do you expect that to be down by year end?

Yes. Thanks for the question. We haven't seen any significant trends with respect to destocking. So, no signals for us to suggest that that's going to be changing.

Okay. And then just on raw, it looks like it's still going up in Q4. What's your current lag versus raw material price increases? And I guess, when do you expect any relief on raws [ph]?

Yes. So first of all, just a reminder for everybody. We've seen raw material cost inflation, about 55% since the beginning of 2021. And we have continued on our pricing journey on that recovery of margins to pre COVID levels, and we're continuing there. Overall, raw materials, as we indicated in our script, have slowed in their rate of increase, but are still increasing. And really, it's the basket of raw materials that depending upon region, and category, have slightly different trends, but in total are up, in particular, some of our additives and our enabling chemistry surfactants acids bases are still continuing to inflate. So, we're expecting that trend to continue, but again, at a decelerated rate. I'd also like to emphasize that regardless of what raw materials are doing, we are implementing our value based pricing and recovering value over and above what maybe happened on inflationary basis. And we'll continue that journey.

And I guess, lastly, are you seeing any incremental volume loss as the employment move presses?

Yes. Well, I'd like to highlight that the one of the key strategies for us is to continue to have profitable new business wins for us. And we talked over the long period of time that we expect it to grow over and above our underlying markets. And at the same time, right now, we're also doing some strategic pricing to test elasticity in order to recover our margins. And then the third quarter, we really did both, we had about 3% in new business wins. But that was offset as we implemented the strategic pricing on a volume basis with reduction on choices of where we wanted to serve business. The net result however, is our portfolio is much healthier margins are up. So while we anticipate there could still be some volume, decline, that will be focused on lower value business that will be replacing with higher value business, we continue to balance that as we manage things and the focus of the organization remains on profitable growth, as well as margin recovery.

Thank you.

Thank you. Our next question is from Laurence Alexander with Jefferies. Please proceed with your question.

Hi, everyone. It's Dan Rizzo on Laurence. Thank you for taking my questions. If we think about -- or I should say, if current conditions persist in terms of cost cutting raw materials and pricing, what would the initial setup look for -- look like in 2023?

Dan, thanks for the question. Good morning. So it's premature for us to give guidance at this stage. We haven't finished 2022 yet. And as you imagine we're in budgeting season and so forth. And as I've highlighted before, we're really focused on executing on the things we can control, and that includes focusing on value adding for our customers and earning more wallet share from them. Long term trends in our markets, we think are still positive despite some of the short term challenges that could carry over. But our strategy is to remain customer intimate to execute our model and outperform the underlying markets, regardless of what they do. We'll be balancing our pricing as well as margin recovery and efficiencies on costs. And we expect earnings growth in 2023.

So can you answer maybe how we should think about CapEx and working capital for next year? Or is it too early for that as well?

Maybe I'll kick off with CapEx and then I have Shane to talk a little bit more about working capital. But first of all, our capital allocation strategy remains intact, no change there. And that clearly includes CapEx in particular to support our organic growth, our innovation and continuing to be more customer intimate and do that in an efficient way. And at the same time, we're going to be prudent, on our spending. And as Shane indicated, we'll maintain within the levels that we've been previously, but maybe you want to highlight a little bit there and then working capital.

Yes. So Dan, we had talked about this before. And going into this year, we said the next couple of years, we'd be within the range of 1.5% to 2.5% of CapEx compared to net sales. This year, we're at about 1.4%. Next year going into there, we think we'll probably be in the mid range in the twos. However, as Andy just talked about, we will be flexible and prudent, depending upon where the economy goes and spending associated with that. As we look about working capital, I indicated in my script, that A, we're going to be working on improving conversion, as well as working capital efficiency. Specifically, we did take on a little bit of more safety staff to make sure that we can serve our customers, on time during COVID. We're working on reducing that to realize levels. And as I looked ahead to next year, we will come back to a normalized cash conversion, in a normal period without those raw material cost types, I would love to unlock a significant amount of working capital next year.

Okay, thanks. And then last question. So it just a little clarification, so if you look at like your end markets like auto and steel, are the volumes declines in line with what we're hearing from OEMs? And what's happening, or have you been sheltered by new product launches and legs?

Yes. I would say as I think about the fourth quarter, right, you kind of look at the bridge here. We were down roughly 8% in volumes with fourth quarter. Within that, we were down from a perspective year over year, right, we were down 8% volumes. And then within that we had 3% volume declined due to Russia and Ukraine, as well as the total investing of -- or the total for the previously domestic products. Without that we get down to around 5% decline. And that shows neutral share gains and then offset by the strategic personal losses. So that 5% we think is in line with where we believe our markets were which is low down mid single digits. That is a blend of obviously our auto, steel as well as overall industrial markets.

Thank you very much.

Thank you. Our next question is from Jon Tanwanteng with CJS Securities. Please proceed with your question.

Good morning. This is Stefanos Crist for John. Thanks for taking our questions. Good morning. Could you talk about the what's driving the strength in the U.S.? And do you think that's sustainable?

Yes. I think we've seen progress really across the board. The under underlying markets, we're continuing to perform over and above those, some of the things I referenced a little bit earlier about some of the innovations and mix that we've continued to improve as we move forward. And really just deepening our relationships with customers, providing more solutions, participating in a greater percentage of their wallet. So, I think some of the macro challenges that exist in China and Europe, for example, are not as acute in the U.S. And on top of that, we're executing extremely well on our strategy.

Great, thanks. And then can you talk about your confidence level and continuing to push price as your end markets do come under pressure? And do you think you can get back to historic gross margin levels just on price?

Yes. I think it's a it's really a question of timing. We continue to be very successful with our customers. I don't want to minimize the challenges and discussions with customers, no one's excited about having a price increase. And as we've talked about previously, there's a lag in our business model because of our focus on value and the value that we're providing to our customers. But I think the results show even with our strategic pricing that's relatively under control. And allowing us to maintain volumes and improve the health of our portfolio in our margins is an indicator that our value is pretty sticky, and will continue to balance our approach as we go forward.

Great. Thank you so much.

Thank you. Our next question is from David Silva with CLK. Please proceed with your question.

Yes. Hi, good morning. I had a question, I guess about your new business wins, and maybe your philosophy of selecting which areas you wish to target. So my impression is that you bring an awful lot -- a very broad array of products and services that customers can choose to upgrade or mix and match when they consider signing on with you. And I was just wondering, with the current -- if you look back to the current quarter, maybe a quarter or two ago, is there a trend in which parts of your value proposition tend to be more successful or more convincing in securing new business? In other words, is it offering labor savings? So they can outsource? Is it supply chain reliability? Is it ESG compliance, amongst your array of benefits that you offer? Could you point to any trend in which of those attributes are most attractive to new clients? Thanks.

Thanks for the question, David. I mean, I think one of the inherent characteristics of a customer intimate model is we serve the customer based upon what problems they have and how we can add solutions for them. So, it's any number of things, including most if not more than you suggested there. Where we tend to add new business and greater share of wallet is where we build up an overall value in the number of solutions that we can provide to customers and our ability to adjust as they need us to adjust. So it's not related to necessarily a specific product, and really more about the relationship with the customer and deploying the full capabilities, which of course, got much more significant with the combination two years ago, to a greater portion of our customer base.

Yes. Just add on with that, David. You started the conversation with choice around the share losses in the pricing side and how we get to the end product. It's not so much a product level, it's really our cost to serve, right. So we look at things from a return metric, we pride ourselves on the EDA basis, economic value add. So looking at each individual transaction, both on a customer level and product level to ensure the appropriate return. So it's not necessarily just a product decision, it is a profitability decision too.

Okay. Thanks for that. And then maybe just a question about the near term outlook, and in particular, in Europe, excuse me. But from a number of my industrial companies that are reported, today, I'm getting kind of somewhat mixed signals about how the major European customers are, let's say, coming back or coming back online, let's say following the traditional downtime for vacations in August, maybe early September. But from your more strategic customers, is it your opinion that they can continue to kind of operate or restore mostly normal operations? Or would you say the tone is a little more negative than that, and there may be hunkering down for a more difficult stretch. And so just a sense of how your major customers in Europe are thinking about the next few months or three to six months? Thank you.

Thanks, David. First of all, Europe is a region for us, and for sure, we know we're a bit behind on the price cost balance, and we've done work and we will continue to improve in that space. Price was actually up relatively significantly in the third quarter, but offset by some of the foreign currency translation, in fact, more than offset. And we all know about the direct impacts of the Russia/Ukraine situation, but then the indirect impacts of energy, in particular in steel and automotive are continuing, and I saw yesterday ArcelorMittal just made a decision to take some of their capacity offline, at least temporarily. So I think those pressures are going to continue. At the same time, we're staying focused on our pricing initiatives, as well as controlling costs and looking for opportunities in that space. We believe with no new significant issues that we will reach an inflection point on margins in the fourth quarter, but Shane if you want to add to that.

Yes. Only to add Andy, as you mentioned an inflection point outside of anything extreme, we do see our margins, our responsibility margins going up in the fourth quarter than in the third, Europe. And that really reflects operating around things that we can control. Andy, talked about our pricing initiatives in Europe. You know, it's important to look for the third quarter, our organic top line growth was actually positive as our pricing offset our volumes, but the FX was pretty sharp.

Okay. Thank you for that. I appreciate the color.

You're welcome.

Thank you. Our next question is from Mike Harrison with Seaport Research Partners. Please proceed with your question.

Just a couple more for me. First of all, you mentioned that, you're still seeing some limited raw material availability. You said that it was impacting your ability to win new customers. But it sounds like you still are winning some new customers with the 3% number that you threw out there. So maybe help us understand, what your sales efforts look like relative to normal? How much more new business could you be winning, if you had the raw materials that you needed? And I guess, do you expect the availability issues to get better? Maybe not next quarter, but as you look out into 2023?

Thanks, Mike. I would say that, the supply chain issues have certainly decreased compared to the acute period we experienced in previous quarters. But I think we're trying to highlight that they're not gone. There are still spot issues in specific geographies or with specific products. For the most part, we're managing our way through that, and we talked about our normal target is to be outperforming our underlying markets 2% to 4%. We grew new business by about 3% in the third quarter. I think it would be safe to assume we would have been at the higher end of that range. Had we not had some of the supply chain issues, but I don't want to characterize it as material.

And do you expect a little bit of further improvement in supply chain issues going forward?

We certainly hope so. And I think we've seen cases in particular bundles of raw materials. Again, it depends upon region. But we've seen some areas where some of the mineral oil materials and some of the base oils from vegetable and animal derivative standpoint have started to stabilize. So I think we're seeing signals, at least anecdotally, that things will continue to improve.

All right, thank you. And then, I was also hoping that maybe you could give a little bit more color on the reorganization that you referred to moving Joe and Jeewat into global roles. Are there still going to be individual business unit leaders? Or is this part of a greater shift away from your regional structure toward more of a global or like a matrix structure?

Yes. Mike, first of all, I mean, I always like to go back to the fact, we have not changed our customer intimate strategy. And that's really in service of this. But it's one of the one of the activities that we feel is important and contemporized, that customer intimacy and serving our customers exactly the way that they want to be served and do that in the most efficient way for the value that's available and that makes sense. And so, taking advantage of our scale, we think this is an opportunity to deploy more of our capabilities in more places with more customers get more of that wallet share, as we're able to cross sell and get into other applications with technologies and so forth. At the same time, we'll be doing some targeted investments to be able to support this that's going to allow us to be even more efficient from a process standpoint, digital capabilities, we have some productivity enablers, as well as footprint leverage that we'll be taking a look at here. So, with respect to the comments that I made in the script, while Joe will be leading the commercial organization globally, we will still clearly be implementing regionally and locally.0

Alright. Thanks very much.

You're welcome. Thanks.

Thank you. Our next question is from Arun Viswanathan with RBC. Please proceed with your question.

Great, thanks. Good morning. Thanks for taking my questions. So a couple questions. Just thinking about Q4 and some of the dynamics there. So, do you expect double digit price increases to continue in Q4. When do those start to lap kind of tougher comps? Is it say Q2, Q3 of next year? And then similarly, if I just look at the volume side, I think you said that you were down 8%, but maybe 5% if you normalize some of the things out. So do we expect kind of mid single digit volume declines for the next couple of quarters? Maybe you can just help us with price and volume a little bit? Thanks.

Sure. Thanks for the questions. So I'll discuss price first. Looking at it sequentially, you're asking year on year, I think it's easier to explain sequentially, given some of what we talked about with our underlying raw material costs, as well as on price and gross margin increase. We indicated that our raw material costs are still going up. But at a decelerated pace, they went up roughly 4%, from Q2 to Q3. So something less than that, we will price above that, I'll be most likely a little less than what we saw, from Q2 to Q3 to continue to gain gross margins. From a volume perspective, I had indicated in one of the conference or one of the questions earlier, but Q4 for us, we tend to see seasonality in that 4%, range-ish. So we're going to see continued volume softness that we saw from Q2 to Q3, which was roughly in the 5% range, plus that seasonality. So, you're looking at, at least high single digit volume declines. And as you think about unpacking the overall kind of performance there, I think I indicated before, we are going to continue to just operate where we can control, right, and the underlying markets are there or continue to try to gain share to offset that pricing less just the volume, as well as grow our gross margin percentages.

Great, thanks. And on that last point, then so, I know that maybe on an EBITDA margin basis, the target is to get back to say 17% or 18%, that you saw in Q1 of 2021 before all the inflation. So what's kind of the path and trajectory that we should keep in mind? Are there any specific initiatives on the cost reduction side? Or is it mainly going to take just some moderation, inflation and the pricing to kick in? And maybe some relief on the FX side? Or how should we think about the path back to those margin levels? Thanks.

So I think we'll start with the point that we're on a journey here, and we've talked about margin recovery being a journey that was going to take us some time. I think this specific answer your question depends a little bit on what happens with the inflationary environment. Of course, if raw materials and other inflationary factors start to recede, that will help us to get back to our targeted levels more quickly. I think it's unclear for us to be able to predict exactly when that's going to happen. Presently, in addition to recovering margins and capturing value to price, we're also continuing to control our costs, and look for opportunities to be as efficient as possible in delivering our model. So we'll continue that focus going forward.

Great. Thanks a lot.

Thank you.

Thank you. There are no further questions at this time. I'd like to turn the call back over to Andy Tometich for any closing comments.

Yes. Thank you for that. Really, I want to leave every with the future of Quaker Houghton is bright, and we are executing on our priorities and we are committed to generating value for all of our stakeholders. I want to thank you for your continued interest in Quaker Houghton and encourage you to please reach out to Jeff with any follow up questions.

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