Greetings and welcome to the Quaker Houghton's Third Quarter 2021 Results Conference Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. . 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. Thank you, sir. Please go ahead.

Good morning, everyone. Joining me today are Andy Tometich, our incoming CEO; Shane Hostetter, our CFO; Robert Traub, our General Counsel; and David Will, our Global Controller. We have slides for our conference call. You can find them in the Investor Relations section at our website at www.quakerhoughton.com. Before I provide an overview of our business in the third quarter, I do want to introduce Andy Tometich, who will become CEO on December 1st. Andy joined Quaker Houghton on October 13th, and we are in the midst of a detailed transition process over this seven-week period until he becomes CEO. Andy has over 30 years of experience in the specialty chemicals industry, with a strong track record of accomplishments and a passion for the customer intimate business model. Andy, please feel free to say a few words.

Thanks, Mike, and good morning, everyone. I'm very pleased to now be at Quaker Houghton and to be with you here today. It's only been a few weeks, but I'm already grateful for the welcome I've received it from everyone. Over Mike's very successful tenure, he and the Quaker Houghton team have developed a business model with customer experience as its true differentiator. And that truly resonates with me. After three decades in specialty chemical companies that focused on customer-based solutions, I'm really looking forward to building on this strong foundation at Quaker Houghton, especially as we look to grow in areas where our model adds sustainable value for our customers and our stakeholders. For now, I'll just wrap up my brief comments by saying I'm excited about the opportunities for Quaker Houghton. Mike, I really appreciate everything you are doing to support our seamless transition, including your continuation as Chairman. And I look forward to working with our analysts, investors, and stakeholders, including those who are with us on the call today. Thanks again, Mike, and back to you.

Thank you, Andy. I am very excited that we will have Andy's leadership going forward and I'm highly confident, Andy will take Quaker Houghton to new heights. And now on the quarter, our results for the third quarter, where were we expecting them to be, although how we got there was different than our original expectations. The major headwind for the quarter was raw material costs. They increased nearly 10% from the second quarter to the third quarter, which was considerably higher than our expectations. However, we also had good sales growth, and continued our efforts around cost control, which helped offset the raw material headwinds. Let me now dive deeper into our performance and I'll start with sales. Overall, our top-line revenue was up 22% from the prior-year, with all segments showing strong growth. We saw good organic volume growth between 7% and 9% for our three largest segments, which was the Americas, EMEA, and Asia Pacific. Higher prices of around 10% were also a major factor in our sales growth. In addition, we saw a benefit from acquisitions of 4% and from foreign exchange of 2%. On a sequential basis, our sales volumes were relatively flat. While we did see growth in some of our end markets, the sequential growth was muted by both seasonality in certain segments as well as the semiconductor shortage, which we estimate caused us approximately two percentage points of growth in the quarter. I also want to point out that our ability to gain new pieces of business and take market share continued to contribute to our strong performance, as we estimate total organic sales growth due to net share gains was approximately 3% in the third quarter of 2021 versus the third quarter of 2020. So we continue to feel good about…

Thanks, Mike, and good morning, everyone. Prior to discussing results for the quarter, I'd like to remind everyone that comments made during this call include forward-looking statements, which are based on current expectations and are subject to risks and uncertainties that could cause our actual results to differ materially. Further discussion of these risks please review the cautionary statements regarding forward-looking statements included in our earnings release and our Form 10-Q. In addition, please reference our Risk Factors disclosed in our 2020 Form 10-K for more discussion of the company's risks that could also impact our forward-looking statements. In addition, Mike and I make reference to several non-GAAP measures during this call; such are consistent with the press release and call charts filed yesterday. And also there are reconciliations between U.S. GAAP measures and non-GAAP measures provided in our call charts on Pages 11 to 22 for reference, Getting into our third quarter performance, the story was pretty consistent with our previous quarters this year. And that it was really a tale of a positive solid top-line performance tempered by a negative higher input costs due to the global supply chain disruption that we and the rest of the world are currently facing. As I begin to discuss our quarterly performance, I'll point you to Slide 6, 7 and 8 in our call charts, which provide a further look into our financials. Our record net sales of $449.1 million increased 22% from the prior-year driven by 6% organic volumes, 10% from our pricing initiatives, 4% from acquisitions, and 2% from foreign exchange. When looking sequentially, we were up 3% from the second quarter, largely due to increases from our pricing initiatives on flat volumes. Turning to our gross margin trend. Our third quarter margin ended at 32.3%. Given the upward…

Thank you, Shane and I appreciate those remarks. It's really been an honor and privilege to work for Quaker Houghton for 23 years and to work with such a great people throughout this company that really deliver solutions for our customers every day and really make this a very special place to work. And with that, we will now open it up for questions.

Thank you. The floor is now open for questions. . Our first question is coming from Mike Harrison of Seaport Research. Please go ahead.

Good morning, and congratulations and best wishes, Mike, and welcome aboard, Andy.

Thanks Mike.

Thank you, Mike. Good morning.

And Mike, just like there's no rule saying that Chairman can't be on the earnings call. I mean, you'll be back you want these -- the questions and give us the hard answers. First question here is actually for Shane, this SG&A number I know you mentioned some lower professional fees. But the sequential decline there, just trying to get a sense of how sustainable that decline is. Was there any kind of true-up of accruals or anything else that might mean that it kind of comes back to a more normal level or a higher level as we get into 2022?

Thanks, Mike, for the question. Yes, I referenced incentive compensation, professional fees and some other items that ran through there. We've benefited $5 million sequentially compared to the second quarter. I would say, if you look at the trends over the last three quarters, we were running in the $102 million to $103 million of SG&A and we topped out at $108 million last quarter. So I think as you look at that trend, I think that's indicative of kind of where we are on average.

All right. And then, wanted to get to this question around pricing and around margins. And I think you guys are intentionally using this term, product margins. And, Shane, you got into it a little bit in talking about kind of a dollars per kilo type of margin level. So it sounds like what your plan is to cover the dollar impact of the higher raw material costs by the end of the year. But as we think about gross margin percentage, that's something that's going to be taking longer to recover. Maybe just talk a little bit about how your product margin commentary translates to gross margin as we think about it on a percentage basis for Q4 and into Q1?

Yes. We're -- you're absolutely right, Mike, in the way you described exactly that. So we are focusing on getting our product margins, which we have internally what we call our contribution margin per kilogram for our products, getting them back to our targeted level, which were established at the beginning of the year, and are very similar to where, let's say where things were a year-ago. And obviously, as raw materials have gone up, and we've been putting price increases, there's always a lag effect. And we're -- we've been falling behind or we've been below our target level as things just continue to progress here throughout the year. So it is our expectation that we will get back to that targeted level of product margins that's same per kilogram by the end of the year. That's -- so that as we enter into next year, we kind of at least would have recovered the raw material inflation. And you're right, the gross margins even at that level just when you do the math on the gross mark -- even though we recovered from zero inflation, the gross margins will be deflated. Yes, we haven't given any guidance on that at this stage. But it will be deflated. And I think the most important thing now is that, our next step is certainly and goals is that we want to over time to increase that gross margin level. And that will be our next steps. But for our first step we have to at least get the raw material inflation.

But as we think about the gross margin percentage sequentially in Q4 that should be higher than Q3?

Yes, it could be some modest improvement in our gross margin percentage.

Okay.

In Q4, and then like I said, some bigger expense in that as we go-forward.

Okay. And then, the last question I have is on the global specialty business. Just noticed that all your other segments posted volume increases and volume decline there, can you just speak to what's happening in that business?

Well, yes, we had. I think there is one -- is kind of an anomaly. There was one major shipment of products that that we did in our -- let's say our mining business that that when we ship the products last year, it was shipped as fully diluted product. So there was a lot of water content in the product. And that that turns into the -- to a pretty high volume. And then now we more traditionally shipping it more as a concentrate, which is more normal. And just to show how leveraging that was that that when the overall volume impacted us, that was a little over 1% of volume decline. Just even though it really didn't have any material impact from a company from a profit perspective or anything like that. So it's just kind of skewed our volumes a little bit. But that was kind of a thing that's in the past. And we won't see anything like that going forward again. But so it's just an anomaly there. So they did -- we did have nice growth in general and number of areas in the global specialty businesses like greases were up, cans were up, metal finishing, there are number of things were up in our businesses there.

Thank you. Our next question is coming from David Begleiter of Deutsche Bank. Please go ahead.

Thank you. Good morning. And Mike again, congrats as well for your -- for your retirement and your future.

Thank you.

Andy, welcome aboard.

Thanks David.

Mike and Andy just on the guidance could you just unpack the guidance, it sounds like your guidance towards the sales growth in the high-single-digits. And this is for 2022 and EBITDA growth of low-double-digits. Am I in the right ballpark in those long-term trend directional numbers?

Yes, I mean, yes, I might phrase it a little differently. But I'm not going to argue. But in general, I think we -- when I think -- when I use the term long-term trends, when I think about that, and let's talk first sales. So we have sales in our markets that typically grow one to three percentage points. And then of course, we -- let's say on average two. And then we grow, let's say another two to four percentage points due to market share gains. So let's say on average three. So you add three plus two, maybe normally, we would expect to see five percentage in our growth -- sales growth. And look, what we're saying now is that, just as our markets begin to rebound, we just -- things haven't really come back from COVID yet, number of markets are going to be increasing next year. We actually see that being higher than that kind of a longer term expectation of growth there. So that's -- and then of course from a profit perspective, if we were normally growing 5%, maybe we were growing our EBITDA, let's say 8% or something like that, some higher than that, as we leverage our growth to the bottom line. And now that will be higher than that. So that's kind of what we're pointing to. So, I think the -- so I anyway, I'll just stop there and I think you're, you know what you're saying?

That's perfect. That's perfect. And just on the selling price increases, if, and when raw material costs do roll over, what portion or how much of these price increases do you retain with your customers?

Well, we -- yes -- we -- we have price increases in place. And of course, if we start seeing dramatic drops in raw materials, that could definitely have to give back some of those raw materials. But over time, what we've been able to do is continue to keep and capture some of that price. And certainly when we're in a period of time here where we've been really just trying to get back and cover our raw material costs, but not getting to where we want to be on our gross margin, then we're going to have more we're going to be stronger certainly trying to keep those price increases in place as we go-forward even if for raw materials drop.

Great. And last thing just, Shane, on your working capital in 2021, what's your expectation in terms of a growth of use here?

For 2022 Dave or for --?

For 2021, I'm sorry, 2021.

So if you can see for here we are sitting three quarters into 2021, we've had a pretty substantial outflow for working capital, roughly $150 million. If I am looking at rounding out the year we've indicated raw material costs will go up modestly. So we may see a little bit more in the inventory, but we're making a concerted effort to decrease some inventory that we have on stock. From a receivables perspective, top-line, Mike indicated, demand wise. So I don't foresee working capital outflows in Q4 to match what we've seen in the past quarters, but I also don't see massive inflows either.

Right now. Yes. I meant the use of cash in 2021 and source of cash in 2022 is that an appropriate forecast right now?

So sorry, David, for the source of cash in 2021, you said?

Any reversal of working capital trends in 2022 I apologize.

2022, okay. So for 2022, just in general working capital, I see potentially some release on the inventory side, as we are carrying a little bit more from a bulk perspective, just to ensure supply, given the global supply chain. And depending upon where pricing goes and sales obviously, that depends on the unlock there, but I certainly don't see the increases, I would say in working capital that we saw in 2021.

Yes, it shouldn't be, I think we would expect to have 2022 be another pretty good strong year in our cash flow.

Thank you. Our next question is coming from Jon Tanwanteng of CJS Securities. Please go ahead.

Hi, good morning. It's Pete Lukas for John. First, Jon wants to send his best to Mike. Congratulations there. And just wondered if you could talk a little bit about how much auto revenue you may have left on the table any way to quantify that. And what are your internal expectations for when you might catch-up to some of that pent-up demand?

I don't know necessarily mean what you mean by auto revenue. But have you heard any, Shane?

Yes. So we had indicated, and you may have missed this, that the semiconductor impact on auto we have roughly estimated to be 2% in the quarter. So you can say that from that perspective, that really was a negative on that side.

But as you know, so I mean, we do expect, I would say maybe autos to grow more next year than this year. I mean, based on external projections that we have. There's going to be some semi go up or headwinds as we go into next year, but over the course of the year, it should lessen up, but the autos in general feel better. So we expect better sales next year versus from autos in this year.

Oh, great. And then you talked about some share gains that you're seeing. Do you think these are results of -- you being better than your peers in terms of global supply chain and procurement abilities? And do you think that these new gains will be sticky customers as you've seen in the past?

It's a really good question. I actually think these are real gains that are very sustainable for the future and not just opportunistic sales, because our customers couldn’t supply. We have been approached by people because some of our competitors, I shouldn't say competitors, competitors couldn’t supply our customers, so they're customers, so people have come to us, we have not, I'd say taken advantage of a lot of that because we want to make sure there are supply chain shortages, we want to ensure our customers are being taken care of, plus, these market share gains that we've been getting are things that we've been working on, and we want to have for the long-term. So we want to make sure we're able to supply those new gains as well. So those were our top priorities. And we haven't really had much, much hitting us as an opportunistic sale. Had we had unlimited supply chain raw materials and things like that, we could have done more of that, but we didn't, and we thought it was prudent not to do it just to keep our customers satisfied.

Yes, .

And last one from me -- sorry --

Sorry, I was just going to add, I mean that's fundamental to the business model here, which we intend to continue is to have these sticky customer intimate relationships, because we're solving their problems, not just for the immediate, but by going forward. So I just reinforced Mike's comments.

Great. And the last one for me, you talked about some of the deals that you've seen on the smaller side here, just as you approach your target leverage ratio, and get to where you want to be wondering what the landscape looks like, and your thoughts on larger deals?

Sure, yes, as we said, I guess when we finalize things with the combination that were two years ago, we said, hey, in the next these first two years, we want to concentrate on integration and paying down debt. We're getting rate close to that point now to be at our targeted ratio. And we said in the -- we've thought we will continue to look at in the meantime, smaller acquisitions. And that's what we've done. We made a number of those since the combination was completed. But you're right, we said that as we kind of get to the targeted ratio at the end, which is the end of this year, we would expect to look and entertain and be more, I'd say more proactive in looking at larger deals. So that's something that as we enter into next year, we will be doing that, we do feel there's some opportunities out there, they're not instantaneous things that would just turn on and have a meeting and get it. But that things we'll be working on as we enter into 2022.

Thank you. Our next question is coming from Laurence Alexander of Jefferies. Please go ahead.

Hi, guys. It's Dan Rizwan for Laurence. The market share gains that we've talked about for a bit, is any of that coming from former Houghton or I should say, or recently Houghton customers and vice versa is cross-selling now a tailwind I know your sales process sometimes takes couple of years. But we are two years past the merger. And I was just wondering where we are with that process?

Sure, yes, thanks, Dan for that. The -- you're right, I mean part of this is 3%, let's say of growth, part of that is coming from cross-selling opportunities where we can sell either I'd say former Houghton customers, Legacy Quaker products, or vice versa. So it's really coming from both perspectives. So we are seeing some nice traction there we are making and that's something Dan, we think we'll be able to continue on for a while. It's not something and it does take a while to continue it. So I mean, it's -- so this will continue for a while. But the remaining part of the -- that growth is just really kind of getting new pieces of business. That's not related to cross-selling just because of our, we feel we have a differentiated model that allows us to save our customers more money, and they may have issues and we can solve their issues and we're getting that business. So kind of a combination of those two things.

Okay, thanks for that. And then is there a speed or pace of price increases where it might affect share gains where share gains might slow down because of progressive or price hikes?

Yes, it's a good question. We, in general two things that are hitting us over this past year are not necessarily great and conducive to trying to gain any share is COVID where it makes it more difficult sometimes to get into customer facilities and to get new opportunities. And the other is price increases, because you're talking about price increases, instead of talking about new piece of business and how that can save the customer money. So you're right from that perspective, but again, when you continue to look at our numbers, and are looking at our net share gains, we actually are achieving pretty good share gains. So it hasn't, let's say, hurt us so far. And we'll just continue what we're doing here. And as far as the pace, you're right. We're probably -- it depends where you are around the world, and what customer you're dealing with, but we're probably on price increase number five, or maybe even six with some customers at this point. And you have to be, in some ways, it's an art as well as the science to do that and to manage that situation with the customer and we think we do. I mean, this is unprecedented time with raw materials. I think we can logically show our customers that this is what's happening to our raw materials. And this is why we need to get back. And so far, we've been very successful with that and we expect to continue to be.

Thank you. Our next question is coming from Marisa Hernandez of Sidoti and Company. Please go ahead.

Hi, good morning, and thank you for taking my question. Congratulations on the result in a challenging environment.

Thank you, Marisa.

Thank you.

So I have a couple of questions to follow-up on the raw material cost inflation here. So this cost pressure that you're seeing, is that across all of your raw materials in a similar way, or are there differences?

Yes, so it is everywhere. And it is almost every group, whether you're talking. We have major raw material groups like base oils, vegetable oils, animal fats, additives, surfactants, and a whole host of kind of other types of chemicals. And every one of those groups are increasing and going up. And they are really doing that in every geography around the world. So it's a very broad base increase in our raw materials.

Understood. And have you seen any signs of a slowdown anywhere just yet, whether it's a specific input or specific geography?

You mean slowdown in our raw material cost escalation, it's that's -- yes.

Yes. So you mentioned that you were expecting the pace to slowdown in the fourth quarter. So wondering if you already started to see that somewhere?

Yes, we have. Yes, it's not -- I won't say it stopped. But the pace is definitely lower than it was in the third quarter. So we do expect it to continue to go up in the fourth quarter, but at lower pace than the third quarter. And we expect that same kind of trend to happen in the first quarter as well, based on everything we know now.

So basically, in October, the pace of raw material price increases on average was lower than what you saw in the third quarter?

Yes, I would say where we are today. Yes, the incremental change, while still may be going up, month-over-month is considerably lower than it was when we were hitting June, July, August, and that timeframe. It's starting to slowdown.

Okay. So I suppose that is what gives you confidence that the pressure will be lower in the fourth quarter?

Yes, it's really our best guess. It's one of these things, every time we guess; we haven't been really great in guessing. And so -- and that's because events happen like in the industry. So for example, Hurricane Ida happened in that, that caused some disruptions as well as price increases. There is the Texas freeze earlier in the year; there were a number of supplier shutdowns. And now, we have things going on in China. So there's always -- there's always these things happening, but based on everything that we know right now, Marisa, it should be at a slower pace.

Okay.

Yes, and Marisa, if I could add. Thank you for the question. I think it's not unique to Quaker Houghton. And I think what I would like to emphasize is, regardless of what's happening with that, we're going to react to that. I think that's what this company's been doing and that's what we're going to continue to do going forward.

Excellent. And so, if I can ask about the power restrictions that you mentioned impacting your customers in China. Could that be mostly your steel and aluminum customers or also -- all the customers and anything you can comment on in terms of quantifying that trend that would be helpful.

It is impacting a number of our customers, and it's really region-by-region and where they have these power shortages. But it is definitely impacting our primary metals business, steel and aluminum. But it's also impacting other ones as well. And it's hard to exactly forecast this. But we do believe it's certainly a negative, it's not -- if I compare it to the semiconductor shortage and how that's impacted us, it's not -- it's greater the impact of that, might be somewhere half of that, but it's -- but it is an impact to our business in the fourth quarter.

That's helpful. Thank you. And finally, more on the strategic side to follow-up on an earlier question about, you potentially are starting to look at larger deals after you've reached your 2.5 times net debt-to-EBITDA target ratio. In -- does the current environment on the raw material side potentially influence what you are looking to do, what your strategic priorities might be in terms of type of businesses? How do you incorporate, what's going on in 2021 and with raw material costs inflation into your thinking about M&A?

Sure. Yes, I think -- I guess I don't think it influences us that much. We -- for example, I don't think we would -- because of the raw material situation that we would have, let's say, think about backward integrating and securing raw materials or anything like that. There is so many broad-based raw materials that we buy that doesn't really wouldn't be a difficult thing for us. So I don't think it really influences us much at all. I think we would just continue to concentrate on the kind of strategic acquisitions that we normally would look at.

. Our next question is coming from Garo Norian of Palisade Capital Management. Please go ahead.

Hey, guys. Wanted to first ask just on the labor side of things, you guys didn't talk much about it. Some other companies have had some labor challenges. Wondering how you're managing through, and if the new kind of vaccine mandate from the government, could have any impact as we head into the next year?

Sure. I mean, labor shortages, most of our impact of that is in our manufacturing sites, where we tend to have -- we're blue collar type of roles, and trying to attract people into those type of roles are the majority of our business, and professional staffs and cuss people calling on customers. It really hasn't been an issue for us, and we're still able, you know what, it's continues to be a challenge and we have to be very creative in how we attract people to those sites. That's not a big component of our workforce, but -- and we have been able to get by and do well and to do that, but it's just like everybody else. It's just not a big part of our workforce. That's all. And we are -- from a COVID perspective, we are certainly back in our majority of our offices now around the world. And as a company, we don't mandate vaccines, but we certainly encourage them. And, but we are certainly working with the frameworks that are being put out like yesterday with President Biden and the frameworks that he would be putting out around that.

Got it. And there has been obviously several questions around the raw material side of things on the cost, but I'm curious on the availability, you had mentioned that, there were certainly challenges during the quarter. Have you seen availability improving already? And do you feel like based on the course we're on, things should hopefully be normal as we start next year?

It hasn't improved as much as I would have expected it to. We still have challenges in availability. We do expect it to improve though, Garo, but what I would have, if you would ask me, three or four months ago, where we'd be today, it'd be a better situation. I would have said yes. And I think we're getting there. But we're still -- it's still challenging. And it's still something, but I do, we do see a raise, I hope here on the horizon around that.

Yes, if I could add too, Garo, I think, there's two components to this. There's the supply side, and then there's also the logistics. And I think, there's plenty of signals out there to suggest the supply side is going to start to become less volatile, and get a little more stable. I think the logistics aspects are still being worked through. And I think getting both of those, both of those corrected is what's going to be necessary to kind of take the noise out of the system.

Got it, great. And I know, Aero is now a pretty small piece of the company. But I was just curious, are you seeing any real signs of life of improvement there?

Yes, we are. It certainly is considerably better than it was last year, but still below where it was I would say in 2019, which was a record year for us in 2019 in the aerospace business. So it's been a, I'd say we had expected to be higher this year. It's higher than our expectations are. And we expected that continue to ramp up over the next several years as we get back to where it was.

Great. And I just say, hey, thanks so much for the many years of great stewardship, Mike; it's been a pleasure to be in communication with you.

Thank you, Garo. Appreciate it.

Thank you. At this time, I'd like to turn the floor back over to Mr. Barry for closing comments.

Okay. Given there are no other questions, we will end our conference call now. And I want to thank all of you for your interest today. It's certainly been my pleasure to be with you during these last 53 quarterly conference calls, I've been on and just remind everybody that our next conference call for the fourth quarter and full-year 2021 results will be in late February. Thanks again for your interest in Quaker Houghton and please be safe and well.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or logoff the webcast at this time and enjoy the rest of your day.