Greetings, and welcome to the Quaker Houghton Fourth 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, Vice President of Investor Relations. Mr. Schnell, you may begin.

Thank you, Paul. Good morning, and welcome to our fourth quarter and full-year 2022 earnings conference call. Joining us today are Andy Tometich, our President and Chief Executive Officer; 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, February 23, 2023. 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 additional information, please refer to our filings with the SEC. Now, it's my pleasure to turn the call over to Andy.

Thank you, Jeff, and good morning, everyone. In the fourth quarter, we demonstrated progress on our key priorities. We delivered double-digit sales and EBITDA growth, compared to the prior year, driven by continued execution on our value-based pricing initiatives and disciplined cost management, which in turn drove an improvement in gross margins. We generated $68 million of operating cash flow and strengthened our balance sheet. Overall, we displayed our ability to work together to deliver results in an uneven and difficult operating environment. Sales volumes did decline compared to the prior year, but this result was largely in line with our markets and our expectations. Volumes reflected a continuation of a softer end market environment, which was most pronounced in the back half of the year. This was evident at varying degrees across our regional segments and primarily in the steel and industrial end markets. In the fourth quarter, we delivered a year-over-year improvement in price and product mix of approximately 24%. Though, this was partially offset by substantial foreign currency impacts, it illustrates the team's strong execution, balancing customer relationships and needs with our top financial priority of improving our margins back to historic levels. Compared to the third quarter, pricing and product mix increased another 4% and across all segments. Sales volumes declined 6% sequentially as softer demand was amplified by typical fourth quarter seasonal patterns. Gross margins were 32.2% in the fourth quarter, an increase of approximately 100 basis points compared to the prior year period. This was primarily driven by higher prices and partially offset by higher raw material, manufacturing, supply chain and logistics costs. Gross margins declined slightly compared to the third quarter of 2022. Though, we are making progress with our margins, the inflationary pressures on our cost dampened our progress in the quarter.…

Thanks, Andy, and good morning, everyone. In the fourth quarter, we delivered net sales of $485 million, which was an 8% increase compared to the prior year. This was driven by a 24% increase in price index, partially offset by a 9% decline in total sales volumes and a 7% unfavorable impact from foreign exchange. Consistent with recent quarters, our value-based pricing initiatives drove the increase in net sales. And on a sequential basis, we realized pricing gains of another 4% as we continue to implement these actions across our portfolio in response to the persistent inflationary pressures on our business. Compared to the prior year, volumes declined due to the ongoing conflict between Russia and Ukraine, as well as from the wind down of previous tolling on volumes we divested as part of the combination. Excluding these two impacts, our volumes declined about 4% compared to the prior year. Sequentially, a 4% increase in price was offset by a 6% decline in volumes, as soft market conditions were further impacted by normal seasonal patterns. In both cases, and on balance, we believe volumes were largely in line with our underlying markets. Gross margins in the fourth quarter were 32.2% compared to 31.1% in the prior year, and 32.7% in last quarter. The 110 basis point improvement year-over-year reflects our strong pricing actions implemented to contend with significant inflationary pressures. Gross margins did decline 50 basis points sequentially. The primary drivers of this were higher than expected raw material costs, limited availability of certain key raw materials for some high-value products in the Americas, which impacted our product mix, and manufacturing absorption on our fixed costs, especially in December. While raw material costs increased another 4% in the fourth quarter, raw material cost pressures have largely stabilized but remain at…

Thank you, Shane. 2022 was a challenging year, but we executed well. I want to thank the entire Quaker Houghton team once again for their ongoing commitment to our customers, our company and for living our values. And with that, we'd be happy to address your questions.

Thank you. We'll 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.

Congratulations on a solid finish to the year. Was wondering if you can maybe kind of walk us around the world and talk about what you're seeing in terms of demand trends in the different regions. I'm particularly interested to hear if you're seeing any signs of some post-COVID recovery in China and whether you have any concerns about underlying demand in the Americas as a result of inflation and higher interest rates may be affecting industrial demand?

Yes. Thanks, Mike. Maybe starting with what we kind of saw in the fourth quarter because I think there's some continuity. First part is there's still a lot of uncertainty in a lot of the end markets. We all know about the underlying markets being down. But in the case of EMEA, there's been additional pressure as a result of the knock-on effects of the war in the Ukraine and impact on energy with primarily some of the metal making assets being taken offline. And then, also in Europe, I think in the fourth quarter, there was some work down of some inventories. To a greater degree, though, I think in the Americas, there was a little bit of a seasonality as well as working through inventories. And again, these are not inventories of our products. These are more our customers' products and downstream of them kind of having the knock-on effect. In Asia-Pacific, I think there was a combination of factors. There was also some customer inventories, I think being worked out of the system. I would also characterize a pretty uneven restart after the relaxation of the COVID policies. And then, in particular, for us in Asia as well, there was a small but controllable amount of churn because of our margin -- margin initiatives that we had going. I think a lot of that, Mike, is kind of continuing as we go forward. There's still a fair amount of uncertainty. We hear a lot in Europe about assets being brought back online. But I would say at this stage, it's more words than action. So we'll see where that goes. And just to prove the world is an unstable place. Just in the last two weeks, we've been dealing with the situation in Turkey. And I just want to take a moment, too, and comment, a very devastating impact there. We've been working very hard with our colleagues to ensure that they're safe, their families are safe, and that's our primary objective there. But the knock-on effect of that is a little bit unclear. In Asia, we're coming off of the Lunar New Year. So a little bit of uncertainty there and how that's going to play with, again, these COVID restarts and some of the supply chain unevenness. With respect to the Americas, we highlighted that we had a couple of issues with some raw materials affecting our ability, but the demand for those products is still there. We think the wind down is probably still occurring on some destocking. So that result is a little bit of a continuation of what we saw in the fourth quarter. However, I think we anticipate that it's going to improve as we move through the year. A lot of these shorter-term things, I think will have worked their way through the system, and we'll be back to a little more stability. So we're cautiously optimistic about where the year will develop.

All right. Thank you. That was very helpful. I wanted to also see if we could get a little bit more detail on some of the cost actions you're going to be taking, it sounds like if this is going to be implemented over the course of the next few years that it's more comprehensive. It's a bigger set of actions. So help us understand, is this more on the operational and procurement side? Is it more SG&A? And how much savings do you project for the entire program? And what would the costs look like?

Yes. Thanks, Mike. Why don't -- I'll get that started and then maybe I'll ask Shane to add a little bit of commentary first. I mean the first thing I'd highlight is these actions are consistent with our strategic intent and our growth strategy to support a customer intimate model. We want to continue to do that as effectively and efficiently as possible. It will touch all of our businesses around the world. Obviously, we're going to have a big focus on Europe. As we've highlighted, we've already started some activities there. But the overall goal is to optimize the delivery of our customer intimate model and to grow profitably. So major buckets will include simplifying the organization, looking at footprints, opportunities, some supply chain improvements as we have a broader global scale now that we can take advantage of and some optimization on go-to-market. So we're going to be looking pretty broadly. But as indicated, it will continue for a while, and maybe Shane, you can add some color there.

Yes, Mike. So it already began in -- fourth quarter, as you just mentioned, so we took a $4 million restructuring charge there and it will continue in the coming quarters. As Andy just talked about the emphasis is to drive growth and profitability across the business with possible runs whether that be footprints or simplifying the portfolio and also repositioning EMEA for profitable growth. From a perspective of SG&A, as I talked about in my scripts, it would be going up mid-single-digits, and that is net of this cost program.

All right. And I guess in terms of the overall expected savings from this program, do you guys have a number at this point or a ballpark?

Yes. Thanks, Mike. Not at this time, but we will keep you informed as the quarters to come.

Okay. And then last question I have for now is maybe just a little bit better understanding of what your expectations are around raw material and energy costs as we kind of get into Q1 and start 2023? I know there's a lot of uncertainty. But maybe just talk about your expectations and maybe help us understand how much of a headwind was inflation in 2022? You mentioned the $25 million headwind on EBITDA related to FX in Russia. Was inflation more than that in terms of EBITDA impact in 2022?

Thanks, Mike. I'll start on the raw materials, and then I think Shane can wrap on the back half of that. You're correct. There's still a fair amount of uncertainty. I mean, as we highlighted, even in the fourth quarter, we continue to see some increase in raw material costs. I would characterize it as raw materials stabilizing as an overall pool. As you know, we have a pretty complicated pool with major buckets on petroleum derived base oils as well as biologically derived base oils, a number and significant portion of enabling chemistry surfactants and so forth that allow us to put our formulations together and then a large chunk of additives that really differentiate. And there's different dynamics happening within each one of those buckets and within individual components in each one of those. But in total, we see those starting to stabilize. Really, we continue to be focused not only on managing that, but reinforcing our value proposition, which is security of supply to our customers. So we've continued to keep that focus, even the situation we had in the fourth quarter, we worked very closely not only with our supplier, but also with our customers to ensure that we did everything possible and continue to deliver that security supply. And so we will continue to look at where raw materials are going in the future, make adjustments as necessary. But again, we believe they are starting to stabilize.

Yes. Mike. And on your latter point, certainly, we've had to combat significant inflationary pressures throughout the year. Obviously, as the biggest cost bucket we have on our raw materials, at the beginning of 2021, our raw materials have gone up over 60%. So we've had to, obviously, price to get that back on that side from a dollar perspective and then work back our margins. And then also, obviously, significant inflationary costs related to energy as well as on our SG&A.

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

Thank you. Good morning. Andy, just on pricing --

Hi, David.

Hi, David.

Good morning. Just on pricing, how much carryover pricing we have in 2023 from actions you took in 2022?

Yes. So I mean, first of all, thanks for the question, David. And I want to reinforce that we continue on our value and use-based pricing and really the total cost of ownership for our customers. So that continues in all of our efforts. We were working very hard on that throughout 2022, that continues. We still have very targeted actions as we go forward. As I've indicated, and we've talked about previously, we do have about a quarter of our customer base that is tied to indices with contracts. And really, it's going to depend on where raw materials go. As I mentioned, raw materials are starting to stabilize, depending upon how that moves forward, that will have a direct impact on what happens with pricing. So we will continue to focus on the value and use approach, manage the relationship with our customers. We want to make sure that they're supporting what we're doing here as well, and the goal is to drive margin improvement.

Yes. And just to add on to that, David, all things equal, obviously, Andy just talked and highlighted things that could change at the year, but all things equal. We're expecting about a mid-single-digit increase just from a pure pricing ramp year-over-year.

Very good. And Shane, just on working capital, given the use of cash the last couple of years, should we expect to release some cash this year from working capital?

Yes, David. So obviously, over the last two years, I've had over $200 million of working capital investment as we prioritize some continuity of supply. In Q4, we did drive an improvement in our working capital, and these are largely due to effects around inventory reductions as we really focus on improving our working capital efficiency. Looking at 2023, we will continue to drive that improvement in our working capital, where possible and to drive improvement in our cash flow conversion. And so we'll look to 2023 is compared to prior years, definitely an improvement in our cash flow.

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

Great. Thanks for taking my questions. Good morning, Andy, Shane and Jeff. Hope you're well. So I guess --

Good morning, Arun.

Good morning. When you look into Q1, was there some seasonal impacts that also hampered Q4? And so do you expect a little bit of growth in Q1? And maybe you can touch on if there was some destocking as well in Q4 and if that's kind of subsiding? Thanks.

Yes. Thanks, Arun. Yes. As I highlighted a few minutes ago, we did see across to our different regions, varying degrees of destocking, again, not with our products per se with our customers because we are a just-in-time model, but it's really more about our customers and their downstream. For sure, there is a seasonality that occurs in the fourth quarter as well as in the Asia region, in particular, the unevenness that comes around Lunar New Year. With those things behind us, I think there's still some uncertainties associated with the pickup coming out of where we were in the fourth quarter, but we believe that things will continue to improve, not only as we -- basically, as we move through the full calendar year in 2023.

And how should we think about measuring that? You mentioned that you want to prioritize recovering your margins to pre-COVID levels? Where do you characterize that? Is that on an EBIT dollar basis or EBITDA dollar basis or percent margins? And what are some of those targets, if you could help us with that.

Sure. So ultimately, the goal is to get back to pre-COVID levels, the historic levels on EBITDA. But a big driver for us relates to our gross margin and the progression we make on gross margin. The historic levels have been in the higher -- above 35% from a gross margin standpoint. So that has been our goal. We've communicated that now for multiple quarters. It's going to take us time as we work through this with our value-based initiatives with customers, but we continue to work on it and those goals remain in place.

Yes. Just to add to that, Arun, we certainly focus on EBITDA margin perspective as well. Andy mentioned above 35% historically, which largely equate to above that 18% range from an EBITDA margin perspective as well.

Great. Thanks, Shane. And just to clarify then, so obviously, you've been relatively successful in putting through price, but there's obviously still more to catch up on, but it sounds like that that bucket is moving along. You noted uneven demand. So is it really now recovering those volumes in order to get the margins back and the fixed cost leverage that you get from that kind of improvement? Or is it may be less FX pressure? Or what are some of the buckets that would get you to that 18% plus EBITDA margin? And when do you expect to get there? Is that, say, an early 2024 kind of run rate basis? Or what's the timing there?

So the biggest lever for us is continuing to add more value for our customers and focusing on the value in use. And that's the approach we have historically used and we've continued to use. And I think we've seen the robustness of it in this current inflationary environment. So that is our primary goal of continuing to work with customers to add more value, participate in more of their wallet to ensure growth is profitable as we continue to go forward here. As I've mentioned before, depending upon raw materials and the degree in which they hopefully stabilize will give us the opportunity to move that path forward a little more quickly. But regardless, we'll continue to focus on the value and use pricing as our approach.

And just lastly, just to clarify, the FX, given the headwind that you did see last year, do you expect that to be a slight tailwind here just given some of the movements in currencies and again, maybe a slightly more manageable comp? Or how should we think about FX?

Yes, Arun. If I think about the year-over-year comp, right? So obviously, we had a strong U.S. dollar throughout the year last year. So as I think about, given where the rate is right now, the year-over-year comparison looks like there was going to be a headwind. That said, if I look at it sequentially, right? I think that it's probably around neutral. So sequentially, it's probably not as big an impact versus prior year.

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

So good morning. Two questions. One is, can you give a sense for just how much volume you feel you missed out on based on the supply chain issues? And is any of that going to be picked back up in Q1?

Hi Laurence, yes, thanks -- thanks for the question. I think we've been pretty manageable -- managed to this point in time. It's been relatively small. It's had more of an impact really on the margin mix that came as a result of it. We're serving our customers and their demand is still there. So I don't believe there's any demand destruction. It's just catching up as we get more security on the key raw material.

Yes. Margin -- respective to numbers, Laurence, I think it's probably 1% to 2% of Americas volume, somewhere in that range.

And then with respect to the sort of the SG&A inflation, which is after the restructuring savings, what are you seeing in terms -- are you seeing any regional abatement in wage inflation pressure?

Yes. I think, in general, I mean you can talk country by country, and we don't want to go to that level of detail. But I would say, Laurence, we're continuing to see it everywhere in each of the different regions. I don't see -- there are idiosyncrasies in each particular geography. But for the most part, the pressure remains on overall inflation for labor continuing to increase.

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

Hi, good morning, guys. Thank you for taking my questions.

Good morning, Jon.

First one is, can you comment sequential pricing volume trends in Q1 coming out of the western holiday season and then some destocking, but going to Lunar New Year. I think you did mention price just lapping year-over-year will be up mid-single-digits or so, but maybe more volume as a question and specific price on a sequential basis if you have that.

Yes. Thanks, Jon. For the first quarter, as I've highlighted already, there's still a fair number of uncertainties that have not gone away here. But we anticipate pricing is going to be up sequentially from the fourth quarter. Volume for the reasons that I highlighted already, including new challenges like Turkey, and of course, this is assuming no new significant upsets anywhere in the world, we think we'll be flattish to potentially a little bit down sequentially. So net result though is we believe our gross margins will expand and be up.

Okay. Great. That's helpful. And then can you just talk in general about your pricing power? And if you believe that will hold through the year in an environment where volumes are maybe declining or flat. And as moderating or maybe even declining as you head through the year. Are you getting more pushback from clients just in terms of when you try to push price to them? Has it still been mostly the same? Just help us understand the elasticity and kind of the implications you think about going forward.

Yes. Great question, Jon. So first I'll say in my three decades of being involved in the specialty chemicals industry, I don't think I've ever seen the sustained period of inflation and necessity to push through pricing based on value and use. I'm also the first one to admit, there's never a meeting you go into where a customer is asking us to give them a price increase. And so there's, of course, the normal type of pushback that would occur. But I think what we've been very successful in doing, and it shows in our results, as Shane highlighted, we had net new business wins, and that's net of business we chose not to participate in because we were doing strategic price increases. We were still positive in 2022. And so now with multiple quarters getting close, I think to probably about two years' worth of price increases, we're still having successful conversations because we're basing those on our value and use and in real deliverables that the customers can benefit from.

Got it. No, that's very helpful commentary. Thank you. And then just last one for Shane. I think you mentioned increase in SG&A going forward. Again, mid-single-digits for the year, but I was wondering if you could be a little more specific about Q1. And if that remains stable through the year or is up, based on savings.

Yes. So if I look at sequential SG&A from Q4, we do anticipate it being up from Q4 to Q3, and that's related to inflation as well as some of the timing of our compensation with the cost. If I look at timing throughout 2023, it will increase a little bit ratably given inflation kicking in midway through the year. But all in all, I don't anticipate much variances between second quarter, third quarter, and fourth quarter.

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

Thank you for that. So just to wrap up, we're clearly focused on executing on clear priorities and committed to generating value for all of our stakeholders. I want to thank you for your continued interest in Quaker Houghton, and please do reach out to Jeff if you have any follow-up questions.

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