Greetings, and welcome to the Quaker Houghton First Quarter 2023 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, Melissa. Good morning, and welcome to our first quarter 2023 earnings conference call. Joining us today are Andy Tometich, our President and Chief Executive Officer; Shane Hostetter, our Executive Vice President and Chief Financial Officer; and Robert Traub, our General Counsel. Our comments relate to the financial information released after the close of the US markets yesterday, May 4, 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. The 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 first quarter, we delivered record net sales while continuing to manage through significant uncertainty and persistent macroeconomic challenges. We drove our recovery in margins and double-digit increases in adjusted EBITDA and adjusted earnings per share compared to the prior year quarter. We also generated strong operating cash flow in the quarter, driven by our improved performance and working capital efficiencies, further strengthening our balance sheet. I am very pleased with the financial and operational execution in the first quarter, and excited about the momentum we have built in the organization, delivering results by controlling what we can control. Compared to the prior year, net sales in the first quarter increased 5% to a record $500 million. The year-over-year improvement in net sales was primarily driven by execution on our value-based pricing initiatives, which were implemented across all regions to offset the continued inflationary pressures impacting our cost to serve. Though volumes declined compared to the prior year, they increased sequentially. Volumes continue to be impacted by a continuation of softer end market conditions, primarily in the steel and industrial markets, and were offset by some improvement in auto. We also have declined some incremental volumes in the quarter, consistent with our ongoing margin improvement initiatives. In total, and taking into account our customer mix, we are still trending directionally in line with the specific end markets and regions we serve. We're pleased to see the benefits of the diversification of our portfolio, which continues to drive targeted and valuable new business growth regardless of market trends. Our gross margin recovery also continues. Gross margins of 34.7% improved approximately four percentage points compared to the prior year quarter, and 2.5 percentage points compared to the fourth quarter of 2022. The sustained focus…

Thanks, Andy, and good morning, everyone. In the first quarter, we delivered net sales of $500 million, which was a 5% increase compared to the prior year. This was driven by a 19% increase in price and mix, partially offset by 11% decline in total sales volumes, and a 3% unfavorable impact from foreign exchange. Similar to recent quarter themes, our value-based pricing initiatives were the primary driver to increased net sales. Compared to the prior year, the decline in volumes was primarily driven by softer market conditions and our value-based pricing actions, as well as the ongoing conflict between Russia and Ukraine, the winddown of previous tolling of volumes we divested as part of the combination, and the direct and indirect effects of the pandemic in China. On a sequential basis, sales increased approximately 3%, including an increase in volumes of 1%, and a benefit from foreign exchange of 2%. Volumes increased in our Americas and EMEA segments, but were offset by continued soft conditions in Asia Pacific. Further, we have continued to implement targeted price actions, consistent with our value-based pricing initiatives. Gross margins in the first quarter increased to 34.7%. This was compared to 30.8% in the prior year, and 32.2% in the fourth quarter of 2022. The 400-basis point improvement year-over-year and 250-basis point improvement sequentially, reflects continued execution on our pricing actions and relatively stable raw materials. Overall, our raw material costs still remain at historically elevated levels, and while supply chain and logistic challenges have improved, they remain delicate. Therefore, we will remain agile, implementing additional actions and efficiencies as necessary. Looking at our SG&A, excluding one-time items, we had an increase of approximately $10 million or 10% compared to the prior year period. This primarily reflects year-over-year inflation on our labor costs, as…

Thank you, Shane. The positive momentum in our business is evident, and the entire Quaker Houghton team is very focused on executing, for our customers and our company. With that, we'd be happy to address your questions.

Thank you. [Operator Instructions]. Our first question comes from the line of Mike Harrison with Seaport Research Partners. Please proceed with your question.

Hi, good morning. Congratulations on the strong start to the year. In terms of gross margin trajectory, you got to a level here in Q1 that I think a lot of us didn't think you would attain maybe for several quarters. Can you give us a little bit more color on how you achieve that? Is there anything unusual or unsustainable in the Q1 performance, and where do the margins go from here as you look at Q2 and the rest of the year?

Thanks, Mike. Of course, our gross margin recovery has been a journey we've been talking about for quite some time, and as we've said, it'll be a continuous progression, but it may not always be at the same pace or necessarily linear. Really in the first quarter was a combination of us continuing our value-based pricing with some targeted actions and some minor raw material easing. Unpacking those two points just a little bit, on the pricing, we continue to focus on where we're adding value for customers. We sell against the value and use proposition, and we did in fact actually see some benefits from that in some increased price. On the raw material side, just as a reminder, we have about 4,000 different raw materials that we provide. And so, we're not seeing a broad change or a broad deflation. However, some of them have started to ease a little bit. So, we are at least seeing some stability, but still at extremely high levels. We anticipate we're going to continue to use those same levers going forward in the second quarter and beyond. Again, I'd highlight that it's not necessarily going to be a smooth path, but we're still working on margin recovery, and we'll continue to interact with our customers, making sure that we're striking the right balance on the value we're providing against the cost to serve.

All right, thank you for that. And then in terms of the EMEA performance, that kind of stood out to us on both the revenue and margin front. Can you talk about what you saw in Q1 in terms of kind of underlying metalworking and primary metals demand? And are you guys in a good place now on price versus cost now that energy costs have come off peak levels in Europe?

Yes, thanks, Mike. So, it is true, we did see some volume improvements in EMEA, in fact, in line with what we believe the underlying markets are doing. Part of that was building off of some of the shutdowns that had occurred at the end of last year and early into this year. But EMEA is still at a relatively low base. We anticipate there'll be some resilience as we continue to go forward, but there could be some unevenness in how that resilience develops. As far as margin goes, we obviously made a lot of progress on our value-based pricing initiatives across the entire portfolio, but made significant progress in EMEA coming out of 2022 and into 2023. We still have some work to do on that, but again, improvements in the value that we're seeing, some optimism about volumes as we go forward. We anticipate Europe could continue to improve.

All right. And then my last question for now is on the full-year outlook. The consensus EBITDA number before you printed this strong quarter, was around $280 million, $285 million for EBITDA. This quarter's performance, you said that Q2 should look similar, but it definitely suggests that you could be well north of $300 million in EBITDA for the full year. So, as we're thinking about modeling the rest of the year, should EBITDA be higher in the second half than the first half? Maybe just some additional color on the full-year outlook and where you have confidence, where you're still seeing some uncertainties.

Yes. Thanks, Mike. So, first, I'd like to start with, we're really encouraged by the performance that we've seen over the last couple of quarters and here in the first quarter, continuing to really deliver on the things and the priorities that we said we were going to. The macro uncertainties still remain there and we're focused on controlling what we can control. But for the second quarter, we anticipate still continued margin recovery, as I've highlighted before. It doesn't necessarily all mean it'll be at the same pace, but we continue to balance that value and use pricing with our customers against the cost of the serve, and believe that we'll continue to recover towards our historical margins over time. The adjusted EBITDA in the second quarter we anticipate to be similar. And kind of unpacking that just a little bit for you, as price and raws continue to move, we manage the yield of that and anticipate that again, a little bit of expansion continues in gross margins. Volumes could slight - could show some slight improvement, and that's really based upon expectations in China as we go forward. And we're continuing with our focus on new business wins. As we look beyond Q2, we know we have a lot of earnings power embedded in our portfolio and the activities that we've done, but a lot of the uncertainties are still out there, and we're focused on controlling what we can control. So, as we continue to implement the things we've been doing and anticipate continuing to do, we'll see continued margin recovery as we move through 2023, and then that yields to earnings growth in 2023 over 2022.

All right, thanks very much.

Thank you. Our next question comes from the line of Laurence Alexander with Jefferies. Please proceed with your question.

Hi, everyone. It's Dan Rizzo on for Laurence. So, in Asia, some of the companies you were talking to are saying in verticals whether they saw a surge coming out of COVID, it ended quickly, so it was kind of like a start-stop. I was wondering if you guys saw something similar or just any color on how demand trends are within the region.

Yes. thanks, Dan. So, for sure, as we moved through Q1, our volumes did increase sequentially and we believe we're below the underlying end markets. Really, the reason for that was related on a sequential basis with some of the lunar New year impact, and then an expectation that things might pick up a little bit quicker than they did. We also had some uneven customer order patterns that occurred. And then finally, we had some volume. China's probably the most sensitive place with respect to pricing, and as we continue to use our value in pricing, we're choosing where we continue to serve business that's valuable for customers. And what we're seeing is a little bit of a wrap effect from the decisions we made in 2022. We do have cautious optimism though going forward. Coming out of the lockdown scenarios that were in place, we are anticipating that volumes could improve, and we're ready to serve them in Asia.

The optimism that you're alluding to, is that from just what you, I mean, think is going to happen to the region, or are there order trends or customer commentary that suggests that it is going to start to ramp up?

Yes, I think it's based upon the expectation of what the new policy will allow and remove some of the stops and starts that had happened before. That should build some momentum. And of course, we're seeing some stabilization as well. So, it's a combination of what we're seeing directly and hearing from customers and the general macro.

Okay. And then final question. In terms of pricing, if we hit a deflationary environment where your costs are rolling over, is there an amount you can hold onto? Is there a value-added component that makes some of the pricing you've taken permanent?

Yes. So, first of all, as we've talked previously, our model on pricing is always around value and use, and what we're actually adding from a value proposition to our customers. And of course, we have to balance that against the cost to provide that value to them. So, that's part of the reason why we've been very programmatic as we've moved up in our pricing, and that serves us well because we don't have the discussions based upon what's happening immediately in raw materials. It's really about the benefits that we're providing the customers. In every pass cycle for Quaker Houghton, we tend to hold on to that value and use pricing. Of course, depending upon what a rollover could look like or not with raw materials, that could have some impact, but we believe we'll be able to maintain some of the gains we've made as a result of our value and use pricing.

Thank you very much.

Thank you. Our next question comes from line of David Begleiter with Deutsche Bank. Please proceed with your question.

Thank you, and good morning, and very nice first quarter. Andy, and Shane, just on the Q2 guidance, given you should have some price-cost tailwinds, higher volumes, savings from the new cost program, and lower SG&A costs, I'm unclear why EBITDA would be flat quarter-over-quarter and not up perhaps even meaningfully. What else is there that's offsetting these potential tailwinds?

Yes. So, David, as I indicated, we're anticipating some potential increases in volumes as we go forward, and still gaining on some gross margins. So, that's the result that we think that we could contribute at the gross margin line with some improvements. We will have some of the sequential flow-through on our SG&A inflationary spending, which will partially offset that.

Okay. And just on a new cost program, is the $20 million the entirety of the savings? And maybe just touch again on where exactly these savings are coming from. Thank you.

Yes. I'll start that one off, David, and then I'll ask Shane to make a few comments. So, there's a number of actions that we're doing in this restructuring program, this cost savings program, but they're all in service of our growth strategy and the organization that we need to be able to implement that. We're going to be driving both efficiency and effectiveness in the moves that we're making. This is a global program, and the immediate focus is on Europe, and we've already started to make some progress there. We'll be looking at organization optimization, as well as footprint and some supply chain efficiencies, as well as redefining how we exactly deliver customer intimacy in the most valuable way for our customers as we grow profitably.

Yes, just going into the specific numbers, David, and a little bit more color on that, as you mentioned, the program is $20 million of annual run rate savings by the end of 2024. We did begin this in Q4 of last year, and we'll continue to have some charges coming in the next quarters. Our total costs, we expect to be roughly 1x to 1.5x of the savings. And this really depends upon the nature and negotiation there too. As I think about run rate benefit, about three quarters of the run rate benefit probably will be in 2024 versus a quarter this year. And as I think about, I think you asked kind of where we see them going through, Andy talked about it's a mixture of org optimization footprint and supply chain. So, we will see both reductions in SG&A as well as manufacturing costs. And just to note, savings thus far have been somewhat immaterial to our financials.

Thank you.

Thank you. Our next question comes in line of Arun Viswanathan with RBC Capital Markets. Please proceed with your question.

Great. Thanks for taking my question. Maybe I'll just ask a similar kind of question on the price mix. Very, very strong performance in Q1, 19%. And conversely, you had the 11% volume decline. So, was this kind of by design that you were maybe calling some lower margin, lower mix volumes and that drove an overall better mix and better margin for you? How should we think about how volumes kind of trend through the year? Maybe do they turn positive in Q4? And similarly, maybe your price mix wanes as we get into Q2 and Q3, just not only mainly mathematically, but maybe you can just comment on your outlook for both price mix and volume as you go through the year.

Sure. Thanks, Arun. As we've talked about in previous sessions, our value-based pricing is focusing on the value that we're providing for our customers. And we realized that there could be some small amounts of business that may not be as high value to the customers. And so, as we've been strategically targeting our price initiatives, we knew that there was likely going to be some amount of volume churn, but we were very careful not to be reckless. And we felt a little bit of churn is actually healthy. That's essentially what we've done, and we've seen a little bit of that wrap effect as we've come into some of the volumes in this year. As we go forward, we'll continue to focus on that value-based pricing, taking into account, of course, the cost to serve it, kind of being agile and managing against those two things so that we continue to maintain and grow our gross margins as we go forward. And then on the underlying volume side, as I mentioned, we have some optimism that there could be some growth on those underlying volumes, and we know we're continuing to win new business at much more profitable levels, and we're going to continue that focus on new business wins.

Okay. And just to clarify, though, what would it take to really see volumes kind of back in the, say low to mid-single-digit range? Is that really dependent on a better environment in metalworking and steel, or is it an aluminum, or is it China and regionally-based recovery, and a better Europe macro environment? What are some of the drivers that maybe that are not under your control that need to improve for the volumes to get to a sustainably better place?

Yes, Arun, I'd start right with the part we can control, and that is the new business wins. And as I've highlighted in previous quarterly earnings calls, we continue to gain new business based on the value we're offering to our customers, and that will continue. The challenge that has been here has been in some of the underlying markets we've served for the last couple of years. Several of those are still not at their historic levels. We're optimistic that those will come with time. Automotive, aerospace, some of the primary metals and general industrials still have ample opportunity to be at higher levels. So, as that continues to develop, we're in a really good position to be able to service it.

Thanks. And just one more for me. So, you've talked in the past, I think around the upper teens or mid to high teens as the EBITDA margin target. Is that still how you're thinking? And when you look into maybe is that kind of achievable in ‘24? Already well on your way to that metric in Q1 here, but maybe you get into the 16% to 18% range in ‘24. Is that a fair assumption?

Yes. So, I would say first of all, we're really pleased with the progress that we're making and what we saw in previous quarters and in particular in the first quarter. Our end goal remains the same, to be back into those high teen levels for EBITDA. And the pace of that will be determined by a number of different factors, but that is our objective.

Thanks.

Thank you. [Operator instructions]. Our next question comes from line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Hi, thanks for taking my questions and congrats on a really nice quarter and improvement in the gross margins. If I could ask, Andy, for you to put your macro hat on. Where do you see the biggest risks in the coming quarters? I mean, assuming that we might potentially be heading into a broad recession, even with that, it seems like there's automotive, aerospace, onshoring, infrastructure tailwinds that may not really abate so much, even in that case. China looks like it's going to improve. Europe was already a trough. What do you see as actually coming off in case we hit some more headwinds here just at a broader level on that kind of standpoint?

Yes, Jon, thanks for that. I mean, just building off of what I've already highlighted, what we are seeing is actually improvements. As I've highlighted, I think we're optimistic about the improvements that could come in China. We believe that Europe is a bit more resilient now and could be a little bit uneven going forward, but some of the previous headwinds are starting to mitigate, and we're still seeing resilience within the Americas. So, based upon our interactions with customers and what we see, that's why we still have some cautious optimism that things will continue to be beneficial.

Could you give us a real-time update as to what's going on in the ground in China today? Are you actually seeing a pickup now or is that still on the come, number one, and then number two, in Europe? Are there more mill restarts ahead of us that could help you improve sequentially?

Yes. I mean, the real-time update I would say, Jon, is we see just order patterns improving, as I think about that side. And we think it might ramp up as I think about the back half. So, we're cautiously optimistic, as Andy mentioned beforehand.

Okay. Shane, one for you. Just, you've had some nice free cashflow in the quarter I think, which was not seasonal for you. What's the expectation for the rest of the year? Did you just pull in some working capital recovery, or was there something else going on? Help us understand what your expectations are just going forward with the cashflow and maybe debt paydown and other use of those capital.

Sure. Thanks, Jon. Yes, so as you mentioned, we generated pretty good operating cash flow in Q1, with slight working capital outflows, which really just mirrored the growth in the quarter, as well as some increment in cash conversion, as we continue to manage safety stock on hand, which was a bit higher previously due to ensuring some supply. As I look ahead, I think we will continue to have some working capital outflows to support our growth, but nothing like we've experienced over the last two years. Therefore, as I said today, like Q1, I would expect our operating performance should generate a good amount of operating cashflow, slightly offset by important capital investment in the quarters to come. And from a cashflow perspective, where we would use this, we were able to delever in the first quarter from 3x to 2.7x. As we've talked about before, our priorities with capital application perspective is dividend payouts and then debt repayment and then investing in the business, both organically, and inorganically. And our target remains to get below 2.5x. And so, given the strong cashflow conversion, I would anticipate hitting that by the end of the year.

Got it. Just one last quick one. What are the expected costs of the $20 million cost savings that you're expecting o over the next two years or so?

So, I mentioned it was about 1x to 1.5x worth of savings.

Got it. Thank you so much.

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Tometich for any final comments.

Thank you. We're excited about the future and unlocking our growth potential at Quaker Houghton. We appreciate your continued interest in Quaker Houghton, and please reach out to Jeff with any follow-up questions. Thank you.

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