Q3 2021 Quaker Chemical Corp Earnings Call

[music].

Greetings and welcome to the Quaker Houghton 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. If he would like to ask a question. Please press star one on your telephone keypad.

If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Michael Barry Chairman, Chief Executive Officer, Chief Executive Officer, and President. Thank you. Sir. Please go ahead.

Good morning, everyone. Joining me today are Andy Thomas pitch, our incoming CEO Shanghai was better our CFO, Robert Traub, Our general counsel and David well, our global controller.

We have slides for our conference call you can find them in the Investor Relations section at our website at Www Dot Quaker Houghton Dot com.

Before I provide an overview of our business in the third quarter I do want to introduce anytime attach who will become CEO on December 1st Andy joining Quaker Houghton on October 13th and we are in the midst of a detailed transition process over the seven week period until they become see yep.

And he 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.

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 have received from everyone.

Over mikes 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 and 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 add 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.

Putting 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 onto the quarter.

Our results for the third quarter, where we were where we expected them to debate, although how we got there was different than our original expectations.

The major headline for the quarter was raw material costs they.

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 help 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%. We're 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.

Sequential growth was muted by both seasonality in certain segments as well as the semiconductor shortage, which we estimate cost 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 'twenty, one versus the third quarter of 'twenty.

So we continue to feel good about our ability to deliver on our historical performance of consistently growing 2% to four percentage points above the market due to share gains and looking forward. We continue to feel good about delivering these levels given the opportunities. We have recently won or are actively working on.

So in summary, the big picture on Agamic volume growth for US was approximately 3% was due to market share gains about 4% due to growth in our underlying markets, which we estimate would have been 2% higher if it wasn't for the semiconductor shortage.

While sales were a positive for us in the quarter a clear negative was the continued increase in our raw material costs, while we knew raw materials were trending up the last time, we talked the increases have continued longer and at a higher level than we expected.

Overall, our cost of raw materials have increased nearly 10% sequentially in the third quarter for.

Further the availability of raw materials has impacted us at times, but I'm proud to say that we navigated. This so far and have ensured that all of our customers have continued to operate their business.

The increase in raw material costs did put downward pressure on our gross margins in the third quarter and the increases in raw materials will continue into the fourth quarter, although at a slower projected rate.

We have continued to implement price increases and we will be implementing more over the next two months. Our expectation is that we will see sequential improvement in our product margins in the fourth quarter as we make strides to offsetting raw material increases.

For the fourth quarter, we should start to see some improvement in our product margins, but we expect to have a larger improvement in the first quarter of 2022.

Our goal still remains to exit the year with enough price increases in place that we will offset raw material inflation from 2021 as we enter into 2022 and we believe this is achievable.

So overall, we are pleased with the quarter, especially considering the challenges we face with raw material pricing as well as the headwinds from the semiconductor shortage.

Our trailing 12 months adjusted EBITDA of $279 million is an all time high as 25% higher than our $222 million from last year.

So we are experiencing a step change in our profitability that we projected as we entered into the year.

Related to our liquidity, our net debt in the quarter was relatively flat due to increases in our working capital primarily related to raw material cost increases and availability. However.

However, our leverage ratio of net debt to adjusted EBITDA continues to be at $2, seven which is the low point since the combination of two years ago and down from $3 four one year ago.

You may have no native noticed in our press release that we recently made three small acquisitions for approximately $13 million.

Each of them expands our technology capabilities and.

<unk> geographic expansion and certain product lines.

In total there, adding $15 million in revenue and $2 million in EBITDA.

Well, maybe not that meaningful given the size each provides another building block block and our strategic portfolio.

This also continues our trend of buying smaller companies for an attractive multiple of approximately seven to eight times EBITDA.

As we look forward to the fourth quarter, we expect short term headwinds from high higher raw material costs.

Restrictions in China, and the continued impact from the semiconductor shortage on the global automotive market.

But as I mentioned earlier, we expect to see some sequential improvement in our product margins.

Overall, we expect our adjusted EBITDA in the fourth quarter to be similar to the third quarter it would be somewhere in the sixty's.

And stepping back and looking at the year as a whole I am more optimistic about our business now than I was at the beginning of the year.

I will likely end up with our profitability in 'twenty one in the same place as we originally expected the way we're getting there is different essentially we're seeing higher demand in our products in most end markets, but at the same time. This higher demand was largely offset by the very large rise in input costs, which negatively.

That our margins due to the lag effect of getting price increases.

However, we are making headway in our price increases and as I mentioned before we remain committed to our goal of exiting the year with product margins back to our targeted levels.

So as to recover the past year's raw material inflation as we enter into next year.

I believe this scenario is better than we expected entering the current year as we will exit with better demand in our end markets, coupled with getting our margins in a better place going into 'twenty two.

As we enter 2022.

The headwinds in the fourth quarter caused by high raw material costs in the semiconductor shortage as well as the power restrictions in China are likely to last into the first part of the year.

But become less of a headwind over time.

For the full year, we believe 2022 will be a strong year for us with net sales and earnings growth to be above our long term trends.

We expect this to be driven by one good growth in our end markets as our markets continue to rebound.

To continue market share gains.

And three sequential improvement in our product gross margins over the course of the year as we recapture the raw material inflation from 'twenty one.

In closing I want to thank all of our colleagues at Quaker Houghton, whose dedication and expertise helps to create value for our customers and shareholders and differentiate us in the marketplace.

So proud of how our team has performed in servicing our customers meeting their needs and successfully continuing with our integration execution, which is both critical and difficult for us given the conditions, we face this year.

People are everything in our business and by far our most valuable asset and ensuring their safety and wellbeing is and will continue to be a top priority for us.

So I can't help that emphasize my pride in our Quaker Houghton team and what we have and we will be able to accomplish for our customers and investors, both now and going forward.

And that concludes my prepared remarks, I'll now hand, it over to Shane So that he can review some of the key financials for your for the quarter.

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 and.

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 made 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 topline 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 six seven and eight in our culture Arts, 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 trend generally all input costs in the world. We knew this quarter would decline compared to the 35, 5% level. We had in the second quarter and also signals that this quarter would be the lowest of the year.

That said the pace of the raw material cost increases were more than we expected and our sequential gross margin decline shows such.

Looking ahead to the fourth quarter margins as Mike mentioned, we expect to see sequential increases in our product margins on a dollar profit basis. However, the impact of the price increases to our top line will naturally impact our overall gross margin level on a percentage basis as we were putting in price increases to offset raw material.

Cereal inflation, initially and retain our product margins on a per kilo basis to ensure we maintain our levels of gross profit in dollars. We expect to achieve this by the end of the year on a going forward basis, once our price increases offset raw material inflation and we protect our gross profit dollars going forward. We will then be.

Again to put in place additional initiatives to return our gross margin more to targeted levels over time.

SG&A was up 7 million compared to the prior year as we had additional direct selling costs due to our increase in sales and related margin higher labor and other costs that were directly impacted by Covid last year and additional costs associated with our recent acquisitions.

Sequentially, we benefited from $5 million of lower SG&A costs, which were primarily due to lower incentive compensation and some lower professional and other similar fees.

The company also benefited from other higher income.

Due to FX transaction gains in the current quarter compared to losses in the prior year, which was partially offset by lower performance from our equity investments primarily in Korea.

The net of this performance resulted in adjusted EBITDA of $66 2 million for the quarter, which was up 3% compared to the prior year of $63 9 million as you can see in chart nine this increased our trailing 12 month adjusted EBITDA to a record $279 million.

From a segment perspective. These results were driven by significant net sales increases in each of the company's segments year over year, while gross margins and higher SG&A negatively impacted all segments. The net of these impacts resulted in a 16% increase in EMEA earnings compared to prior year generally flat performances in Americas.

And GSP and a decline in Asia Pacific earnings, which was due to our solid performance last year as China was less impacted by COVID-19 in the prior year as well as a decline in gross margin in the current quarter due to the continued increases in raw material costs.

When looking at our segments sequential performance each segment's top line was either above the second quarter of relatively consistent largely due to global pricing initiatives on flat volumes, which were offset by lower gross margins in all segments. Due to continued increases in raw material costs that exceeded our pricing initiatives.

From a tax perspective, we had low effective tax rates in the current and prior year quarters of two 6% and eight 1% due to various one time noncash related items. Excluding these items in each period, our tax rate would have been relatively consistent at 25% for the current quarter compared to 24% in the prior year.

To note, we expect our fourth quarter effective tax rate to be a little higher in the range of 26, 28%, but our full year effective tax rate will be more consistent with past estimates in the range of 24% to 26%.

Our non-GAAP EPS of $1 63 grew 5% compared to the prior year as our solid adjusted EBITDA, coupled with over $1 million of interest savings due to lower borrowing rates and average borrowings were partially offset by a slightly higher tax expense.

As we look to the company's liquidity summarized on chart 10, our net debt of $759 million was flat compared to the second quarter. This was primarily driven by $12 million of operating cash flow offset by $7 million of dividends paid and 6 million of additional investments in normal capital expenditures.

The quarter's low operating cash flow was driven by further investment in the company's major cash requirement working capital specifically the company continued to see cash outflows from accounts receivable due to higher net sales and also have considerable increases in inventory, which were due to higher raw material costs as well as restocking in bulk purchases to ensure safe.

Stock given the disruption in the global supply chain.

The company's liquidity and leverage still remain healthy with our reported leverage ratio of two seven times as of the third quarter compared to $3 two times entering the year.

Overall I want to emphasize we are committed to prudent allocation of our capital and remain committed to reducing leverage to our target of two five times, which we still are targeting to be near by year end.

This commitment includes prioritizing debt reduction, but also continuing to pay our dividends as well as investing in acquisitions that provide growth opportunities, which make strategic sense.

This is evidenced by our most recent tuck in acquisitions of grind X three S and bear in industries, which were acquired for $13 million or rough multiple of seven times, EBITDA and bring with them a wealth of opportunity in technology and product reach.

So to summarize quicker Houghton had a solid quarter that was relatively consistent with our expectations, but a little different than initially expected due to continued strength in demand and good market share gains, which were partially offset by higher input costs.

Our liquidity remains very healthy and we remain committed to our overall capital allocation and deleveraging strategy.

Before I conclude my remarks, I just wanted to make I wanted to take a moment to note that this is the last call for Mike. During these incredibly successful tenure as CEO under his guidance Quaker Houghton has reached new heights and grown in areas that some believe could never been achieved I wanted to take this time to thank you Mike on behalf of the company for your many years of <unk>.

Service to our company of course, we look forward to your continued dedication and contributions as our board chairman.

And that concludes my prepared remarks. Thank you for your interest in Quaker Houghton and I'll now turn it back over to Mike.

Thank you Shane and I appreciate those remarks, it's really been an honor and a privilege to work for Quaker Houghton for 23 years.

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. If you would like to ask a question. Please press star one on your telephone keypad at this time, a confirmation tone will indicate your line is in the question queue.

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Once again Thats Star one to register any questions at this time.

Our first question is coming from Mike Harrison of Seaport Research. Please go ahead.

Hi, good morning, and congratulations and best wishes, Mike welcome aboard Andy.

Thanks, Mike Thank you Mike good morning.

And Mike just so you know there is no rule, saying the chairman Ken.

The earnings call I mean, you'll be back you you know you want.

The questions and give us the hard answers.

First first question here is actually for Shane.

That's true.

Or I know you mentioned.

Some some lower professional fees.

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.

I mean that kind of kind of comes back to a more normal level or a higher level as we get into 'twenty two.

Thanks, Mike for the question, Yeah, I referenced incentive compensation professional fees and some other items that ran through there we 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 S. G.

G&A and we topped out at 108 last quarter.

So I think as you look at that trend I think thats indicative of kind of where we are on average.

Alright, and then wanted to get to this question around pricing and around margin and I think you guys are intentionally using this term.

Product margins and Shane you got into it a little bit and 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.

But as we think about gross margin percentage.

That's something that's going to be taking longer to recover.

Maybe 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 are.

Youre absolutely right Mike in the way you described is 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 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 in price increases there is always a lag effect and where we've been falling behind or we've been below our target level.

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 at Sam per kilogram by the end of the year.

So that as we enter into next year, we kind of at least would have recovered.

The raw material inflation.

And Youre right that gross margins even at that level. When you do the math on this gross margin, even though we recovered raw material inflation of the gross margins will be deflated, yeah, we haven't given any guidance on that at this stage.

But it will be deflated and I think the most important thing though is that our next step is certainly and goals is that we want to over time too.

Increased that gross margin level and that will be our next steps, but first step we have to lease 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 it could be some modest improvement in our gross margin percentage.

In Q4, and then like I said, some bigger expand and that is as we go forward.

Okay.

And then the lag.

Last question I have is on the.

The global specialty business, just noticed that all your other segments posted volume increases in volume declines. There can you just speak to what's happening in that business.

Well, yeah, we we had I think there is this one is kind of an anomaly.

There was one major shipment of products that we did in our let's say our mining business that.

That when we ship the product last year it was shipped as.

Fully diluted products. So there was a lot of water content in the product and that turns into the <unk>.

So a pretty high volume and then now more.

Traditionally shipping it more as a concentrate which is more normal and and just to show how leveraging that was that on the overall volume impact of that that was a little over 1%.

Volume declined.

Even though it really didn't have any material impact.

From a company from a profit perspective or anything like that so it just kind of skewed our volumes a little bit but that was kind of a I think that's in the past and we won't see anything like that going forward again, but so I was just an anomaly. There. So they did we did have a nice growth in general in a number of areas and a global specialty businesses like Reese's were up.

Cans were up metal, finishing.

A number of things are up in our businesses there.

Alright sounds good thanks very much.

Thank you Mike.

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

Thank you and good morning, and Mike again, congrats as well as your for your retirement and your future and Andy are welcome aboard.

Mike and Andy just on the guidance can you just unpack the guidance it sounds like you're guiding towards sales growth in the high single digits.

And this is for 'twenty 2022, and EBITDA growth of low double digits I am I in the right ballpark and those are long term trend.

Directional numbers.

Yes, I mean, I might phrase it a little differently, but.

I'm not going to argue but in general I think we are.

When I think when I use the term long term trends when I think about that and let's talk first sales. So so we have sales in our markets that typically grow 1% to three percentage points and then of course, we let's say on average two and then and then we grow let's say another 2% to 4%.

<unk> points of market share gains so let's say on average three so you're at three plus to maybe maybe normally we would expect to see five percentage.

And our growth sales growth.

And.

What we're saying now is that just as our markets begin to rebound.

Things haven't really come back from Covid, yet number our 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 from a profit perspective, if we were normally growing 5%, maybe we were growing our EBITDA, let's say, it's 8% or something like that something higher than that as we leverage our growth.

<unk> to the bottom line and now that will be higher than that so that's that's kind of what we're pointing to so.

I think the.

So I think that anyway I'll stop there. Thank you.

Correct.

Perfect and just on the selling price increases if and when raw material costs to rollover.

For sure how much of these price increases do you retain with your customers.

Well, we yes.

We have price increases in place and of course, if if we start seeing dramatic drops in raw materials that could definitely have to give back some of those raw materials, but but over time, what we've been able to do is continue to keep and capture some of that price and certainly in when we're not 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 or our gross margin and we're going to have.

More.

The stronger certainly trying to keep those price increases in place as we go forward, even if raw materials.

Rob.

Great and last thing just a.

Changes in working capital in 2021, Whats your expectation in terms of a.

Source of use here.

For 'twenty two Dave.

I'm sorry 21.1.

So if you can see for here, we are sitting three quarters into 'twenty. One we've had a pretty substantial outflow for working capital roughly $150 million. If I look at rounding out the year, we've indicated raw material costs will go up modestly. So we may see a little bit more on the inventory, but we're making a concerted effort to decrease some.

<unk> that we have on stock.

From a receivables perspective topline 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 that use of cash of 21 and source of cash in 0.2 is that an appropriate.

Forecast right now.

So sorry, David for the source of cash in 'twenty. One you said any reversal of working capital trends in 'twenty two I apologize.

Two 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 in 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 should be I think we would expect to have 20 to be in a pretty strong year in cash flow.

Great. Thank you very much.

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

Hi, Good morning, it's Pete Lucas for Jon first John wants to send his best to Mike Congratulations there.

And just wondering 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 what you mean by auto revenue.

But yes.

Yes. So we had indicated and you may have missed this that the semi conductor impact on auto.

We estimate to be 2% in the quarter.

So you can say that from that perspective that really it was a negative on that side.

So I mean, we do expect I would say maybe.

<unk> grow more next year than this year I mean based on external projections that we have so there'll be some semi to be up there are headwinds as we go into next year, but over the course of the year it should lessen up but the autos in general to be better and so we expect better sales next year for modest in this year.

Oh, Great and then you talked about some of the share gains that you're seeing do you think these are the result of.

Are you being better than your peers in terms of the global supply chain and procurement abilities and do you think that these.

New gains will be sticky customers, so as you've seen in the past.

It's a really good question.

I actually think these these are really 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 should say competitors competitors Clinton supplier customers. So their customers. So people have come to us we have not.

I'd say taken advantage of a lot of that because.

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 wanted to make sure we're able to supply those new gains as well so those were our top priorities and.

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 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 customer satisfied.

Last one for me 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 going forward. So.

I'll just reinforce Mike's comments.

Oh, great and the last one for me you talked about some of the deals that you've seen on the 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 Yeah, as we said.

I guess, when we finalized things with the combination in over two years ago, We said.

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.

We said in the.

We will continue to look at in the meantime, smaller acquisitions and that's what we've done we've 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, which at the end of this year, we would expect to look and entertain and be more I'll say more proactive in looking at larger deals. So so that's something that as we enter into next year, we will be doing that we do feel there is some opportunities out there.

Theyre not instantaneous things that.

Turn on it have a median and get it but that things will be.

We'll be working on as we enter into 'twenty two.

Great. Thanks, so much.

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

Hi, guys, it's Dan Rizzo on 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 originally houghton customers and vice versa.

Question on 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.

Yes, thanks, Dan for that.

<unk>.

Youre right I mean part of this this.

3%, let's say of growth part of that is coming from cross selling opportunities, where we can sell either let's say former houghton customers legacy Quaker products or vice versa. So it was really coming from both <unk>.

Perspectives.

We are seeing some nice traction there.

And that's something that we think we will be able to continue on for a while it's not something and it does take a while the continuous so.

I mean, so this will continue for a while but the remaining part of that.

That growth is just really kind of getting new pieces of business that is not related to cross selling and just because of our we feel we have a.

A differentiated model that allows us to save our customers more money than they may have issues and we can solve their issues and we're getting that business so kind.

Kind of a combination of those two things.

Okay. Thanks for that and then is there a speed or piece of price increases where it might affect share gains where share gains might slow down because of <unk>.

Thanks.

Yes, it's a good.

Good question.

<unk>.

In general two things that are.

Hitting us over this past year.

Or not necessarily a great and conducive to China, gaining share is is COVID-19 where it.

It makes it more difficult sometimes to to get into the customer facilities and to get new opportunities than any other price increases because you're talking about price increases that are <unk>.

Talking about new piece of business and how that can save the customer money. So 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 are actually are achieving.

Pretty good share gains so so it hasnt in let's say hurt us so far.

And.

We will discontinue up continue what we're doing here and as far as the pace of that Youre right.

We're probably it depends where you are around the world on what customer you're dealing with but we're probably on price increase number five or maybe even a six with some customers at this point.

And you have to be.

<unk>.

In some ways, it's an art as well as the science to do that and to manage that situation wealth to customer and we think we think we do I mean this is an 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 in.

So far we've been very successful with that and we expect to continue to be.

Thank you very much.

Thank you.

Thank you. Our next question is coming from Marissa Hernandez of Sidoti <unk> Company. Please go ahead.

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

Thank you Mark.

So I have a couple of questions.

To follow up on the raw material cost inflation.

I'm here so.

This.

Cos specially that Youre seeing is that across all of your raw materials in a similar way.

Or are there differences.

Yeah. So.

It is it is everywhere.

It is almost every group whether youre, we have major raw material groups they pay soils.

<unk>.

First of oil animal fats additives surfactants and whole host of kind of other types of chemicals and every one of those groups.

Our 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 then have you seen any signs of slowdown anywhere just yet whether it's a specific.

Input or a specific geography.

You mean slowdown in our raw material cost escalation.

Yes.

You mentioned that you were expecting the pace to slow down in the fourth quarter. So wondering if you already started to see that somewhere.

Yes, we have yeah.

Not one site stopped.

But the pace is definitely lower than it was in the third quarter. So we do expect that to continue to go up in the fourth quarter, but at a lower pace in the third quarter and we expect that same kind of trend that happened into the first quarter as well based on everything we know now.

So basically in October the pace, so far of raw material price increases on average was lower than what you saw.

In.

The third point there.

Yes, I would say I'd say, where we are today, yes.

The incremental change why it 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 slow down.

Okay. So.

So I suppose that is what gives you confidence that.

I sure will be lower in the fourth quarter.

Yes, it's really our best gas its one of these things.

Every time, we with.

We guess, we haven't been really great.

And that's because the events happen like in the industry. So so for example.

Hurricane either.

And 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 marissa it should be at a slower pace.

Marissa if I can.

Thank you for the question I think it is not unique to <unk>.

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 has 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 of restrictions that you mentioned.

Impacting our customers in China, but would that be mostly your steel and aluminum costs customers are.

Also.

So customers and anything you can comment on in terms of quantifying that trend that'd be helpful.

It is.

It is impacting a number of our customers and it's really.

Region by region, and where are they have 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.

We do believe it's it's a it's certainly a negative it's not if I compare it to the semiconductor shortage and how that's impacted us. It is not as great of an impact of that you know it might be somewhere half of that but it's but it is it is a.

It has an impact to our business in the fourth quarter.

That's helpful. Thank you and finally.

More on the synthetic side to follow up on an earlier question about <unk>.

You potentially starting to look at larger deals. After you reach your two five times net debt to EBITDA.

Target duration.

In the current environment.

On the raw materials side.

Potentially influence what you are looking to do with your strategic priorities might be in terms of type of businesses. How do you incorporate.

What's going on in 2021.

With raw material cost inflation into your thinking about M&A.

Sure Yeah.

I think I guess I don't think it influences.

As at March.

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.

So many broad based raw materials that we buy that doesn't really.

When it because thing for us so.

So I don't think it really influences us much at all I think we would just continue to concentrate on that.

The kind of strategic acquisitions that we normally would look at.

Thank you.

Thank you.

Once again, ladies and gentlemen that star one to register any questions at this time.

Our next question is coming from Garo <unk> of Palisade capital management. Please go ahead.

Hey, guys.

I wanted to first ask just on the labor side of things you guys Didnt talk much about it. Some other companies have had some labor challenges I'm wondering how you're managing through and if the new kind of vaccine mandate from the government could have any impact.

Heading into the next year.

Okay.

Sure I mean labor shortages.

Most of our.

The impact of that is in our manufacturing sites, where we tend to have more.

Or blue collar type of of rolls in and trying to attract people into those type of roles are the majority of our business and professional staff and cost people, calling on customers it really hasnt been.

Issue for Us and we're still able it's a continues to be a challenge and we have to be very creative in how we attract people to the site 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 in.

<unk>.

We are.

From a COVID-19 perspective, we are certainly.

Back in or a majority of our office is now around the world.

As a company, we don't mandate vaccines, but we certainly encourage them.

And but we are certainly working with the frameworks that.

That are being put out like yesterday with president of bite in the frameworks that he would be putting out around that.

Got it.

There's been there's obviously several questions around the raw material side of things on the costs, 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 you are.

Based on the course, we're on you if things should hopefully be normal.

Next year.

It hasn't improved as much as I would have expected it to we still have challenges.

<unk> availability, we do expect it to improve though.

Garo, but but.

But I would have it.

Would asked me you know 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 it's.

It's still it's still something but I do you do we see.

<unk> raised our hope here on the horizon around that.

Yes, if I could if I can add too if I could add to Garo I think theres two components to this there's the supply side and then there's also the logistics.

And I think theres.

Theres plenty of signals out there to suggest the supply side is going to start to become less volatile.

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.

Yeah.

Got it great.

And I know Arrow is now 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.

Certainly it's a considerably.

Considerably better than it was last year, but still.

Below where it was let's say in 2019, which was a record year for us in 2019 in the aerospace business. So it's been a I would say we had expected to be higher this year, it's higher than our expectations are and we expect that that continue to ramp up over the next several years as we get back to where it was.

Great.

I'll, just say hey, thanks, so much for that many years with great stewardship, Mike it's been a pleasure to be here and communication with you.

Thank you Gary I 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's no other questions. We will end the conference call now on 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.

Or just remind everybody that our next conference call for the fourth quarter and full year 'twenty one results will be in late February.

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.

May disconnect your lines or log off the webcast at this time and enjoy the rest of your day.

Yes.

Yes.

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Okay.

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Yeah.

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Okay.

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[music].

Greetings and welcome to the Quaker Houghton 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.

If you would like to ask a question. Please press star one on your telephone keypad.

If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Michael Barry Chairman, Chief Executive Chief Executive Officer, and President. Thank you. Sir. Please go ahead.

Good morning, everyone. Joining me today are Andy Thomas touch our incoming CEO Shanghai was better our CFO, Robert Traub, Our general counsel and David well, our global controller.

We have slides for our conference call you can find them in the Investor Relations section at our website at Www Dot Quaker Houghton Dot com.

Before I provide an overview of our business in the third quarter I do want to introduce anytime attach who will become CEO on December 1st Andy joining Quaker Houghton on October 13th and we are in a less of a detailed transition process over the seven week period until they become see yep.

And he 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.

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 have received from everyone.

Over mikes very successful tenure Chi 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 and 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 add 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 though.

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 onto the quarter.

Our results for the third quarter, where we were where we expected them to debate, although how we got there was different than our original expectations.

The major headline 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.

Continued our efforts around cost control, which help 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%. We're 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.

Sequential growth was muted by both seasonality in certain segments as well as the semiconductor shortage, which we estimate cost 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 'twenty, one versus the third quarter of 'twenty.

So we continue to feel good about our ability to deliver on our historical performance of consistently growing 2% to four percentage points above the market due to share gains and looking forward. We continue to feel good about delivering these levels given the opportunities. We have recently won or are actively working on.

So in summary, the big picture on Agamic volume growth for US was approximately 3% was due to market share gains about 4% due to growth in our underlying markets, which we estimate would have been 2% higher if it wasn't for the semiconductor shortage.

While sales were a positive for us in the quarter a clear negative was the continued increase in our raw material costs.

We knew raw materials were trending up the last time, we talked the increases have continued lager and at a higher level than we expected.

Overall, our cost of raw materials have increased nearly 10% sequentially in the third quarter.

Further the availability of raw materials has impacted us at times, but I'm proud to say that we navigated. This so far and have ensured that all of our customers have continued to operate their business.

The increase in raw material costs did put downward pressure on our gross margins in the third quarter.

And the increases in raw materials will continue into the fourth quarter, although at a slower projected rate.

We have continued to implement price increases and we will be implementing more over the next two months. Our expectation is that we will see sequential improvement in our product margins in the fourth quarter as we make strides to offsetting raw material increases.

For the fourth quarter, we should start to see some improvement in our product margins, but what we expect to have a larger improvement in the first quarter of 2022.

Our our goal still remains to exit the year with enough price increases in place that we will offset raw material inflation for 2021 as we enter into 2022 and we believe this is achievable.

So overall, we are pleased with the quarter, especially considering the challenges we face with raw material pricing as well as the headwinds from the semiconductor shortage.

Our trailing 12 months adjusted EBITDA of 279 million is an all time high as 25% higher than our $222 million from last year.

So we are experiencing a step change in our profitability that we projected as we entered into the year.

Related to our liquidity, our net debt in the quarter was relatively flat due to increases in our working capital primarily related to raw material cost increases and availability. However.

However, our leverage ratio of net debt to adjusted EBITDA continues to be at 2.7, which is the low point since the combination of two years ago and down from 3.41 year ago.

You may have no native noticed in our press release that we recently made three small acquisitions for approximately $13 million.

Each of them expands our technology capabilities and our geographic expansion in certain product lines.

In total there, adding $15 million in revenue and $2 million in EBITDA.

While maybe not that meaningful given the size each provides another building bra block and our strategic portfolio.

This also continues our trend of buying smaller companies for an attractive multiple of approximately seven to eight times EBITDA.

As we look forward to the fourth quarter, we expect short term headwinds from high higher raw material costs.

The power restrictions in China, and the continued impact from the semiconductor shortage on the global automotive market.

But as I mentioned earlier, we expect to see some sequential improvement in our product margins.

Overall, we expect our adjusted EBITDA in the fourth quarter to be similar to the third quarter it would be somewhere in the sixty's.

And stepping back and looking at the year as a whole I am more optimistic about our business now than I was at the beginning of the year.

While we'll likely end up with our profitability in 'twenty one.

At the same place as we originally expected the way we're getting there is different essentially we're seeing higher demand in our products in most end markets, but at the same time. This higher demand was largely offset by the very large rise in input costs, which negatively impacted our margins due to the lag effect of getting price increases.

However, we are making headway in our price increases and as I mentioned before we remain committed to our goal of exiting the year with product margins back to our targeted levels.

So as we as to recover the past year's raw material inflation as we enter into next year.

I believe this scenario is better than we expected entering the current year as we will exit with better demand in our end markets, coupled with getting our margins in a better place going into 'twenty two.

As we enter 2022.

The headwinds in the fourth quarter caused by high raw material costs in the semiconductor shortage as well as the power of restrictions in China are likely to last into the first part of the year.

But become less of a headwind over time.

For the full year, we believe 2022 will be a strong year for us with net sales and earnings growth to be above our long term trends.

We expect this to be driven by one good growth in our end markets as our markets continue to rebound.

Two continued market share gains.

And three sequential improvement in our product gross margins over the course of the year as we recapture the raw material inflation from 'twenty one.

In closing I want to thank all of our colleagues at Quaker Houghton, whose dedication and expertise helps to create value for our customers and shareholders and differentiate us in the marketplace.

So proud of how our team has performed in servicing our customers meeting their needs and successfully continuing with our integration execution, which is both critical and difficult for us given the conditions, we face this year.

People are everything in our business and by far our most valuable asset and ensuring their safety and wellbeing is and will continue to be a top priority for us.

So I can't help but emphasize my pride in our Quaker Houghton team and what we have and we'll be able to accomplish for our customers and investors, both now and going forward.

That concludes my prepared remarks, I'll now hand, it over to Shane So that he can review some of the key financials for your for the quarter.

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 made reference to several non-GAAP measures during this call.

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 topline 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 six seven and eight and are called 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 trend generally all input costs in the world. We knew this quarter would decline compared to the 35, 5% level. We had in the second quarter and also signaled that this quarter would be the lowest of the year.

That said the pace of the raw material cost increases were more than we expected and our sequential gross margin decline shows such.

Looking ahead to the fourth quarter margins as Mike mentioned, we expect to see sequential increases in our product margins on a dollar profit basis. However, the impact of the price increases to our top line will naturally impact our overall gross margin level on a percentage basis as we were putting in price increases to offset raw material.

Real inflation, initially and retain our product margins on a per kilo basis to ensure we maintain our levels of gross profit in dollars. We expect to achieve this by the end of the year on a going forward basis, once our price increases offset raw material inflation and we protect our gross profit dollars going forward. We will then be.

Again to put in place additional initiatives to return our gross margin more to targeted levels over time.

SG&A was up 7 million compared to the prior year as we had additional direct selling costs due to our increase in sales and related margin higher labor and other costs that were directly impacted by Covid last year and additional costs associated with our recent acquisitions.

Sequentially, we benefited from $5 million of lower SG&A costs, which were primarily due to lower incentive compensation and some lower professional and other similar fees.

The company also benefited from other higher income.

Due to FX transaction gains in the current quarter compared to losses in the prior year, which was partially offset by lower performance from our equity investments primarily in Korea.

The net of this performance resulted in adjusted EBITDA of $66 2 million for the quarter, which was up 3% compared to the prior year of $63 9 million as you can see in chart nine this increased our trailing 12 month adjusted EBITDA to a record $279 million.

From a segment effective these results were driven by significant net sales increases in each of the companys segments year over year, while gross margins and higher SG&A negatively impacted all segments. The net of these impacts resulted in a 16% increase in EMEA earnings compared to prior year generally flat performances in Americas.

And GSP and a decline in Asia Pacific earnings, which was due to our solid performance last year as China was less impacted by COVID-19 in the prior year as well as a decline in gross margin in the current quarter due to the continued increases in raw material costs.

When looking at our segments sequential performance each segment's top line was either above the second quarter of relatively consistent largely due to global pricing initiatives on flat volumes, which were offset by lower gross margins in all segments. Due to continued increases in raw material costs that exceeded our pricing initiatives.

From a tax perspective, we had low effective tax rates in the current and prior year quarters of two 6% and eight 1% due to various one time noncash related items. Excluding these items in each period, our tax rate would have been relatively consistent at 25% for the current quarter compared to 24% in the prior year.

To note, we expect our fourth quarter effective tax rate to be a little higher in the range of 26, 28%, but our full year effective tax rate will be more consistent with past estimates in the range of 24% to 26%.

Our non-GAAP EPS of $1 63 grew 5% compared to the prior year as our solid adjusted EBITDA, coupled with over 1 million of interest savings due to lower borrowing rates and average borrowings were partially offset by a slightly higher tax expense.

As we look to the Companys liquidity summarized on chart 10, our net debt of 759 million was flat compared to the second quarter. This was primarily driven by $12 million of operating cash flow offset by $7 million of dividends paid and 6 million of additional investments in normal capital expenditures.

The quarter's low operating cash flow was driven by further investment in the company's major cash requirement working capital specifically the company continued to see cash outflows from accounts receivable due to higher net sales and also have considerable increases in inventory, which were due to higher raw material costs as well as restocking in bulk purchases to ensure safe.

Destock, given the disruption in the global supply chain.

The company's liquidity and leverage still remain healthy with our reported leverage ratio of two seven times as of the third quarter compared to three two times entering the year.

Overall I want to emphasize we are committed to prudent allocation of our capital and remain committed to reducing leverage to our target of two five times, which we still are targeting to be near by year end.

This commitment includes prioritizing debt reduction, but also continuing to pay our dividends as well as investing in acquisitions that provide growth opportunities, which make strategic sense.

This is evidenced by our most recent tuck in acquisitions of grind next three S and bear in industries, which were acquired for $13 million or a rough multiple of seven times EBITDA and bring with them a wealth of opportunity in technology and product reach.

So to summarize quicker Houghton had a solid quarter that was relatively consistent with our expectations, but a little different than initially expected due to continued strength in demand and good market share gains, which were partially offset by higher input costs.

Our liquidity remains very healthy and we remain committed to our overall capital allocation and deleveraging strategy.

Before I conclude my remarks, I just wanted to make I wanted to take a moment to note that this is the last call for Mike during his incredibly successful tenure as CEO under his guidance Quaker Houghton has reached new heights and grown in areas that some believe could never been achieved I wanted to take this time to thank you Mike on behalf of the company for your many years of <unk>.

Service to our company of course, we look forward to your continued dedication and contributions as our board chairman.

And that concludes my prepared remarks. Thank you for your interest in Quaker Houghton and I'll now turn it back over to Mike.

Thank you Shane and I appreciate those remarks, it's really been an honor and a 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. If you would like to ask a question. Please press star one on your telephone keypad at this time, a confirmation tone will indicate your line is in the question queue.

You May press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys.

Once again Thats Star one to register any questions at this time.

Our first question is coming from Mike Harrison of Seaport Research. Please go ahead.

Hi, good morning, and congratulations and best wishes, Mike welcome aboard Andy.

Thanks, Mike Thank you Mike good morning.

And Mike just so you know there is no rule, saying that chairman Ken.

The earnings call I mean, youll be back you you know you want.

The questions and give us the hard answers.

First first question here is actually for Shane This SG&A number I know you mentioned.

Some 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.

I mean that kind of comes back to a more normal.

<unk> are a higher level as we get into 'twenty two.

Thanks, Mike for the question, Yeah, I referenced incentive compensation professional fees and some other items that ran through there and we 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.

G&A and we topped out at 108 last quarter.

So I think as you look at that trend.

Think thats indicative of kind of where we are on average.

Alright, 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 and talking about.

Kind of a $1 per kilo type of margin level.

So it sounds like what your plan is 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 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.

For Q4 and into Q1.

Yes.

You're absolutely right Mike in the way you described it exactly that so we are focusing a lot on getting our <unk>.

Product margins, which we have internally.

Internally, what we call our contribution margin per kilogram.

For our 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 in price increases there is always a lag effect than where we've been falling behind or we've been below our target level.

As things 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 Sam per kilogram by the end of the year that thats. So that as we enter into next year, we kind of at least would have recovered.

The the raw material inflation.

And Youre right that gross margins even at that level. When you do the math on Hell on this gross margin, even though we recover raw material inflation of the gross margins will be deflated, yeah, 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 too.

Increased that gross margin level and that will be our next steps, but first step we have to at least get the.

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

In Q4, and then like I said, some bigger expand and that is as we go forward.

Yeah.

Okay, and then the <unk>.

Last question I have is.

The global specialty business just noticed that.

All your other segments posted volume increases in volume decline. There can you just speak to what's happening in that business.

Well, yeah, we we had I think there is this one is kind of an anomaly.

There was one major shipment of products that we did in our let's say our mining business that.

That when we ship the product last year it was shipped as.

Fully diluted products. So there was a lot of water content in the product and that turns into these.

So a pretty high volume in that and then now.

More traditionally shipping it more as a concentrate which is more normal and and just to show how leveraging that was that on the overall volume the impact of that that was a little over 1%.

Volume declined just even though it really didn't have any material impact.

From a company from a profit perspective or anything like that so it just kind of skewed our volumes a little bit but.

That was kind of a I think that's in the past and we won't see anything like that going forward again, but so it was just an anomaly. There. So they did we did have nice growth in general in a number of areas and a global specialty businesses like Reese's were up cans were up metal, finishing in a number of things are up in our businesses there.

Alright sounds good thanks very much.

Thank you Mike.

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

Thank you and good morning, and Mike again, congrats as well as your for your retirement and your future and Andy are welcome aboard.

Mike and Andy just on the guidance can you just unpack the guidance it sounds like you're guiding towards sales growth in the high single digits.

And this is for 'twenty 2022, and EBITDA growth of low double digits I am I in the right ballpark and those are long term trend.

Directional numbers.

Yeah, I mean, yeah, I might phrase it a little differently, but I'm not going to argue that 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 so we have sales in our markets that typically grow 1% to three percentage points and then of course, we let's say on average two and then and then we grow let's say another 2% to 4%.

<unk> points of market share gains so let's say on average three so you had three plus to maybe maybe normally we would expect to see five percentage.

In our growth sales growth.

And.

What we're saying now is that just as our markets begin to rebound.

Things haven't really come back from Covid, yet number our 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 from a profit perspective, if we were normally growing 5%, maybe we were growing our EBITDA, let's say, it's 8% or something like that something higher than that as we leverage our growth.

<unk> to the bottom line and now that will be higher than that so that's that's kind of what we're pointing to so.

So I think that.

So I think that anyway, I'll stop there, but I figure.

Perfect.

That's perfect and just on the selling price increases if and when raw material costs to rollover.

What proportion or how much of these price increases do you retain with your customers.

Well, we yes.

We have price increases in place and of course, if if we start seeing dramatic drops in raw materials that could definitely have to give back some of those raw materials, but 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 or our gross margin then we're going to have.

No more.

The stronger certainly trying to keep those price increases in place as we go forward, even if raw materials.

Drop.

Great and last thing just.

Changes in working capital in 2021, Whats your expectation in terms of a.

Source of use here.

For 'twenty, two Dave or for Tony.

I'm sorry 21.1.

So if you can see for here, we are sitting 30 quarters into 'twenty. One we've had a pretty substantial outflow for working capital roughly 150 million. If I look at rounding out the year, we've indicated raw material cost will go up modestly. So we may see a little bit more on the inventory, but we're making a concerted effort to decrease some.

Tori that we have on stock.

From a receivables perspective.

Topline, 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 that use of cash of 21 and source of cash in 0.2 is that inappropriate.

Our forecast right now.

So sorry, David for the source of cash in 'twenty. One you said any reversal of working capital trends in 'twenty two I apologize.

Two okay.

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.

Depending upon where pricing goes in 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. It should be I think we would expect to have 20 to be in a pretty good strong year.

Cash flow.

Great. Thank you very much.

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

Hi, Good morning, it's Pete Lucas for Jon first John wants to send his best to Mike Congratulations there.

And just wondering 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.

Yes. So we had indicated and you may have missed this the semiconductor impact.

To auto.

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 that I would say maybe.

Autos that grow more next year than this year I mean based on external projections that we have still there'll be some semi to be up there headwinds as we go into next year, but over the course of the year it should lessen up but the autos in general to be better and so we expect better sales next year, whereas for modest in this year.

Great and then you talked about some share gains that you're seeing do you think these are a result of.

Are you being better than your peers in terms of the 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 these are really 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 should say competitors competitors clinic supplier customers. So their customers. So people have come to us we have not.

I'd say taken advantage of a lot of that because.

Cause fundamental sure there are supply chain shortages, we want to ensure our customers are being taken care off 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.

And we haven't really had much much hitting us as an opportunistic sale.

Had we had unlimited supply chain raw material and things like that that we could have done more of that but we didn't and we thought it was prudent not to do it system to keep our customer satisfied.

Last one for me sorry, 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 would just reinforce Mike's comments.

Oh, great and the last one for me you talked about some of the deals that you've seen on the on the smaller side here just as you approach.

Your target leverage ratio and get to where you wanted to be wondering what the landscape looks like and your thoughts on larger deals.

Sure Yeah, as we said.

I guess, when we finalize things with the combination in over two years ago. We said hey in 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 <unk>.

We will continue to look at in the meantime, smaller acquisitions and that's what we've done we've 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, which at the end of this year, we would expect to look at and entertain and be more let's say more proactive in looking at larger deals. So so thats something as we enter into next year, we will be doing that we do feel there is some opportunities out there.

Not instantaneous things that would just turn on it have a median and get it but that things will be we'll be working on is as we enter into 'twenty two.

Great. Thanks, so much.

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

Hi, guys, it's Dan Rizzo on for Laurence.

The market share gains that we've talked about for a bit has any of that coming from former Houghton or I should say originally houghton customers and vice versa.

It's cross selling now 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.

Yes, thanks, Dan for that.

<unk>.

Youre right I mean part of this this ah.

3%, let's say of growth part of that is coming from cross selling opportunities, where we can sell either let's say former houghton customers legacy Quaker products or vice versa. So it was really coming from both perspectives.

Perspectives.

So we are seeing some nice traction there.

And that's something that we think will be able to continue on for a while it's not something and it does take a while a continuous.

I mean, 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 is not related to cross selling just because of our we feel we have a.

A differentiated model that allows us to save our customers more money than they may have issues and we can solve their issues and we're getting that business so kind.

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 <unk>.

Or price hikes.

Yes, it's a good.

Good question.

<unk>.

In general to two things that are.

Hitting us over this past year.

Or not necessarily a great and conducive to China, gaining share is is COVID-19 where it.

It makes it more difficult sometimes to to get into customer facilities and to get new opportunities and the other is price increases because you're talking about price increases is that of <unk>.

Talking about new piece of business and how that can save the customer money. So so.

Youre right from that perspective, but again when you continue to look at our numbers and looking at our net share gains we are actually are achieving.

Pretty good share gains so so it hasnt, let's say hurt us so far.

And.

We will discontinue up continue what we're doing here and as far as the pace of that Youre right.

We're probably it depends where you are around the world on what customer you're dealing with but we're probably on the price increase number five or maybe even a six with some customers at this point.

And you have to be.

<unk>.

It's in some ways, it's an art as well as the science to do that and to manage that situation wealth the customer and we think we think we do I mean this is an 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 in.

So far we've been very successful of that and we expect to continue to abate.

Thank you very much.

Thank you.

Thank you. Our next question is coming from Marissa Hernandez of Sidoti <unk> Company. Please go ahead.

Hi, Good morning, and thank you for taking my question congratulations on the results in a challenging environment.

Thank you Mark.

Thank you.

So I have a couple of questions to.

To follow up on.

On the raw material cost inflation.

So.

This.

Cause, especially that Youre seeing is that across all of your raw materials in a similar way.

Or are there differences.

Yeah. So.

It is it is everywhere.

It is almost every group whether youre, we have major raw material groups they pay soils.

<unk>.

First of oils animal fats additives surfactants and whole host of kind of other types of chemicals and every one of those groups.

Our 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 then have you seen any signs of slowdown anywhere just yet whether it's specific.

Input or specific geography.

You mean slowdown on our raw material cost escalation that's yeah.

Yes.

You mentioned that you would expect the pace to slow down in the fourth quarter. So wondering if you already started to see that somewhere.

Yes, we have yes. It is.

Not a one sided stopped.

But the pace is definitely lower than it was in the third quarter. So we do expect that to continue to go up in the fourth quarter, but at a lower pace in the third quarter and we expect that same kind of trend that happened in the first quarter as well based on everything we know now.

So basically in October or the pace of raw material price increases on average was lower than what you saw.

In.

The third quarter.

Yes, I would say I'd say, where we are today, yes.

The incremental change why you still may be going up month over month is considerably lower than it was when we were hit in June July August and that timeframe, it's starting to slow down.

Okay. So.

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 gas its one of these things you know.

Every time we.

We guess, we haven't been really great.

And that's because the events happen like in the industry. So so for example.

Hurricane Ida.

And in that that caused some disruptions as well as price increases there is the Texas res 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 marissa it should be at a slower pace.

Marissa if I can.

Thank you for the question I think it is not unique to <unk>.

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 has 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 our customers in China could that be mostly your steel and aluminum costs customers are.

Also.

Total customers and anything you can comment on in terms of quantifying that trends that'd be helpful.

It is a.

It is impacting a number of our customers and it's really.

Region by region, and where they have.

They have these.

Power shortages, so, 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.

We do believe it's it's a it's certainly a negative.

If I compare it to the semiconductor shortage and how that's impacted us. It is not as great of an impact of that you know it might be somewhere half of that but it's but it is it is a.

It has an impact to our business in the fourth quarter.

That's helpful. Thank you.

Finally, more on the <unk> side.

To follow up on an earlier question about.

You potentially starting to look at larger deals after usually tier two five times net debt to EBITDA.

Jason.

And does the current environment.

On the raw materials side.

Potentially influence what you are looking to do with your other strategic priorities might be in terms of type of businesses, how do you incorporate.

What's going on in 2021.

With raw material cost inflation into your thinking about M&A.

Sure Yeah.

I think I guess I don't think it influences.

Also at March.

For example, I don't think we would because of the raw materials 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.

When we had been good thing for us so.

So I don't think it really influences us much at all I think we will just continue to concentrate on that.

What kind of strategic acquisitions that we normally would look at.

Thank you.

Thank you.

Once again, ladies and gentlemen that star one to register any questions at this time.

Our next question is coming from Garo <unk> of Palisade capital management. Please go ahead.

Hey, guys.

I wanted to first ask just on the labor side of things you guys Didnt talk much about it. Some other companies have had some labor challenges I'm wondering how you're managing through and if the new kind of vaccine mandate from the government could have any impact.

Heading into the next year.

Okay.

Sure I mean labor shortages.

Most of our.

The impact of that is in our manufacturing sites, where we tend to have more.

Or blue collar type of of rolls in and trying to attract people into those type of roles are the majority of our business and professional SaaS and cost people, calling on customers it really hasn't been.

An issue for us and we're still able in our lives. It's a 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.

<unk> of our workforce, but we have been able to get by and do well in and to do that but it's just like everybody else. It's just not a big part of our workforce that's all in.

<unk>.

We are.

From a COVID-19 perspective, we are certainly.

Back in or a majority of our office is now around the world.

As a company, we don't mandate vaccines, but we certainly encourage.

And but we are certainly working with the frameworks that.

That are being put out like yesterday with president <unk> and the frameworks that he would be putting out around that.

Got it.

Theres been obviously several questions around the raw material side of things on the costs, but I'm curious on the availability you had mentioned that there was some.

Certainly challenges during the quarter have you seen availability improving already and do you feel like you know.

Based on the course, we're on here if things should hopefully be normal.

Next year.

It hasn't improved as much as I would have expected it to we still have challenges.

<unk> availability, we do expect it to improve though.

Garo, but but.

But I would have if you would ask me you know 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 while we're still it's still challenging and it's it's.

It's still it's still something but I do you do we see.

Rays of hope here on the horizon around that.

Yes, if I could if I can add too if I could add to Garo I think theres two components to this there's the supply side and then there's also the logistics.

And I think.

Theres plenty of signals out there to suggest the supply side is going to start to become less volatile.

A little more stable I think the logistics aspects are still being worked through.

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.

Yeah.

Got it great.

And I know Arrow is now 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.

Certainly it's a considerably.

Considerably better than it was last year, but still.

Below where it was let's say in 2019, which was a record year for us in 2019, an aerospace business. So it's been a I would say we had expected to be higher this year, it's higher than our expectations are and we expect that that continue to ramp up over the next several years as we get back to where it was.

Great.

I would just say hey, thanks, so much for that many years with great stewardship, Mike it's been a pleasure to be here and communication with you.

Thank you Gary I 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 the 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 to remind everybody that our next conference call for the fourth quarter and full year 'twenty. One 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.

May disconnect your lines or log off the webcast at this time and enjoy the rest of your day.