Quaker Houghton

Greetings and welcome to the Quaker Houghton third quarter 2021 results conference call. At this time, all participants are on 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 1 on your telephone keypad. If anyone should require operator assistance during the conference, please press star 0 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, and President. Thank you, sir. Please go ahead.

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

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

Thank you, Andy. I am very excited that we will have Andy's leadership going forward, and I'm highly confident Andy will take Quaker Houghton to new heights. And now on to the quarter. Our results for the third quarter were where we expected them to be, although how we got there was different than our original expectations. The major headwind for the quarter was raw material costs. They increased nearly 10 percent from the second quarter to the third quarter, which was considerably higher than our expectations. However, we also had good sales growth and continued our efforts around cost control, which helped offset the raw material headwinds. Let me now dive deeper into our performance, and I'll start with sales. Overall, our top-line revenue was up 22% from the prior year, with all segments showing strong growth. We saw good organic volume growth between 7% and 9% for our three largest segments, which was the Americas, EMEA, and Asia Pacific. Higher prices of around 10% were also a major factor in our sales growth. In addition, we saw a benefit from acquisitions of 4 percent and from foreign exchange of 2 percent. 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 2 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 21 versus the third quarter of 20. So we continue to feel good about our ability to deliver on our historical performance of consistently growing two 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 organic volume growth for us was approximately 3 percent was due to market share gains, about 4 percent due to growth in our underlying markets, which we estimate would have been 2 percent higher if it wasn't for the semiconductor shortage. While sales were 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 costs 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've navigated this so far and have ensured that all 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 the 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 and is 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, our leverage ratio of net debt to adjusted EBITDA continues to be at 2.7, which is the low point since the combination two years ago, and down from 3.4 one year ago. You may have noticed in our press release that we recently made three small acquisitions for approximately $13 million. Each of them expands our technology capabilities and or geographic expansion in certain product lines. In total, they're adding $15 million in revenue, and $2 million in EBITDA. While maybe not that meaningful given the size, each provides another building block in 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 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 and be somewhere in the 60s. In 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 21 in the same place as we originally expected, the way we are getting there is different. Essentially, we're seeing higher demand in our products in most M 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 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 22. As we enter 2022, The headwinds in the fourth quarter caused by higher raw material costs and 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. Two, continue market share gains. And three, sequential improvement in our product and gross margins over the course of the year as we recapture the raw material inflation from 21. 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. I'm 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 well-being 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 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 you 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 make reference to several non-GAAP measures during this call. Such are consistent with the press release and call charts filed yesterday. And also, there are reconciliations between U.S. GAAP measures and non-GAAP measures provided in our call charts on pages 11 to 22 for reference. Getting into our third quarter performance, the story was pretty consistent with our previous quarters this year in that it was really a tale of a positive, solid top-line performance tempered by a negative, higher input cost 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 slides six, seven, and eight in our call charts, which provide a further look into our financials. Our record net sales of $449.1 million increased 22% from the prior year, driven by 6% organic volumes, 10% from our pricing initiatives, 4% from acquisitions, and 2% from foreign exchange. When looking sequentially, we were up 3% from the second quarter largely due to increases from our pricing initiatives on flat volumes. Turning to our gross margin trend, our third quarter margin ended at 32.3 percent. Given the upward trend of generally all input costs in the world, we knew this quarter would decline compared to the 35.5 percent 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 are putting in price increases to offset raw material 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 begin 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 9, 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 GSB, and a decline in Asia-Pacific earnings, which was due to a solid performance last year as China was less impacted by COVID-19 in the prior year as well as a declining gross margin in the current quarter due to the continued increases in raw material costs. When looking at our segment's sequential performance, each segment's top line was either above the second quarter or 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 2.6% and 8.1% due to various one-time non-cash 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% to 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 a 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 had considerable increases in inventory which were due to higher raw material costs as well as restocking and bulk purchases to ensure safety stock given the disruption in the global supply chain. The company's liquidity and leverage still remain healthy with a reported leverage ratio at 2.7 times as of the third quarter compared to 3.2 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 2.5 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 token acquisitions of GrindX, 3S, and Barron Industries, which were acquired for $13 million, or a rough multiple of 7 times EBITDA. and bring with them a wealth of opportunity in technology and product reach. So to summarize, Quaker 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 take a moment to note that this is the last call from 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 have been achieved. I wanted to take this time to thank you, Mike, on behalf of the company for your many years of 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 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 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, that's star 1 to register any questions at this time. Our first question is coming from Mike Harrison of Seaport Research. Please go ahead.

Good morning and congratulations and best wishes, Mike, and welcome aboard, Andy. Thanks, Mike. Thank you, Mike. Good morning. And, Mike, just so you know, there's no rule saying that Chairman can't be on the earnings call. I mean, you'll be back. You know you want to face the questions and give us the hard answers. Okay. First question here is actually for Shane. This SG&A number, I know you mentioned some lower professional fees, but the sequential decline there, just trying to get a sense of how sustainable that decline is, was there any kind of two-up of accruals or anything else that might mean that it kind of comes back to a more normal level or a higher level as we get into 2022?

Thanks, Mike, for the question. 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 to $103 million of SG&A, and we topped out at $108 last quarter. So I think as you look at that trend, I think that's indicative of kind of where we are on average.

All right. And then I wanted to get to this question around pricing and around margins. And I think you guys are intentionally using this term product margins. And Shane, you got into it a little bit in talking about, you know, kind of a dollars 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 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.

Yeah, you're absolutely right, Mike, in the way you described exactly that. So we are focusing on getting our product margins, which we have internally what we call our contribution margin per kilogram for our products, getting them back to our targeted level, which were established at the beginning of the year and are very similar to, 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's always a lag effect and we've been falling behind or we've been below our target level as things just continue to progress here throughout the year. So it is our expectation that we will get back to that targeted level of product margins, that cm 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 you're right, the gross margins, even at that level, just when you do the math on this, even though we recovered raw material inflation, 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, you know, our next step is certainly, and goals is that we want to, over time, to increase that gross margin level. And that will be our next steps. But for our first step, we have to at least get the raw material inflation.

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

Yeah, it could be some modest improvement in our gross margin percentage in Q4. And then, like I said, some bigger expansion in that as we go forward. Okay.

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

Well, yeah, we had, I think there was this one, it's kind of an anomaly. There was one major shipment of products that we did in our, let's say, our mining business that when we shipped the product last year, it was shipped as a fully diluted product, so there was a lot of water content in the product, and that turns into the to a pretty high volume. And then now we more traditionally ship it more as a concentrate, which is more normal. And just to show how leveraging that was, on the overall volume impact of us, that was a little over 1% of volume decline, 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 thing that's in the past, and we won't see anything like that going forward again. So it's just an anomaly there. So we did have nice growth in general in a number of areas in the global specialty businesses, like greases were up, cans were up, you know, metal finishing. You know, a number of things were up in our businesses there.

All right. 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. Good morning. And Mike, again, congrats as well for your retirement and your future. And Andy, welcome aboard. Mike and Andy, just on the guidance, can you just unpack the guidance? It sounds like a guidance towards sales growth in the high digital digits. And this is for 2022. and EBITDA growth of low double digits. Am I in the right ballpark in those long-term trend directional numbers?

Yeah, I might phrase it a little differently, but I'm not going to argue. In general, I think we... When I use the term long-term trends, when I think about that, and let's talk first sales. So we have sales in our markets that typically... grow one to three percentage points. And then, of course, let's say on average two. And then we grow, let's say, another two to four percentage points due to market share gains. So let's say on average three. So you have three plus two. Maybe normally we would expect to see five percentage in our 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. The number of markets are going to be increasing next year. We actually see that being higher than that kind of longer-term expectation of growth there. And then, of course, from a profit perspective, if we were normally growing 5%, maybe we were growing even, let's say, 8% or something like that, something higher than that, as we leverage our growth to the bottom line. And now that will be higher than that. So that's kind of what we're pointing to. So I think, anyway, I'll just stop there. I think what you're saying is fine.

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

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

Great. And last thing, just Shane doesn't work in capital in 2021. What's your expectation in terms of a source of use here?

For 22, Dave, or for? 21, I'm sorry. So if you can see, here we are sitting 30 quarters into 21. 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 in the inventory, but we're making a concerted effort to decrease some inventory that we have on stock. from a receivables perspective, top line, Mike indicated, demand-wise. So I don't foresee working capital outflows in Q4 to match what we've seen in the past quarters, but I also don't see massive inflows either.

Right now, yes, I meant the use of cash in 21. And source of cash in 22, is that an appropriate forecast right now?

So, sorry, David, for the source of cash in 21, you said?

Any reversal of working capital trends in 22? I apologize.

22, okay. So for 2022, just in general working capital, I see, you know, 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, you know, pricing goes and sales, obviously, that depends on the unlock there. But I certainly don't see the increases, I would say, in working capital that we saw in 2021.

Yeah, it should be. I think we would expect to have 22 be a pretty good strong year in our cash flow.

Great. Thank you very much.

Thank you. Our next question is coming from John Tanwantang of CJS Securities. Please go ahead.

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

I don't know necessarily what you mean by auto revenue, but what did you want to say?

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

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

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

It's a really good question. I actually think these are 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 couldn't supply our 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 ensure, you know, there are supply chain shortages. We want to ensure our customers are being taken care of. Plus, these market share gains that we've been getting are things that we've been working on and we want to have for the long term. So we want to make sure we're able to supply those new gains as well. So those were our top priorities, and we haven't really had much hitting us as an opportunistic sale. You know, 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 customers satisfied.

And last one from the start.

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 going forward. Right. I just reinforce Mike's comments.

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

Sure. Yeah, as we've said before, I guess when we finalized things with the combination over two years ago, we said, hey, in the next, these first two years, we want to concentrate on integration, paying down debt. We're getting right close to that point now to be at our targeted ratio. And we said in the, you know, we thought 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 is the end of this year, we would expect to look and entertain and be more proactive in looking at larger deals. So that's something as we enter into next year, we will be doing that. We do feel there's some opportunities out there. They're not instantaneous things that would just have a meeting and get it, but that's things we'll be working on as we enter into 2022.

Great. Thanks so much.

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

Hi, guys. It's Dan Rizawan for Lawrence. 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? Is cross-selling now a tailwind? I know your sales process sometimes takes a couple years, but we are two years past the merger, and I was just wondering where we are with that process.

Sure. Yeah, thanks, Dan, for that. You're right. I mean, part of 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's really coming from both perspectives. So we are seeing some nice traction there where we're And that's something, Dan, we think we'll be able to continue on for a while. It's not something, and it does take a while to continue it. So this will continue for a while. But the remaining part of that growth is just really kind of getting new pieces of business that's not related to cross-selling just because we feel we have a differentiated business. model that allows us to save our customers more money and they may have issues and we can solve their issues and we're getting that business. So it's 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 aggressive or price hikes?

Yeah, that's a good question. In general, two things that are hitting us over this past year are not necessarily great and conducive to trying to gain any share is COVID, where it makes it more difficult sometimes to get into customer facilities and to get new opportunities. And the other is price increases, because you're talking about price increases instead of talking about new pieces of business and how that can save the customer money. So you're right from that perspective. But again, when you continue to look at our numbers and are looking at our net share gains, we actually are achieving pretty good share gains. So it hasn't, let's say, hurt us so far. And we'll just continue what we're doing here. And as far as the pace, you're right. We're probably, it depends where you are around the world and what customer you're dealing with, but we're probably on price increase number five or maybe even six with some customers at this point. And you have to be You know, in some ways it's an art as well as a science to do that and to manage that situation well with the customer. And 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. And 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 Sudodian Company. Please go ahead.

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

Thank you, Marissa. Thank you.

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

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

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

You mean slow down in our raw material cost escalation? Yes.

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

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

Yeah, I would say where we are today, yeah. The incremental change, while it still may be going up month over month, is considerably lower than it was when we were hitting June, July, August in that time frame. It's starting to slow down.

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

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

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

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

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

That's helpful. Thank you. And finally, more on the strategic side, to follow up on another question about you potentially starting to look at larger deals after you reach your 2.5 times net equity target ratio. in in does the current environment um um you know on the raw material side um potentially influence what you're looking to do what your strategic priorities might be in terms of type of businesses how do you incorporate uh what's going on in 2021 um and with raw material cost inflation into your thinking about m a sure yeah i i think

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

Thank you. Thank you.

Once again, ladies and gentlemen, that's Star 1 to register any questions at this time. Our next question is coming from Garo Norian of Palisade Capital Management. Please go ahead.

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

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

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

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

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

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

Yes, we are. It's 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. It's been a – I'd say we had expected to be higher this year. It's higher than our expectations are, and we expect that that will continue to ramp up over the next several years as we get back to where it was.

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

Thank you, 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 no other questions, we will end our conference call now. And I want to thank all of you for your interest today. It's certainly been my pleasure to be with you during these last 53 quarterly conference calls I've been on. And just remind everybody that our next conference call for the fourth quarter and the full year 21 results will be in late February. Thanks again for your interest in Quaker Houghton, and please be safe and well.

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