Good day, and thank you for standing by. Welcome to the Ashland Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to you to the speaker today, Seth Mrozek Director of Investor Relations. Please go ahead.

Thank you, Amber. Hello everyone, and welcome to Ashland's second quarter fiscal year 2023 earnings conference call and webcast. My name is Seth Mrozek, Director of Ashland Investor Relations. Joining me on the call today are Guillermo Novo, Ashland's Chair and Chief Executive Officer; and Kevin Willis, Senior Vice President and Chief Financial Officer. We released results for the quarter ended March 31, 2023 at approximately 5:15 p.m. Eastern Time, yesterday May 2. The news release issued last night was furnished to the SEC in a Form 8-K. During today's call, we will reference slides that are currently being webcast on our website ashland.com under the Investor Relations section. We encourage you to follow along with the webcast during the call. As a reminder during today's call, we will be making forward-looking statements on several matters, including our outlook for fiscal year 2023. These forward-looking statements are subject to risks and uncertainties that could cause future results or events to differ materially from today's projections. We believe any such statements are based on reasonable assumptions but cannot assure that such expectations will be achieved. Please refer to Slide 2 of the presentation for an explanation of those risks and uncertainties and the limits applicable to forward-looking statements. You can also review our most recent Form 10-K under Item 1A for a comprehensive discussion of the risk factors impacting our business. Please also note that we will be referring to certain actual and projected financial metrics on Ashland on an adjusted basis, which are non-GAAP financial measures. We will refer to these measures as adjusted and present them to supplement your understanding and assessment of the financial performance of our ongoing business. Non-GAAP measures should not be considered a substitute for or superior to financial measures calculated in accordance with GAAP. The most directly comparable GAAP measures, as well as reconciliations of the non-GAAP measures to those GAAP measures are available on our website and in the appendix of today's slide presentation. The video we played at the opening of the webcast today provides a peek at the truly immersive experience that Ashland provided customers when we launched eight new personal care products steeped in the foundation of environmental, social and governance, or ESG during the recent in-cosmetics global trade show in Barcelona Spain. To learn more about this range of newly launched innovations, visit our web page at www.ashland.com/incause23. Guillermo will begin the call this morning with an overview of Ashland's performance and results in the second quarter. Next, Kevin will provide a more detailed review of results in the quarter. Guillermo will then provide additional commentary related to Ashland's financial outlook for fiscal year 2023. We will then open the line for questions.

Thank you, Seth, and hello everyone. Thank you for your interest in Ashland and your participation today. Results in the March quarter were consistent with our expectations at the beginning of the quarter. Total sales for the quarter were consistent with the prior year. Our global pharma business performed incredibly well, and the inflation recovery actions taken last year and early this year continue to benefit overall results. However, to state the obvious, we continue to operate in a challenging global environment with ongoing macroeconomic uncertainty and diminished demand visibility. The demand dynamics became even more pronounced in the second half of April. Themes for the quarter were China COVID lockdown and reopening, destocking, and the impact of the winter storm. The big question now is, what is happening to volume demand? Given the historic level of destocking activities, I would reframe the question into two parts: how is consumer demand? and how is customer demand? From our position in the value chain, the historic destocking reset has clouded the ability to gauge true underlying consumer demand. Consumer demand seems to be more robust than our customer demand, given destocking. Customer destocking dynamics we saw during the December quarter have slowed but are still present in certain end markets and continued into April. The reopening of China has been slower than expected and visibility has also been muted given customer destocking. As a result, our demand has varied across segments. While demand for pharma products remains strong, we continue to see weak demand and destocking in other segments, in markets like nutrition and construction. Margins and earnings were mostly impacted by the costs associated with the winter storm at the end of last year and the absorption impact of running plants at lower demand. And we completed $200 million of share repurchase during the quarter. I will discuss our outlook and the actions we're taking later in the call.

Thank you, Guillermo and good morning, everyone. Total sales in the quarter were $603 million, essentially flat with the prior year driven by continued inflation recovery, and strong demand for pharma ingredients, mostly offset by continued customer destocking. Sales increased by 2% on a constant currency basis. Gross margin declined to 32.7%, as cost recovery by the commercial teams was offset by increased input costs and the $13 million of cost impact from the winter storm in December. When excluding key items, SG&A, R&D, and internal amortization costs were $110 million, down from $119 million in the prior year. In total, Ashland's adjusted EBITDA for the quarter was $145 million, down 11% from $163 million in the prior year. Note that unfavorable foreign currency negatively impacted adjusted EBITDA by $8 million during the quarter. Ashland's adjusted EBITDA margin for the quarter was 24%. Adjusted EPS excluding acquisition amortization for the quarter was $1.43 per share, down roughly 5% from the prior year. Ongoing cash flow was $37 million for the quarter, a large improvement from the prior year, primarily reflecting changes in working capital.

As you saw in our news release last night, we have adjusted our sales and EBITDA outlook for the fiscal year. I will discuss these changes in more detail at the end of the call, but I want to stress a few key takeaways about the changes. Our reductions to the outlook ranges are a proactive decision based upon the dynamics we saw unfold in April. We are taking inventory control, which accounts for the EBITDA reduction at the midpoint. At the low end of the range, it presumes that additional inventory control actions are required later in the year. Let me turn over the call to Kevin to review our Q2 results in more detail and then I'll come back.

Please turn to Slide 9. As Guillermo referenced at the beginning of today's call, Life Sciences delivered another very strong quarter, driven by our global pharmaceutical ingredients business. Pharma demand remains strong. Product mix was favorable. The team executed on disciplined cost recovery, all contributing to margin expansion. Unfavorable currency impact was a partial offset to the strong performance in Life Sciences. In total, Life Sciences sales increased by 18% to $240 million, while adjusted EBITDA increased by 29% to $75 million. This includes $5 million of costs related to the winter storm. Adjusted EBITDA margin increased meaningfully to more than 31%. Please turn to slide 10. The Personal Care sales were impacted by continued inventory destocking actions by certain customers. As with Life Sciences, the team continued to realize disciplined cost recovery through pricing. For the quarter, Personal Care sales declined by 3% to $167 million, while adjusted EBITDA declined 29% to $32 million. This includes $6 million of costs related to the winter storm. Adjusted EBITDA margin also declined to roughly 21%. Unfavorable currency impact was also a headwind to personal care results in the quarter. Please turn to slide 11. Specialty Additives also felt the impact of reduced demand, primarily related to continued inventory destocking by certain customers, particularly in the construction and Performance Specialties businesses. The reduced demand more than offset improved cost recovery for the segment. For the quarter, Specialty Additives sales declined by 12% to $161 million, while adjusted EBITDA declined by 29% to $34 million. This includes $1 million of costs related to the winter storm. Adjusted EBITDA margin also declined to about 21% for the quarter. Please turn to slide 12. Intermediates reported sales of $51 million, down 23% compared to the prior year, driven by consistent merchant market pricing and lower volumes of higher-value derivatives. Intermediates reported adjusted EBITDA of $20 million, a decrease of 33% compared to the prior year and adjusted EBITDA margin declining to 39.2%. Please turn to slide 13. As we reported last night, during the quarter and into early April, Ashland completed a total of $200 million of share repurchases under two separate programs. The combined programs reduced our outstanding share count by approximately 1.95 million shares or roughly 3.6%. Ashland now has $300 million remaining under the existing evergreen share repurchase authorization that was approved by Ashland's Board of Directors last year. As of the quarter closed on March 31st, we had cash on hand of about $400 million with total available liquidity of roughly $1.1 billion. Our net debt is $929 million, which is about 1.6 turns of leverage. We have no floating rate debt outstanding, no long-term debt maturities for the next four years and all of our outstanding debt is subject to investment-grade style credit terms. We're investing in our existing business to grow organically and continue to pursue our strategy of enhanced profitable growth through targeted bolt-on M&A opportunities focused on Pharma, Personal Care, and Coatings. Against the backdrop of global uncertainty, Ashland has a strong balance sheet with the flexibility to pursue our targeted growth strategy. With that, I'll turn the call back over to Guillermo to discuss our outlook for fiscal year 2023.

Thank you, Kevin. Please turn to slide 15. On our last call, we mentioned three key issues critical to the back half of our fiscal year: the expected magnitude and impact of recessionary momentum, whether there would be more of a reset or destocking impact as we move from higher demand and tight supply to a more recessionary environment, and certainly the impact of China's COVID reopening and the potential changes in the Russia-Ukraine War dynamics. Concern around the magnitude and impact of recessionary momentum continues. The reset has slowed but not ended. Although results in our fiscal second quarter were consistent with expectations, order pattern dynamics in April indicated that customer destocking has not ended. These reset actions are very customer-specific and difficult to forecast, creating a higher level of uncertainty. While we expect to gain more clarity on the destocking and market dynamics during the March quarter, visibility continues to remain low. In this environment of greater uncertainty, we are being proactive with our approach to our outlook and planning. We expect the demand for our pharmaceutical products will remain strong through the second half of the fiscal year. Inventory destocking may continue to create uncertainty for demand in Personal Care and Specialty Additives end-markets. On our last call, we indicated that given our tight capacity position on some product lines, we would control inventory, but not take bigger reduction, inventory reduction actions until we had greater clarity on the demand outlook. Ashland's inventory level at the end of March was consistent with the close of December. However, given the continued demand and macroeconomic uncertainty, Ashland will take action to reduce inventory levels in certain product lines during the fiscal third and fourth quarters. We expect an impact of approximately $20 million related to these inventory control actions during the second half of our fiscal year. If customer destocking persists or consumer demand weakens through the June quarter, we may take additional inventory reduction actions. If destocking resides and the market demand normalizes in line with historical recessionary performance, we will be well positioned to capture incremental volume and lower inventory reduction actions. As such, we're adjusting our sales outlook range for the fiscal year to $2.3 billion to $2.4 billion and adjusting our adjusted EBITDA outlook range to $580 million to $610 million. As I've stated before, this is a time for caution. We will continue to operate with strong capital allocation discipline so that we are in a strong financial position to invest and grow our core business. These changes reflect our current forecast, downside absorption risk, and upside market strengthening potential. Our customers remain resilient, but are clearly taking actions to reset inventory levels consistent with new global demand expectations. We will remain focused on the things we can control: driving innovation, maintaining operating discipline, managing pricing, mix, cost productivity, and capital allocation. Please turn to Slide 16. In closing, I want to restate the key takeaways from the quarter. The results for the March quarter were consistent with our expectations. Our global pharma business performed incredibly well. The inflation recovery actions taken last year and early this year across Ashland continue to benefit overall results. We're being proactive in inventory management based upon the dynamics we saw unfold in April. We are taking inventory control actions which account for an EBITDA reduction at the midpoint of our new outlook. At the low end of the range, that includes any additional inventory control actions required later in the year. Despite the challenging environment, we remain confident in the quality and resilience of the markets we serve and in the future. I want to thank the Ashland team once again for their leadership and proactive ownership of their business in an uncertain environment. With that, thank you everyone and let's move to Q&A.

Thank you. Our first question comes from Christopher Parkinson at Mizuho Securities. Chris, your line is open.

Thank you so much for taking my question. Guillermo, I just wanted to dig a little bit deeper on the guidance revision. What would you say to those investors listening on this call that believe that your updated guidance range for the second part of the fiscal year is not 'completely derisked'? You mentioned that there's the possibility of further deteriorating macro environments for additional destock; would your midpoint include an additional destock to augment the initial $20 million that you're sitting in your PowerPoint, or would it be something different? Just any additional color you could add on the investor's perception of this and the potential for additional inventory actions in the context of guidance would be particularly helpful. Thank you.

Okay. Yeah. From the actions that we're taking right now, the $20 million would be actions we're taking which we would execute during the third and fourth quarter that would put us into the midpoint of our range. Any additional actions would require that there's destocking. I think, in the third quarter, if it continues longer than expected or in the fourth quarter, if consumer demand really gets impacted. The biggest concern we have right now is more the destocking, which is where we have less visibility; but that would require additional actions and that would take us to the lower end of our range. Equally, if the destocking is lower, and things normalize, we would be well-positioned. We have the inventory to pick up incremental volume, and we would ease off on the upside on the inventory actions.

That's very helpful information. One of the topics you addressed during your November 2021 Analyst Day was the need to enhance performance in Personal Care, as it was the last business segment that showed some inconsistency. Life Sciences, on the other hand, has not posed any issues, and the outcomes clearly reflect that. As we consider the necessary adjustments, let's assume that the downtime from the facilities amounts to over $15 million plus $20 million in inventories. When we look at these adjustments alongside the midpoint of fiscal year 2023, and I’m speaking hypothetically rather than about 2024, do you still have confidence in your Personal Care portfolio to continue growing? Can you leverage not just price and cost but also mix and new product growth, some of which I believe Seth mentioned were recently launched? Has your confidence shifted at all over the past six months due to the current macroeconomic uncertainties? I would appreciate your insights on that. Thank you.

I would like to differentiate between the long-term outlook and our current direction, which is driven by innovation. We have strong confidence in our upcoming programs later this year and will share more about our innovations, which are quite exciting. This area is undergoing a significant shift towards more natural and clean beauty, reflecting the themes showcased in the video. We are well-positioned for growth here. Within the Personal Care sector, there are various segments, and the shift from tight markets and high demand to a more normalized recessionary environment is affecting our customers in different ways. Much of the current activity is driven by destocking, which is adding to the challenges. Currently, hair care has performed well, while high-end skin care has seen a bit of a slowdown, particularly due to travel restrictions in various parts of the world, such as Asia. In Oral Care, we are experiencing destocking related to products like denture adhesives. This situation varies by segment, and much of the disruption is a transition from the dynamics of 2022 to those of 2023. These are significantly different, and we are undergoing a challenging reset, which you may also observe in other companies. Our customer base reflects varying circumstances; different companies are facing distinct situations, largely depending on their market segments. Our long-term confidence remains intact, focusing on innovation, and we continue to invest with great enthusiasm in our portfolio.

Thank you very much.

Please hold for our next question. Our next question comes from Joshua Spector of UBS.

Good morning. This is Lucas Beaumont on for Josh. So I was just wondering, could you give us a bit more detail on the guidance changes you're making? So you're cutting your sales by $250 million, but EBITDA by only $20 million. So what are the offsets there, please?

So let me make some comments, and then Kevin, you can give a little bit of color on the segment level. The segments that are getting impacted are not uniform. So there is some different impact between sales and EBITDA based on the margins. Areas, what's interesting for us right now, the segments that have been impacted the most in destocking now are not our core; necessarily, our core pharma is doing well, as we said. Personal Care has been segment by segment; Specialty Additives actually coatings have slightly down, but it's not as big of a surprise. Most of the areas are in our Performance specialties, which are a broader base of industrial type markets: inks, lithium-ion batteries, catalysts. So it's a broader range. Specifically, I would point out our nutrition and construction in Europe were the most impacted. Those tend to be product lines and spaces with much lower gross profit margin for us. So the impact there is some gross profit impact. So there's a difference there, but it's mostly in the absorption side that we're getting impacted. So it's really going to be segment by segment that is driving that. But Kevin, do you want to add any other color on any specific segments?

Yes, just a little bit. You covered it really well. So I think the combination of lower margin segments that saw more destocking like construction and nutrition was certainly part of the story. I think as we look back Q1, we were still within the revenue range. We didn't talk much about that. I mean, we talked more about the EBITDA range and kind of where we expected to be. But frankly, based on where we were forecasting back in Q1 call revenue has not really dropped $250 million from that standpoint. It's a lower number. So when you combine those things, it's less gross profit, therefore less EBITDA impact, but that's really primarily the story. And our SG&A is a little bit lower as well, which also helps.

Great, thanks. And then in terms of your updated guide for the second half, it's implying EBITDA of about $340 million. What are you assuming in terms of phasing between 3Q and 4Q? Traditionally, 4Q is seasonally lower, but would that be bigger this year with the recovery that you're assuming?

I believe we are returning to a more typical seasonal pattern. The last two years, we experienced some disruptions due to supply constraints and the inflation issues we faced in 2021 and 2022. Therefore, we are expecting a more normalized performance this year. Typically, the third quarter tends to perform slightly better than the fourth quarter, but this year they will likely be more comparable. Last year, our fourth quarter was somewhat weaker, so we are moving back to a typical level, with both quarters expected to align more closely than in previous years.

Yes. A couple of things to add to that as well. I mean, we had the impact of the winter storm that's rolling through the first half. Obviously, we don't expect that to repeat in the second half to Guillermo's point. We tend to be stronger in Q3 and Q4 than we are in Q1 and Q2 just in general. And we've also been very focused on cost control and we'll see some of the benefits of that more on the operations side roll through in the second half as well.

Great. Thank you.

Please hold for our next question. Our next question comes from Michael Sison at Wells Fargo.

Hi, guys.

Hi, Michael.

Just a couple of questions on Personal Care. When I think about each of the buckets that you have: skin care, hair care, oral care, household, obviously, two of them are doing well, two of them are struggling a little bit. But in the hair care and household side, is there destocking there? Is that something that we need to worry about, or has that just been really good growth and that you guys have seen in that business? Those two sides.

I would say that destocking is more related to specific customers rather than segments. This applies to all segments, not just personal care. One of the challenges is that we don't have full visibility. We do notice variations in skin care and other areas across regions. Some of our higher-end skin care products, for instance, have been affected, particularly due to travel impacts in Asia in segments where we typically perform well. Overall, we still see strong performance in hair care. In skin care, as we move past destocking and into the summer season, we anticipate an increase in travel and a boost in sun protection. We'll be closely monitoring the dynamics of each segment. Home care is a smaller segment for us, predominantly consisting of additives, which are used more broadly. Our main focus is on personal care. Oral care presents additional challenges as it's a concentrated market regarding both customers and products. We've experienced some destocking in our significant position in venture adhesives. So it varies by segment and customer. In the same segments, we've seen some customers increase their stock or remain flat while others have destocked, reflecting their strategies from 2022.

Got it. And then, I know you have new capacity that you're scaling up soon. And as I recall, it was late because customers really wanted more of your product. How do you think about sort of timing now, given things are weaker? Will you delay it, or does it just make sense to bring it on and start maybe specking in with customers?

Yes. I believe some of these projects are significant, particularly HEC, where we're focusing on our core businesses instead of secondary markets. The areas experiencing the most impact are not where we are investing. HEC will still have a fundamental need for new capacity, and we anticipate being among the first to fulfill that need. We are not postponing the project. A few months ago, we lacked significant volume in our business plan; it was primarily pricing since we did not have the capacity. We need that capacity based on the consumer market. This year involves a reset that we must navigate to understand the true consumer demand. If demand stabilizes, we will still require the volume and will invest accordingly. There are a few projects we are managing in terms of timing, although we may not advance as rapidly as we would like next year. However, we still see a need for core volumes moving forward. I want to highlight that the current destocking indicates a tendency for demand to shift, so if demand normalizes while others are destocked, we might experience some positive fluctuations. This is indeed a turbulent period, and we prefer to position ourselves with a robust balance sheet to drive results through our inventory management. As we’ve mentioned before, we’re not undertaking unnecessary risks, so we aim to be responsible with our capital. If volumes increase, we will expand. Furthermore, where we are reducing inventories, it is primarily in lower-margin businesses. We are well-positioned in the higher-end markets, ensuring that if demand increases, our ability to supply remains unaffected. On the lower end, if demand surges and we struggle to supply, we will adapt. We shouldn't have high inventory levels in the higher segments.

Got it. Thank you.

Please hold for our next question. Our next question comes from John McNulty of BMO.

Yes, good morning. Thanks for taking my question. I guess, similar to the last question, I think investors were pretty comfortable that you were sold out in a lot of the businesses in Personal Care and Specialty Additives. And now, we've got this big inventory destock to work through. Does that make you rethink what the supply/demand actually really was last year? And did the supply chain problems of last year kind of mask what real demand was versus everybody grabbing as much as they could? I guess, how should we be thinking about that and what the normalized supply demand is for things like HEC?

Yes. I would split out HEC from the others. I mean, HEC, the demand has been stronger. We are seeing adjustments across the chain. But I would say, specifically, if you look at coatings, it's been a little bit softer. Some customers have actually been very strong across the region. So, there's been noise there, but that's really not what the biggest issue has been; it's really been other segments driving it. So, our lower-end segment CMC and construction; these are not areas that we're investing in for new capacity, necessarily. So, that's really where we're seeing a lot of the noise. And so we feel confident on the core markets and where we're going. We feel confident that the market demand will be there longer term that the capacity is needed, and we'll continue to invest. In the areas where we're seeing the biggest impact, we are not adding capacity. So we'll continue to manage with the asset and the capacity that we have today.

Got it. Okay. And then, with the destocking that you're doing internally like the self-help or writing to the right levels, whatever, can you help us to think about how much working capital that releases as we kind of look through the second half of the year and into early next year?

The old rule of thumb is that for every dollar of absorption, there is a need for a two-dollar inventory reduction. I am currently focused on figuring out how to reduce that ratio so we can better manage our variable costs as we take these actions. While this is still a work in progress, that's the general guideline we have. Kevin, do you have anything to add?

Yes, that's right. So, John, if we do the full $20 million, and again, it's going to be spread over the back half of the year based on our current thinking. So, we'll do it as we need to. But we're planning on the full $20 million at this point while we adjust the numbers. That would imply $40 million to $50 million of inventory reduction.

Okay. Great. Thanks very much for the help.

Sure.

Please hold for our next question. Our next question comes from Mike Harrison at Seaport Research Partners.

Hi. Good morning.

Hey, Mike.

I was hoping, Guillermo that you could give us a little bit more color on what drove the strength in the Life Sciences margin. If we back out some of the winter storm impacts, you were 300 or 400 basis points higher on that margin level than you've ever seen before. How sustainable is that?

Okay. I think what you're seeing, one, we did take pricing action to recover inflation last year, and we continue to benefit from that like all the other segments. But it's really the mix change. Pharma continues to be very strong. And some of the segments that are getting impacted and in the destocking and all that are the low-end segments. Nutrition has been a big impact. It's a few big customers that have been taking massive steps on inventory reduction. And in the nutraceutical those tend to be lower-margin segments for us. So, strength in the stronger pharma segment, weakness in the weaker lower-margin segments, and that's what's shining through. There is still some noise, I would say, in the quarter because of the freeze, there were some impacts there. But as you look at normalization, it's going to be more about that mix dynamic.

All right. Thank you. And then I wanted to maybe understand the volume impact that you saw in the Specialty Additives business. I think volumes there had to be down high-teens or maybe even 20% year-on-year. Is there any way to break out how much of that is destocking, how much of it's weakness in areas like construction and specialties? And how much of it is architectural paint demand? And is this volume weakness impacting your ability to hold pricing within that Specialty Additives business?

I think the main change is not in the coatings sector, where we are maintaining a strong position. In coatings, for instance, North America is experiencing a decline in DIY, but contractors are performing well globally. Latin America remains strong, and in Asia, major customers are increasing their market share as financial conditions tighten, affecting midsized companies. While there is some disruption in coatings, it isn't the primary concern. The most significant issue has arisen in our Performance Specialties, which is quite fragmented. We observed a substantial slowdown in Specialty Additives, particularly in April, where order intake for both Personal Care and Specialty Additives dropped significantly, primarily among midsized customers. The larger distributors have completed most of their destocking, so the slowdown is more pronounced among regional players and midsized customers in various areas. This trend aligns with our Performance Specialties focus. Although we do business with larger clients, our engagement spans inks and automotive sectors, which are quite broad. This is where we saw the most significant decline across our portfolio. It appears that the situation is more of an inventory reset rather than a complete halt in purchases or shifts in market share. We see it as many customers adjusting their inventory levels rather than stopping their orders.

All right. Thanks very much.

Please standby for our next question. Our next question comes from David Begleiter at Deutsche Bank.

Thank you. Guillermo, in the destocking, do you think it will be done by the end of the June quarter? And is there any evidence of that in your May order books?

I believe that the destocking process should be concluding towards the end of the third quarter, particularly for the larger segments. When considering the most affected areas, nutrition and construction stand out. The destocking in nutrition began in our second quarter and is ongoing, but it will eventually come to an end. Customers can only hold off on orders for so long, so I anticipate that this will normalize. In construction, we are monitoring the situation, especially since most of our operations are based in Europe. With summer approaching, we’ll see how things unfold. Our focus will shift from general discussions to understanding the true consumer demand and its impact on inventory levels. I expect this transition to become evident in the third quarter. In terms of Performance Specialties within Specialty Additives, this issue is more widespread. We are experiencing smaller volumes, especially with midsized customers, even those that are considered large in sectors like automotive. Adjustments in this area are likely temporary, but they may take a month or two to resolve.

And can you discuss the price cost tailwind you saw in the current quarter and the cadence of that how that might increase in the back half of the year?

We are maintaining our pricing, though we are experiencing pressures in specific areas, particularly in intermediates. While we are performing better than historical levels, BDO has decreased, and we are navigating through challenges with other intermediates. In some of our lower-end segments, we are addressing the volume and pricing dynamics in nutrition and similar areas. Overall, our core performance remains strong. Regarding raw materials, there is a general improvement, although not all prices are decreasing. Cellulose remains stable without significant declines. Energy costs have improved, and butane prices have seen some positive movement. The petrochemical aspect, which includes many process chemicals we utilize, has seen slight improvements. Although caustic prices have improved, they remain very high in Europe, still around twice the historical levels. This variability is expected to continue, but we anticipate further improvements in the future. We have successfully protected our margins against inflation, and we have managed to increase them. We will work closely with our customers as market conditions improve, but we are proceeding with caution since raw materials prices are not decreasing significantly. Many companies are still confronting other inflationary pressures, such as labor costs and lower production volumes impacting plant loadings. Therefore, we expect it will take a few more months to work through these market challenges.

Thank you.

Amber, do we have additional questions?

Our next question comes from John Roberts at Credit Suisse. John, your line is open.

Thank you. Are you seeing a divergence in the price for BDO that you use internally with the price for the BDO derivatives that you sell externally?

So, BDO pricing market prices, and that's a much more broad-based material going into many different segments have come down. Our transfer pricing internally has also come down. The intermediates there is a linkage, but they're delinked right now in terms of supply demand just based on the markets that we serve, which were one of the few merchant players in North America and Europe, and more segments that are in region sourcing the battery lithium-ion battery being a big segment for us.

And secondly, could you give us an update on the M&A environment? It looks like you beefed up your capabilities there recently.

We are actively managing our inventory destocking while maintaining our long-term focus across all segments. Our emphasis on innovation in pharmaceuticals, specifically oral solid doses and injectables, remains strong. In Personal Care, the shift towards natural technologies is ongoing. We are expanding our portfolio in coatings, and we will be more focused on innovation and new platforms later this year. These initiatives present significant long-term opportunities for growth. Our M&A activities are targeting these areas specifically, as we believe there will be opportunities. We are ensuring a balanced approach to capital allocation, preferring to invest in bolt-on acquisitions rather than building inventory for short-term gains. We can create greater value through disciplined investment, and we anticipate improved valuations in the current market.

And also, John, just as a reminder, we're also investing organically in our pharma business as well. I mean, while we look for M&A opportunities, we're also expanding both our Klucel and Benecel footprint at existing facilities to increase capacity and those businesses continue to do really well. So, it's going to continue to be a balanced approach. And we're not favoring one over the other. We want to be very balanced in all of that. And you should continue to expect us to do so.

Thank you.

Please hold for our next question. Our next question comes from Laurence Alexander at Jefferies.

Good morning. What are you seeing in terms of the cadence of client inquiries about new projects and what they're telling you about their R&D budgets? Is any of the choppiness the past few quarters had any impact on the interest in pursuing new R&D projects with our new development projects with you? Can you just talk about what the kind of cadence of incoming activity is like?

Yes. I would split it in two groups. I mean, the pharma is very long term, so they don't tend to move around and look through some of these short-term hiccups. Obviously, the market continues to be strong. But that part of the portfolio continues to be very robust and steady, both in our oral solid dose with the main primary pharma, as well as generic producers. Injectable portfolio continues to grow. So we're very happy with the pharma side. I would say in the personal care and the specialty additives side, the innovation hasn't slowed down interest commitment; I mean, personal care. All our customers have made big commitments in terms of their switchover of technology. So that has not changed. I do think in 2022 and into this year, maybe some of the short-term focus has been more in reformulating looking at cost, looking at alternative raw materials last year. So there has been a little bit of noise in maybe the near-term cadence. But I don't think we've seen anything that's changed in terms of the longer-term more strategic focus areas in their reformulation work.

And if I may just two follow-ons on that, I shouldn't reformulation activity should be, if anything, a better return on capital for you, because you have basically the solutions in the library and you're differentiated that way? Or is it just too competitive and some other aspects? And then, just on the Pharma side, if Biotech funding ever comes back or when it comes back at scale, do you have parts of your business that would materially benefit from that?

Yeah.

Or are you just sort of two downstream?

Okay. Well, let me start with the last question. We would benefit. If you look at a lot of the biotech both in the oral solid dose and in the injectables, a lot of the new biotech drugs have been more in injectable form. So we are working with some of these polyresorbable polymers. We're expanding our portfolio of High Purity Piping, so we want that into the injectable area. But you look at for example some of the mRNA applications. Lipids have been the big focus area. And a lot of companies, looking at delivering some of these new drugs, using some of these polyresorbable polymers, so that they can go to higher use level. So there's a lot of interest. We're working not just on mRNA new cancer drugs, things of that nature with our customers. We've expanded into the animal health, also working with customers there to maybe accelerate some of the developments in some of those segments. So a lot of activity that I think is exciting for us. Equally, I would say in the oral solid dose, the big change would be can they start delivering some of these new biologics in oral form. And we see opportunities for new technologies there, and we're working with some customers on that front.

And just on the Pharma side.

We have an extensive portfolio, and when it comes to reformulation, we consistently collaborate with our customers. Our regional presence includes a strong lab network, allowing us to work closely with them to optimize their formulations by replacing raw materials that are in short supply. This necessitates a rebalancing of formulations, which is a key part of the innovation process in Personal Care. In this area, there are two main types of innovation activities. First, we focus on developing new ingredients and introducing them in collaboration with central teams and our customers to secure their approval for inclusion in their core ingredient lists. This allows our regional labs to incorporate these ingredients into new products. We engage in both cutting-edge innovation and formulation work, enabling the integration of both new and existing ingredients into improved formulations.

Okay. Great. Thank you.

Please hold for our next question. Our next question comes from Jeffrey Zekauskas at JPMorgan.

Thanks very much. Have you changed your idea of cash flows from operations for the year or free cash flows and that your cash flow for the first six months is pretty minimal?

Let me make a comment, and Kevin can provide additional insights. The cash flow impacts from last year and into the first part of this year, particularly concerning inventory resets, have resulted in significant cash usage due to inflation last year. As we move forward, this is one of the reasons we're focusing our cash on capital expenditures that Kevin discussed earlier in the call, which includes investments in HEC, Klucel, Benecel, and higher-end segments. Inventory has been a drain on our cash, and we aim to prevent that from continuing. We've also executed some share repurchases. Kevin, do you want to add any further details on cash flow and the outlook for it?

Free cash flow typically tends to be stronger in the second half of the year, which is when we usually generate the majority of our cash. If we maintain our working capital and actually decrease inventory, I would anticipate that cash flow in the third and fourth quarters will be quite solid.

And then lastly, is the trend in operating income in intermediates and solvents downward or upward or flat?

The trend in the intermediate segment has clearly softened. We don't sell much BDO, but if you look at our total segments, BDO pricing has decreased, resulting in lower internal transfer pricing. This change benefits our downstream operations at the expense of intermediates, which we are observing. Although we don't sell a large volume of BDO, we have experienced price erosion in the small amount we do sell. I believe as the market reopens, it will shift toward high-volume segments like fibers and polyurethanes. Our focus is on where we allocate our swing volume, as BDO is not central to our business. Our core areas are NMP and BLO, especially since a significant portion goes into lithium-ion batteries. There is substantial investment happening in the US and Europe in this area. While there has been some slowdown and inventory corrections, 2024 looks promising with new capacity coming online and considerable investment in energy transformation for both regions. We are well positioned as a major supplier, and although we've decoupled our pricing somewhat, NMP and BLO will experience more volatility compared to other parts of our portfolio. Currently, they are not tracking with BDO but are moving independently based on their own factors.

Great. Thank you very much.

Thank you for your question. At this time, I would like to turn it back to Guillermo Novo, Chairman and CEO, for closing remarks.

Great. Amber, thank you so much and thank you everybody for your questions and your interest. We will be on the road over the coming weeks. Hopefully, we'll get a chance to meet many of you and answer other questions. But we appreciate your interest and look forward to seeing you soon. Thank you.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.