Earnings Call Transcript - MTX Q2 2022

Erik Aldag, Head of Investor Relations

Thanks, Jennifer. Good morning, everyone, and welcome to our second quarter 2022 earnings conference call. Today's call will be led by Chairman and Chief Executive Officer, Doug Dietrich; and Chief Financial Officer, Matt Garth. Following Doug and Matt's prepared remarks, we'll open it up to questions. I'd like to remind you that beginning on Page 15 of our 2021 10-K, we list the various risk factors and conditions that may affect our future results. And I'll also point out the safe harbor disclaimer on this slide. Statements related to future performance by members of our team are subject to these limitations, cautionary remarks and conditions. Now I'll turn the call over to Doug. Doug?

Doug Dietrich, Chairman and CEO

Thanks, Erik. Good morning, everyone, and thanks for joining the call today. We've got quite a bit to go over, so let's get started. I'll walk you through the highlights of our results and what contributed to this record quarter. Then Matt will give you details on our financial results and share our outlook for the third quarter. To conclude, I'll provide some highlights from our 14th Annual Corporate Responsibility and Sustainability Report, which was published Wednesday. Let's get started with a recap of the quarter. This was a remarkable quarter for MTI with record sales of $557 million, record second quarter operating income of $74 million and record earnings per share of $1.50. This performance is the result of our team's execution over the past several years on some key fronts; delivering on our strategic growth initiatives, driving continuous operating improvements and disciplined capital deployments. To begin, MTI sales were up 22% versus the prior year and up 27% on a constant currency basis. Every product line grew and contributed to double-digit growth in all three of our segments. We saw growth in every region, in North and South America, in EMEA and in Asia despite lower sales in China due to the COVID situation there. This performance was the result of our broad-based approach over the past several years to grow the company both organically and inorganically. It's also the result of our pricing actions and value selling efforts to offset the significant inflation we've experienced over the past 12 months. Our operations performed well, and our team coordinated seamlessly to overcome persistent challenges and meet market demands, address consumer needs as well as identify and create efficiencies to drive profitability. Supply chain and labor challenges persisted. However, our teams navigated these issues and continued to demonstrate their agility in dealing with the evolving market landscape. We saw higher-than-expected inflationary cost pressures in the quarter of $43 million compared to last year, and our pricing actions accounted for $47 million. I'd like to note that we absorbed $4 million of this cost inflation without pricing adjustments because we couldn't begin to pass through this cost contractually until July 1. Our culture of disciplined cost control and continuous process improvement was on full display this quarter, maintaining efficient overhead spending and integrating two acquisitions, driving our SG&A as a percentage of sales down 160 basis points. The result was operating income of $74 million, a record for the quarter. And despite the significant cost pressures, our margins ticked slightly higher. From an investment standpoint, we maintained our discipline and balance with capital deployment. We acquired Concept Pet, returned $26 million to shareholders through share repurchases and dividends and invested $21 million in capital expenditures to support our facilities and organic growth. All in all, we had a very productive quarter. We're executing well on numerous fronts, and we're well positioned to sustain our strong performance. Now I'll take you deeper into some of the underlying drivers of our record performance this quarter. As I alluded to earlier, our growth strategy is multifaceted. It consists of positioning ourselves in faster-growing markets and geographies and accelerating the development of new products and technologies. It also includes the disciplined acquisition of companies that help accelerate these efforts, further balance our portfolio and expand our technologies and capabilities. For the past several years, we've been executing on each of these fronts, and the second quarter is in part a representation of the results. This quarter, our sales increased 27% over last year, a robust figure that was broad-based and driven by four areas: 7% revenue growth from base revenue growth, 2% from new product sales, 8% from acquisitions and the remainder from price increases implemented across our product lines. Let me take you through each of these components in more detail, starting with the base organic growth. Over the past several years, we've been positioning ourselves in faster-growing markets and geographies, expanded into consumer-oriented markets, which are characterized by favorable secular trends. These trends such as growing pet ownership, consumer preference for over-the-counter functional cosmetics and increased demand for high purity edible oils are driving higher levels of sustained revenue growth. Demand for these products is also more resilient and will lessen the impact of cyclicality on our total sales, balancing the industrial side of our business. We've been benefiting from these macro trends and market positions. Our household and personal care product line, which includes many of our consumer-oriented products, has grown at a 17% compound rate over the past five years. Including acquisitions in this product line, it's grown organically at a 6% compound rate, illustrating the stability and growth potential of these products. In addition, we continue to penetrate growing regions with our high-value products. Our sales of pre-blended greensand bond products in the two largest foundry markets, China and India, have grown at 9% and 20% annually over the past five years. For many years, we've been penetrating growing regions with our latest PCC technology, and this month, we signed an agreement to construct a 43,000-tonne PCC satellite plant in India, which will feature our first deployment of MTI's sustainable NewYield LO PCC technology. This technology is a combination of our traditional PCC technologies, while at the same time, repurposing a paper mill waste stream, saving the customer's money and alleviating a waste disposal challenge. The acceleration of product development and commercialization to meet new customer demands and the transition of our portfolio to more sustainable solutions is having a noticeable impact on the top line. Sales of new products are on track to increase 38% over last year. As I mentioned, our newest products drove 2% of the overall organic growth that we saw this quarter. Some examples of these new solutions are our latest edible oil purification products, which grew 29% versus last year. These products create higher purity, longer shelf-life edible oils. And we're developing new products targeted at the rapidly evolving market for biodiesel. In pet care, we commercialized new fragrance and dust control formulations for customers in our North American market and introduced new product offerings tailored for Asian markets, where sales grew 15% over last year. Personal Care, our Health and Beauty Solutions business, has been supporting several new active skin care products over the past few years with our delayed release retinal technology. Our capabilities to support customer formulations and provide them packaging solutions has driven continued growth in this product line, and sales this quarter grew 13% versus last year. We're also benefiting from the general market appetite for sustainable product and process solutions. We've invested in R&D to expand our portfolio of sustainable solutions. And as a result, the majority of our new products in development, 65% in fact, feature aspects that benefit our customers' sustainability goals. We're also moving into higher tech value-added solutions for our industrial customers. For example, our Refractories business is offering a higher tech solution to improve the safety and productivity of steelmaking. Our solution uses laser-guided systems to measure and collect data on steel furnaces, and automates the application of the refractory material. These systems yield more accurate measurements of furnace wear and lining degradation than conventional methods while also collecting data to enable predictive maintenance through analytics. Not only is this valuable information, but it keeps furnaces running longer without the need for remedial repairs, saving our customers money. Most importantly, it removes people from proximity to a high temperature environment. Our PCC business is also developing new technologies to scale into the growing packaging market. Last year, we signed a contract with Asia Symbol in China to deploy GCC technology in the whiteboard packaging market. And we have new technologies currently in trial with our customers that target additional white and brown packaging applications. We also bolstered our growth in the second quarter by 8% from acquisitions, including Normerica, Concept Pet, and the Specialty PCC facility in the Midwest. These acquisitions accelerated our movement into growing markets and geographies. They are progressing well. And through them, we see avenues for additional growth and value creation. We have an active pipeline of other M&A opportunities that will support our growth objectives, and importantly, we have the balance sheet strength to execute on them. The ability to adjust prices given the inflationary environment has been a key topic for many companies lately, and as you can see, a significant portion of our sales growth this quarter came from our pricing actions. We price our products on the value they provide, and we are uniquely positioned in the marketplace through a combination of our technologies, our applications expertise, and our global mineral reserves to provide supply stability and continued value to our customers. We have deep long-term relationships with our customers and we engage and partner with them to ensure we deliver the solutions they need. In summary, this quarter represents many aspects of the execution of our growth strategy, but it still doesn't show our company's full potential. We are a higher growth, more resilient company with more opportunity ahead. This, combined with our demonstrated ability to navigate challenges gives us conviction that we'll continue on this strong trajectory. With that, I'll hand it over to Matt to discuss the financial results and our outlook for the third quarter.

Matt Garth, CFO

Thanks, Doug. I'll review the second quarter results, the performance of our segments and our outlook for the third quarter. Following my remarks, I'll turn the call back over to Doug to provide some highlights from our recently released sustainability report. And now let's review the second quarter results. Total sales in the second quarter grew by 22% year-over-year to $557 million. And excluding $21 million of unfavorable foreign exchange impact, sales growth was 27% above the prior year. Sales increased by double digits across all three segments. And as Doug detailed, the increases in sales were balanced across contributions from our acquisitions, improved volume and mix, and higher selling prices. Second quarter operating income, excluding special items, improved by 15% compared to the prior year to $73.5 million. The year-over-year operating income bridge, on the lower left side of the slide, shows that we continued to implement selling price actions to offset the impact of inflation. In total, we delivered $46.6 million of selling price increases compared with $43.1 million of inflationary cost impacts. The inflation consisted of approximately 60% raw materials, 30% energy and 10% logistics. Contributions from our acquisitions, continued strength in our Refractory segment, and higher activity in our project-oriented businesses drove a favorable volume and mix impact of $9.6 million. Now shifting to the right side of the slide. The sequential sales bridge shows that sales improved by 7% and were 8% higher when excluding the impact of foreign exchange. The sequential operating income bridge shows an improvement of 8% driven by stronger volume and mix. We experienced higher-than-expected inflation, primarily due to energy and logistics costs, which resulted in a temporary lag between price and cost on a sequential basis. And we expect to fully make up this gap in the third quarter with pricing actions and contractual adjustments that began on July 1. Reported earnings per share were $1.36. We incurred special items of $4.3 million after tax, consisting of acquisition-related transaction and integration costs, a noncash pension settlement charge, and litigation costs. Excluding special items, earnings per share for the company were $1.50 in the second quarter, a record EPS performance amidst a significant inflationary environment that underscores the team's agility and the earnings power of the company. And now let's review the segments in more detail, beginning with Performance Materials. Second quarter sales for the Performance Materials segment were $300 million, a 26% increase compared to the prior year and 10% higher sequentially. Sales in household, personal care, and specialty products increased by 37% year-over-year, driven by our pet care acquisitions and continued strong performance from our portfolio of consumer-oriented products. Our fabric care, personal care, and edible oil purification businesses each delivered double-digit growth versus last year. Increased project activity helped to grow sales in environmental products and building materials by 36% and 6%, respectively, compared to last year, and Metalcasting sales were 10% higher than the prior year and were 11% higher sequentially. Our North America greensand bonds business experienced strong demand in the second quarter, more than offsetting lower sales in China, where we saw reduced volumes amid local COVID restrictions. Segment operating income increased by 12%, both sequentially and versus prior year to $38.9 million and operating margin improved by 20 basis points sequentially to 13% of sales. As we look ahead to the third quarter, we anticipate demand for household, personal care, and specialty products to remain strong, albeit with typical seasonality in our pet care business. In Metalcasting, we expect seasonal foundry outages in North America to be offset by recovering volumes in China. We see a similar strong performance from our project-oriented businesses as the strong order book for environmental products should offset slowing activity levels in Europe for our building materials business. In addition, we expect to continue to adjust our selling prices to offset the impact of inflationary costs. Altogether, we see a similar level of operating income sequentially for the segment. And now let's move to Specialty Minerals. Specialty Minerals sales were $164 million in the second quarter, an increase of 15% year-over-year and 1% sequentially. Global PCC sales increased by 15% versus last year, driven by higher selling prices as well as volume growth in our Specialty PCC business. Processed Minerals sales increased by 16% year-over-year and were 5% higher sequentially on higher selling prices as well as continued strong demand in the construction and consumer markets. Operating income for the segment improved by 10% sequentially to $20.2 million, and operating margin improved by 100 basis points as the impacts from our selling price actions offset the impact from inflationary cost increases. Recall that this segment has been the most impacted by energy inflation, largely as a result of rising European energy costs. This segment also has the largest proportion of price lag, so we'll see a recovery of these costs in the third quarter given contractual time and adjustments. As we look to other third quarter factors, we expect a moderate recovery in China that will offset seasonal maintenance outages in PCC. In addition, demand in Specialty PCC and Processed Minerals is expected to remain strong. In total, we expect a similar level of operating income sequentially. And now let's continue on to the Refractory segment. Refractory segment continued to perform well in the second quarter. Sales were $93 million, an increase of 25% year-over-year and 11% sequentially, driven by higher volumes and selling price increases. Operating income was $16.2 million as the sequential benefit from higher volumes was offset by energy and raw material-related cost increases, most notably in Europe and Turkey. And operating margin remained strong at 17.4% of sales. As we look to the third quarter, we see another strong overall performance for the segment. However, we anticipate some moderation in steel market conditions in Europe, and we expect raw material and energy inflation to continue. As a result, we expect operating income will be lower sequentially by approximately $2 million. Now let's take a look at our cash flow and liquidity. Second quarter cash from operations was $33 million and free cash flow totaled $12 million. Cash flow was higher compared to the first quarter. However, it was lower than last year due to increases in working capital. In the first half of 2022, our working capital has increased $92 million due to the significant growth we are realizing as well as the inflationary impact on our inventories and accounts receivable. As we've discussed previously, we also have some strategic inventory positions, which we put in place this year, and we expect to draw down these inventories by the end of the year. Our strong growth and the persistence of the inflationary environment is resulting in a longer working capital build, which means a portion of our expected 2022 cash flow will likely move into the next calendar year. As a result, we now expect free cash flow this year to be in the range of $100 million to $125 million. Importantly, our working capital efficiency measured in days of working capital has remained the same as last year, and the company's cash flow generation capability remains strong. Capital expenditures during the second quarter were $21.2 million, and we repurchased an additional $24 million of shares under our $75 million repurchase authorization, bringing the program to date total to $52.5 million. At the end of the second quarter, total liquidity was approximately $426 million and our net leverage ratio was 2.3x EBITDA. We continue to maintain a strong balance sheet, providing ourselves with the flexibility to continue to invest in high-value growth opportunities both organically and through M&A. Now let me summarize our outlook for the third quarter. On balance, we see similar conditions to the second quarter with order book strong, consumer-oriented demand continuing solid, and higher sales in China compared to the prior quarter. However, we are monitoring a few risks to this outlook. First, the China recovery may take longer than expected. Second, the inflationary environment may continue at a higher rate than expected. And third, general demand in Europe may be impacted by higher costs for energy and raw materials. Overall, and depending on how these factors play out, we expect operating income in the third quarter to be $2 million to $3 million lower sequentially and earnings per share in the range of $1.40 to $1.45. We remain confident in the team's ability to remain agile in the face of challenges, and we continue to see full year earnings per share in the range of $5.60 to $5.70. I'll now turn the call back over to Doug to review some of the highlights from our 2021 sustainability report.

Doug Dietrich, Chairman and CEO

Thanks, Matt. Before we end the call today, I'd like to take a moment to highlight the publication of our 14th Annual Corporate Responsibility and Sustainability Report. This report provides a comprehensive overview of our wide-ranging ESG efforts for all stakeholders. Equally as important, it describes who we are as a company, our values and how sustainability is embedded into our strategy, our thinking, our product development and our people. One highlight you'll see in the report is that we've not only met but exceeded 5 of the 6 2025 environmental goals we set for ourselves back in 2018. Because we've surpassed those initial goals four years early, we've reset them to more aggressive reduction targets. I encourage you to read the report to understand our safety-first culture, the acceleration of our sustainable product portfolio and our numerous initiatives around employee engagement, diversity inclusion as well as community outreach. I'm extremely proud of all of our employees and their commitment to these efforts. Their contributions and teamwork have driven the progress we've made advancing these objectives. Again, I encourage you to review the report, which is available for download on our website. Now let's open the call to questions.

Operator, Operator

And we'll hear first from Daniel Moore with CJS Securities.

Daniel Moore, Analyst

Maybe start with Metalcasting, drilling in a little bit. Just to contrast what you're seeing in Asia and China specifically in terms of the pace of recovery there versus North America. Whether you're seeing any signs of softer demand in real time? And your kind of outlook beyond the next quarter, in general? That would be really helpful.

Doug Dietrich, Chairman and CEO

Sure. Lots of strong demand so far in North America. Asia, obviously, slow in the second quarter, but rebounding. Jonathan Hastings, you want to take us through what you're seeing in more detail?

Jonathan Hastings, Analyst

Sure, Dan. I'll begin with North America and then address your question about China. In North America, as Doug mentioned, we have very strong demand and are seeing a rebound in the auto sector. Inventories are quite low across most segments. The heavy truck and municipal market sectors continue to perform exceptionally well, and we expect this to persist into the third and fourth quarters. Our discussions with foundries suggest no upcoming issues that should hinder this progress. Regarding China, as you noticed, the COVID shutdowns affected demand, but we have been actively collaborating with our customers and leading foundries, who have been testing new products. We are also growing our market share. We've started to see a rebound in demand, particularly in the last couple of weeks, although it took a bit longer than anticipated after the easing of some COVID restrictions. As various sectors of their economy recover, we expect to see an increase in demand over the next few months. Global estimates for auto production are still around 6% year-on-year, factoring in both North America and Asia. Overall, we've seen strong recovery signs in China, robust performance in North America, and strong activity in Southeast Asia and India as well. If demand continues to rebound, we will be in a favorable position compared to 2021 and poised for future growth. I hope that provides clarity, Dan.

Daniel Moore, Analyst

Very much so. And maybe switching over to environmental products and construction technologies. Obviously, seen nice recovery there. Demand has been building. Any pause to that? Or are things still picking up nicely despite some of the kind of inflationary and global macro dislocations?

Doug Dietrich, Chairman and CEO

Yes. Dan, you've hit it right on the head. We've seen strong demand. Our order books for Q3, for example, in environmental in North America are above 100%. So full order books. That is expected to continue. We see that with municipal landfills. We see with some coal ash products and mining projects. We've got the waterproofing for building, and infrastructure projects continuing to roll as well. In Europe, because of the economic pressures, we have seen some projects starting to slide. That may be the willingness to spend in the economic environment that they're in right now. That has mostly affected our building products markets. However, if you would go further around the world, Australia, for example, very strong with building products. So we've kind of got a mix when you look at it in EP and BM. But overall, the strong North America markets seem to be offsetting what we're seeing elsewhere, especially in Europe, et cetera. So that's kind of the status of the EP, BM right now. Of course, we're taking the time to invest in our technologies. We're working with the customers. Like I said, the order book is good. So we've built a business over the past couple of years. We've been trying to lay in the foundations of new technologies and new manufacturing processes, and that seems to be shaping up real well as demand continues.

Daniel Moore, Analyst

Excellent. Last for me, and I'll jump back. Just in general, inflation, it's been remarkable and your ability to respond to it, it's been pretty remarkable. But is there any areas where you're seeing it taper a bit or even signs where you could see a little bit of favorability and all those pricing actions turn to maybe higher margins in a couple of quarters? Still early to tell, but any signs of relief?

Doug Dietrich, Chairman and CEO

No, inflation has persisted. Matt explained that much of the inflation we are experiencing is related to energy or a result of energy, and we do not expect that to change at this moment. There are a few areas where prices had stabilized, particularly with some raw materials sourced from China, but this stabilization may have been more about supply-demand dynamics in the second quarter. We will observe how that develops in the third quarter. Currently, we are seeing ongoing increases at least through the third quarter. At the beginning of the second quarter, we had an expectation for that period, and ultimately our costs were $10 million more than anticipated. As we sit here today, we have some long positions on various items, some of which we are unable to cover long-term. It’s possible costs may end up being even higher. Certain areas might stabilize, but as Matt noted regarding Specialty Minerals and our contractual pricing, that will stabilize as well, allowing us to recover that pricing and improve our margins. The current pricing reflects our target margins, and we aim to regain those margins. However, the ongoing increase in costs creates delays in passing those costs through. When those costs stabilize, we expect to see those target margins return. Additionally, we still have more work to do with some of our acquisitions, as we are integrating and catching up on costs we've faced this year. As I mentioned last quarter, the synergies from Normerica have experienced about a quarter delay because we were addressing price adjustments there. This issue is largely resolved, and we anticipate that value will start reflecting in the latter half of the year. Therefore, you will likely begin to see an expansion in the margins. However, if we continue to incur an extra $10 million each quarter and need time to pass that through, there will be a corresponding delay. But you will see that progress unfold, Dan.

Operator, Operator

And our next question comes from Mike Harrison with Seaport Research Partners.

Mike Harrison, Analyst

Congratulations on a great quarter. I appreciate the detailed breakdown you provided on the base volumes, pricing, and acquisitions. It effectively illustrates your efforts. I wanted to ask specifically about the household and pet care business. Regarding the 37% growth you experienced, I assume that most of this was due to acquisitions. Could you clarify the contributions from organic volume, pricing, and acquisitions? I also suspect there may have been some foreign exchange impact. Any insights into the household and pet care business would be helpful.

Doug Dietrich, Chairman and CEO

Yes, I believe that most of that growth, around two-thirds, was due to acquisitions. We're still incorporating Normerica, which we didn’t have during the second quarter of last year, and we've also added the Concept Pet acquisition. So, to clarify, two-thirds of the growth is from acquisitions. Additionally, there has been some negative impact from foreign exchange, particularly since Concept Pet and Sivomatic operate in Europe. However, I want to emphasize the long-term potential of our household and personal care business. Even with the acquisitions over the last three years, we've seen a compound growth of 17%. If we exclude the impact of foreign exchange, it has grown at 6%, which holds true across various cycles. We believe that with our new positions and expected growth in Asia, this 6% will increase. Thus, we anticipate a growth rate in the high to mid-single digits throughout the cycle for this business. We also see other opportunities to enhance growth through additional acquisitions. Our strategy is focused on entering growing markets that are experiencing favorable trends, such as increasing pet ownership, which has been stable. This quarter, our growth in that area was 15%. These elements reflect our strategy and will help sustain stable growth moving forward. Although you didn't specifically ask about it, I wanted to mention our initiatives in bleaching earth, specialty products, and health and beauty systems. The same strategy applies there, focusing on markets with higher stable growth rates driven by consumer preferences. We have purposefully positioned ourselves in these areas, and the growth rates we've achieved are the result of our efforts. I know this is more detail than you requested, but I wanted to provide that context.

Mike Harrison, Analyst

No, I think it's understandable to view that segment as primarily pet care, but there are many other promising uses for Bentonite glaze that you are exploring. I appreciate that insight. I was wondering if you could provide some information about your exposure in Europe, particularly regarding energy rationing. Can you discuss how your main facilities in Europe, including production plants, mines, and PCC satellites, are affected by natural gas dependence for electricity? Additionally, what contingency plans are you considering if the situation worsens as we approach winter in Europe?

Doug Dietrich, Chairman and CEO

Yes, it's certainly a challenging situation that could develop in Europe. Our sales in that market account for about 23% to 25% of our total sales as a company. To break it down further, approximately 27% of that is from paper, another similar portion is from pet care, and the remaining third comes from refractories. While these categories represent the majority, there are also other segments like animal health included. Our paper business relies on energy from the host mill, meaning we will adjust our operations according to their status. If large paper mills face extended shutdowns due to curtailments, we will experience similar impacts. In our pet care business, energy consumption mainly occurs in Turkey and the Netherlands, but we can adjust our operations in response to energy cycles as needed, similar to our construction technologies and refractories businesses. Much of our energy use is concentrated in Poland and Turkey, which have been relatively stable in terms of supply, although not necessarily in price. In the event of curtailments, we can manage by adjusting our plants to accommodate those downtimes. Overall, the paper aspect is one we can't control, as it depends on the actions of the host mill.

Mike Harrison, Analyst

All right. And then the last question I had is just on the litigation cost special item. It says in your press release, this is related to a number of cases seeking damages for exposures related to your talc products and operations. What is the number of cases? And can you characterize a little bit better what kind of exposures and what kind of damages these plaintiffs are seeking? And I guess is there something that you've already recorded as a reserve liability? Or I guess how should we think about the potential liability here?

Doug Dietrich, Chairman and CEO

The charge is related to two factors. One is the higher litigation costs due to an increase in the number of cases we're facing. The other is a one-time cost associated with preparing for a potential trial while also creating a more efficient way to manage the cases from an information perspective. We've taken steps to handle the case load effectively. Historically, we've had a small number of talc cases over the past decade, and we have never had any settlements, verdicts, or payments against us. Most of these claims have been meritless. Currently, the situation in the talc industry, particularly concerning Johnson & Johnson and others, has drawn more attention, resulting in a rise in cases. Importantly, we have never supplied Johnson & Johnson and are not involved in that situation. Our talc business is relatively small, valued at $50 million and operating under the subsidiary Barretts Minerals. We anticipate ongoing litigation, but at this moment, we consider all these cases meritless and do not see any liability associated with them. There are about 420 cases right now, which is quite modest compared to the over 33,000 cases faced by others in the industry. Presently, we do not view any potential liability as materially significant or financially impactful to the company.

Operator, Operator

And we'll hear next from Steve Ferazani with Sidoti.

Steve Ferazani, Analyst

I wanted to inquire about working capital and cash conversion. Clearly, inventories are increasing due to higher dollar values, inflation pressures, and rising volumes. I'm trying to understand when you anticipate a reduction in inventory as supply chain issues improve, and whether you expect stronger cash conversion in the latter half of the year.

Matt Garth, CFO

Yes, Steve, I think you got the inventory component right. And the drivers around that: higher volumes requiring a higher level of inventory to feed those volumes. Also, the inflationary factors that we've been talking about and some of the costs have been going into inventory, obviously. Second component of that is the strong pricing that we've been talking about and the higher volume also driving the accounts receivable dollars up. Again, our efficiency is very, very consistent over the last several quarters, exactly where they were here in the second quarter to where they were last year. So I feel good about that. The cash conversion component of that, though, like I said, really just gets pushed out a little bit. We do have a normal seasonal build in working capital that happens in the first half. Second half of the year, we do see some release of that as we have some seasonality in those as project-oriented businesses come off. And so there's typically a working capital release on the third and fourth quarters. This year, any year really, we come into it expecting about $150 million. That working capital that we've absorbed, just pushing out a bit of that in terms of timing. So as you see inflationary factors start to level off, as we talked about earlier, that's going to release some of that working capital. The strategic inventories we talked about; we should be releasing those as we move further through the year. And then also from the strong growth that you're seeing on the top line that is driving that AR side, as you see some of that moderation take place versus a year-over-year consistency, that will also release some of that inventory. So that's why we're saying pushed out to the next calendar year. And so that means that kind of $30-plus million of free cash flow that we would expect here this year, all things being equal, we would expect that next year.

Doug Dietrich, Chairman and CEO

Steve, if I can add, if you examine the history of our cash flow cycle and generation, you'll notice that there have been times when the cycle does not align with earnings. In 2018, we experienced a high-growth period, resulting in cash flow of $120 million that year. The following year, it increased to $180 million. Additionally, during the downturn in 2020, we generated a significant amount of cash, reaching nearly $175 million. We go through these cycles, but we do not believe there has been any change in the company’s cash conversion rate or cash capability. As Matt mentioned, with inflation stabilizing, we anticipate that our cash position will prepare us for a larger than average year in 2023.

Steve Ferazani, Analyst

Makes sense. When I think about that, cash on your balance sheet is still quite significant, and you expect to build next year. Does the timing of that affect your capital allocation priorities and your thoughts on spending in different areas?

Doug Dietrich, Chairman and CEO

No, it doesn't. We do look at it in one area, but that's not related to cash conversion. We have confidence in the company’s cash generation. Currently, we are under a $75 million share repurchase program, with around $22 million to $23 million remaining. We are likely to complete that program. In terms of capital expenditures, out of the $80 million, about $35 million on average annually is allocated to maintenance capital for our facilities and safety, which we will continue. We also consider our growth capital expenditures, and moving forward, we might adjust some of those assumptions based on market conditions and growth potential. We review how quickly we can utilize that expansion, for example. While we always assess this, some deployment may change in the future. We aim for a balanced approach regarding share repurchases, mergers and acquisitions if opportunities arise, and continued investment in ourselves. We believe the company’s cash conversion remains stable and can support all three initiatives.

Operator, Operator

And there are no further questions at this time. I'd like to turn the call back over to Mr. Dietrich for any additional or closing remarks.

Doug Dietrich, Chairman and CEO

Thanks, Jennifer. I appreciate that. Thank you to everyone for joining today. I encourage you to visit our website and check out our sustainability report. It provides a comprehensive view of our company and highlights the efforts of our employees in advancing our sustainability initiatives. Please take a look. I'm happy to answer any questions you may have after you review it. Thanks again for your time today.

Operator, Operator

And this concludes today's conference. Thank you all for your participation. You may now disconnect.