Element Solutions Inc.

Good morning, ladies and gentlemen, and welcome to the Element Solutions Second Quarter 2020 Financial Results Conference call. I will now turn the call over to Yash Nahedi, Associate Director, Corporate Development and Investment Relations. Please go ahead.

Good morning, and thank you for participating on our Second Quarter 2020 Earnings Conference call. Joining me this morning are Executive Chairman Sir Martin Franklin, CEO Ben Glicklich, and CFO Terry Dolman. In accordance with Regulation FD or Fair Disclosure, we are webcasting this conference call. Any redistribution, retransmission, or rebroadcast of this call in any format that the express written consent of Element Solutions is strictly prohibited. During today's call, we will make certain forward-looking statements that reflect our current views about the company's future performance and financial results. These statements are based on assumptions and expectations of future events that are subject to risk and uncertainties. Please refer to our most recent SEC filings for a discussion of the most significant risk factors that could cause actual results to differ from our expectations and predictions. In the earnings release and supplemental slides issued and posted today, Element Solutions has provided financial information that has not been prepared in accordance with U.S. GAAP. The definitions and reconciliations of these non-GAAP measures to comparable GAAP financial measures refer to the release and slides which can be found on the company's website at www.elementsolutionsinc.com in the investor section under news and events. It is now my pleasure to introduce Ben Glicklich, CEO of Element Solutions.

Thank you, Yash, and good morning, everyone.

Like last quarter, I'll begin by thanking those on the front lines of the fight against the coronavirus, the healthcare workers, first responders, hospital staffers, and others going to work every day around the world helping the sick and protecting their communities have our deepest appreciation. We also thank our suppliers and our customers who have overcome a great deal to remain open and keep our supply chains flowing to support their communities and our markets. The pace of adaptation in our supply chain has been remarkable. Nearly all of our facilities were open throughout the second quarter and our team adjusted to remain productive despite substantial disruption to our normal business cadence. I'm very proud of how our team has stepped up to the challenge of COVID without losing focus on their other longer-term activities. Navigating this pandemic has only added to the workload for our people. And while we've had to actively prioritize, we've not lost momentum on key projects in innovation, organizational transformation, or otherwise. We have a world-class organization that has demonstrated its prowess these past five months. Entering the second quarter, our visibility was limited. We can only speculate about the depth and duration of the impact of COVID on our markets in Europe and the Americas. The depth of the decline in demand in our industrial and automotive-oriented businesses in Q2 was significant. It was expected that April would mark a trough, but May was worse. Net sales in May were down 23% year over year. This was primarily driven by our industrial and assembly businesses in the Americas and Europe, which have significant exposure to the automotive sector. Entering the quarter was expected our customers in the sector would begin reopening in early May. And while some did, the pace of reopening was slower than the industry anticipated and suffered from stops and starts. Automotive production in the second quarter was down dramatically in the U.S. and Europe. Nonetheless, our financial results exceeded our expectations going into the quarter. We generated $85 million of adjusted EBITDA on net sales of $387 million. Despite net sales declining 15% organically, we preserved year-over-year adjusted EBITDA margin. Adjusted EPS in the quarter was 18 cents. We began to see a recovery in businesses in June and into July, while our high-end electronics business remained resilient throughout. Driven by wireless infrastructure investments and data center demand, momentum in our circuitry and semiconductor businesses from Q1 carried into Q2. This strength partially offset the decline in our more industrially oriented business. Our semiconductor business grew nearly 20% year over year in the second quarter. This is a smaller business for us, but a strong one. And with growth like this, it should not remain smaller for long. As our higher margin businesses generally outperformed, mix improved in the second quarter, which together with fixed manufacturing cost management allowed us to hold our gross profit margin steady despite the sizable reduction in volumes. We were able to mitigate the impact of the decline in revenue on adjusted EBITDA margin through continued cost actions in both COGS and SG&A.

Adjusted EBITDA margins improved modestly year-over-year.

Once again, we have demonstrated our ability to preserve profit in spite of considerable top-line pressure. This is one of the hallmarks of our business. OBEX declined $16 million compensation expense, lower travel expense, and other cost management actions, as well as the contribution from various government initiatives to address the impact on businesses from the pandemic. Importantly, we have not fundamentally restructured our talented workforce because we believe our markets will recover.

We are not damaging the long-term growth potential of these businesses. The other hallmark of our business is strong and stable cash flows.

This was once again on display in the second quarter. We generated $61 million of free cash flow in Q2 and more than $110 million of free cash flow in the first half. That compares to $86 million in the first half of 2019 on an adjusted basis. So year over year, our top line declined 8% in the first half, while free cash flow increased 29%. Terry will now take you through a result in a little more detail. Terry.

Thank you, Ben.

Good morning, everyone. On slide four, we provide some additional color on the performance of our two segments. In electronics, we saw an organic net sales decline of only 6% year over year. The assembly business was soft, primarily due to prolonged shutdowns throughout the automotive supply chain, where our business is a key supplier. While Europe and America declined in conjunction with the broader auto in these regions, Asia was mixed, with China showing strength also by softness in India. Both circuitry and semiconductor had strong second quarters, with organic net sales above the same period in the prior year. Continued momentum in 5G infrastructure investment, as well as increased demand for data center and cloud infrastructure, provided a positive market tailwind. Adjusted EBITDA margins in this segment were roughly flat, as positive product mix and effect savings were offset by the effects of fixed costs. Organic net sales in industrial and specialty declined 26% versus last year. The industrial solutions vertical drove most of this decline, down approximately 35% organically in the quarter as COVID-related automotive shutdowns and general economic softness impacted all regions. The graphics business, which showed double-digit growth in Q1 as demand for consumer packaging surged, moderated to a small decline in the second quarter as CPG companies delayed the launch of new products and their volumes normalized. Significant oil price volatility drove declines in energy solutions, as operators reduced inventory and postponed drilling activity in response to the uncertain macro environment. The outsized declines in the industrial solution drove positive gross margin makes in the quarter, which despite lower volumes, helped the segment expand gross margin approximately 40 basis points. Despite material affect savings in the segment in the quarter, adjusted EBITDA margins in INF still declined, as the overall dollar value of net sales decline was not fully offset. While our business has a significant variable cost component that we are able to flex in tough market environments, we have to balance short- and long-term objectives when making spending decisions. We believe we struck the right balance in the second quarter in reducing costs without damaging the growth potential of these businesses for the long term. On a consolidated basis, operating expenses were down $16 million, or 10% year-over-year, a quarter on a constant currency basis. Reductions in travel and discretionary expenses drove approximately 40% of the savings year over year. Compensation expense reductions, including temporary salary reduction, furloughs, long-term variable compensation, and government subsidies drove approximately 30% of the savings. We also continue to deliver ongoing savings through continuous improvement cost activity, which explains the rest of the variance. While travel cost reductions should continue to some degree in the third quarter, we have already rolled back some furloughs and salary cuts as you see demand activity starting to recover. Similarly, government subsidies are hard to predict, and we believe we have seen most of the expected benefits already. On slide five, we cover cash flow in the balance sheet. We generated $61 million of free cash flow in Q2, which takes into account our $23 million semiannual bond payment made in June. This is almost double Q2 2019 cash flow, despite the far more challenging backdrop. Working capital release was a large source of cash in the quarter as we focused on collections and managing inventory to reflect the demand environment. We have not seen any material issues with that debt, and our inventory build from the first quarter leads BII as an opportunity into the second half. Nonetheless, we do expect to build some working capital back in the second half as we expect to grow the top line sequentially. Cash taxes in Q2 remained lower year over year in line with lower earnings. CapEx is always modest in this business, and while disciplined, we have not sacrificed any significant spend this year. We remain focused on long-term growth. Free cash flow should remain strong in the second half, and we are revising up our full year 2020 free cash flow expectations to more than $185 million. Net leverage at the end of Q2 remained unchanged from Q1 at 3.2 times adjusted EBITDA, as our strong cash flow mitigated the effect of a decline in earnings. As noted last quarter, we drew on a corporate revolver in March out of an abundance of caution, but then paid it down entirely in mid-April. Our liquidity position remains in excess of $500 million. We did not repurchase any shares in the quarter, as we still have employees on reduced wages and furloughs. However, we remain committed to deploying strategic capital to compound earnings per share, while remaining under our targeted net leverage ceiling of 3.5 times adjusted EBITDA throughout 2020.

With that, I will turn it back to Ben. Thank you, Kerry.

Given the ongoing impact and uncertainty of COVID-19, we intend to continue to give only quarterly rather than longer-term guidance until the macro environment becomes more clear. Our Q3 guidance is for adjusted EBITDA of at least $80 million. While our markets are improving, we remain cautious that macro conditions may impede the recovery in demand we are seeing over the short term. July is shaping up to be about 5% better on the top line than June, but still about 10% down year over year. The sustainability of the current recovery depends on many variables that are unknowable today, so we do not think it's prudent to guide to an up and to the right recovery in demand. Our industrial and assembly businesses show strong sequential quarterly top line growth as their markets begin to recover, but we still expect them to be down on a run rate basis more than 10% from 2019 levels at year end. In our high-end electronics business, we believe inventory buildup in the first half accounts for some of the sales strength we have seen year to date, so we expect that strength could moderate sequentially in the back half of the year. Overall, the long-term macro trends in the electronics business are robust and encouraging. While we intend to continue managing costs prudently, several of the cost benefits we saw in the second quarter will not repeat in the second half. We rolled back some of our salary reductions in July, and we do not expect the same level of impact from government subsidies in Q3. The combination of modest sequential net sales recovery, product mix, and discrete OPEX increases underpins our third quarter adjusted EBITDA guidance. Should the recovery be more robust, there is upside to our adjusted EBITDA guidance. On a full year basis at June 30th rates, FX is a headwind to adjusted EBITDA of $8 million against 2019, of which we've crystallized $5 million in the first half. About $2 million will impact Q3. On our Q1 call, we projected full-year 2023 cash flow to be at least $175 million, which we are now increasing to $185 million. The implied front-loading of half-over-half cash flow generation is due to the working capital investment we expect to see with sequential net sales growth. The other drivers of cash flow, as Carrie mentioned, should be relatively stable. We believe our ability to provide a full-year 2023 cash flow outlook in the absence of a full-year adjusted EBITDA guidance, differentiates our business. We've demonstrated in our first 18 months of ESI that our businesses can generate strong cash flow in all markets. With regard to how we deploy that cash flow, I'd make a few comments. With adjusted EBITDA declining year over year, we intend to be prudent with our capital, given our targeted ceiling of 3.5 times net debt to adjusted EBITDA. Nonetheless, despite those parameters, we remain a growth-oriented company, and we continue to evaluate modest bulk on acquisitions of businesses that are better as a part of ESI, bring us talent and new capabilities, represent good value, and can accelerate our growth rate. We view our own shares as an attractive acquisition alternative as well when trading below what we believe is their intrinsic value. We do not plan to buy shares until we finish rolling back salary actions company-wide, which we expect to do before year-end. We do, however, continue to consider modest tuck-in acquisitions that improve our portfolio. Before turning to questions, I want to reiterate a comment I made on a Q1 call, that this crisis is making Element Solutions a better company for its customers and for its employees. It continues to bring our team together. The relationships we have built across the organization are lasting improvements. At the same time, we've shown our workforce, which is the very foundation of the company, that we are committed to them even in difficult times. We've shown our customers that we can supply them from many locations around the world in the midst of an unprecedented supply chain disruption. In addition, our confidence in the criticality of our solutions to high-growth supply chains has been reinforced. we've also seen the value of our diversification. Through this trying period, we've proven our industry leadership, which would further yield profitable growth in the inevitable market recovery. With that, operator, please open the line for questions.

At this time, if you would like to ask a question, please press the star and one keys now on your touchtone telephone. That is star one on your touchtone telephone. One moment while we queue for questions. And we'll take a question from Steve Byrne, Bank of America. Your line is open.

Yes, thank you. Good morning, Steve. Yes, good morning. You have a very strong functional area in metallization, and I just wanted to ask you about what you're seeing in terms of trends in that technology in either your autos or electronics and markets. Is there – Is there any changes in, you know, new products or new technologies in metallization?

Yeah, it's a good question, and yes, metallization, circuit board metallization is one of the core focus areas for our circuitry business. It's a market that moves slowly, so innovation is incremental development as opposed to radical change. And we are on the leading edge of that development. Obviously, circuit boards are getting more complex as more functionality is coming into them, as smartphones have more capabilities, as automotive circuitry becomes more demanding in terms of what is required in a car, in the computer of a car. You know, we're seeing more flex circuits. We're seeing more high-density interconnect circuits. And we're seeing more direct metallization. And that's an area where we are differentiated in a market leader, which is using alternative to electrolytic plating, which is lower cost, but still quite strong margins for us and better for the environment. So there is some incremental development there, but nothing radical in terms of change. And it's a growth market for us, for sure.

Well, thank you, Ben. And maybe a more broad question in R&D, the R&D expense line, Adam, seems to be quite variable from one quarter to the next. I don't know whether you had any particular challenges in the second quarter with R&D staffing. How did they manage the COVID risks and maybe just – Maybe one more extension on that is anything that you see coming out of the R&D capabilities that give you excitement about a new technology or a new product launch?

Yeah, absolutely.

It's a good question, Steve.

So the comparability of Q1 to Q2 is a little bit apples and oranges because we acquired a piece of technology in the first quarter for our offshore business. and it was categorized as SG&A, and that was about $6 million in Q1. So Q1 to Q2 was a decline because of the absence of that, but we really haven't cut R&D spending year over year. A little bit in compensation expense, which is associated with some of the salary reductions we did, but we are continuing to invest in R&D at an equal pace, to what it's been historically. As Carrie mentioned and as I mentioned in our prepared remarks, we're investing in long-term growth for this and in this business. And the savings that we've generated have not come at the expense of long-term growth. With regard to COVID and how our R&D function has been operating, indeed, it's hard to innovate from home. And, you know, our innovation team works at the bench in our facilities, we have done things to allow for them to continue to work in our facilities with social distancing in place. So, for instance, we've got an early shift and a late shift, or some people come in, work a full day, but they come in early, and then the second shift comes in lunchtime and stays late. So, we have been nimble to allow for our innovation team to continue to be productive despite the disruption. that we've seen. With regard to exciting innovation in the pipeline, as I said to your first question around metallization, this is a business that really relies on incremental development as opposed to breakthrough technology. There have been some compelling, I call them more breakthroughs, around our silver sintering process that's used in power inverters for power electronics. And we have some other things on the come that are very exciting and will allow for us to maintain industry leadership from an innovation standpoint and contribute to the above market growth that we aspire to.

And once again, to ask a question, that is star one on your touchstone phone. That is star one. We'll move next to Josh Spector of UBS. Your line is open.

Yeah, hey, good morning. Thanks for taking my question. So you guys continue to discuss growth infrastructure, particularly around 5G developments. I was curious if you could characterize maybe how much of your sales or earnings benefited from growth in that market. And really what I'm thinking is kind of as I look towards 2021 or relative to 2019, how much higher should like base earnings be, you know, assuming that auto markets eventually recover to some Just trying to think how much additive that is to your base case assumptions.

Sure. Thanks for that question, Josh. So with regard to wireless and Internet infrastructure investment, we are clearly benefiting from that this year. And you can see that in what we call our high-end electronics, in the circuitry and semiconductor businesses that have continued to grow despite what we've seen in the broader macro environment. And, you know, so if you look at our semiconductor business, it's growing 20%. The circuitry business grew more modestly in the second quarter. It is more broadly exposed. But what's supporting that growth is infrastructure investment, Internet and wireless infrastructure investment. One of the comments we made around our guidance is that we expect Some of that growth to abate as we look towards the second half. We attribute some of that outperformance to inventory bills. We haven't seen that in July or into August. So, you know, that's a bit of upside as we look out into Q3. And the demand for this investment is not a one-year trend, right? This is a multi-year trend where base stations and then 5G phones will continue to be invested in around the world. And so it should underpin, you know, continued strength in that high end electronics market into next year and the years beyond that. And so as you think about recovering to the big, you know, baseline for next year, I think the critical assumption is around the industrial economy and automotive, which is where we have struggled this year. as units have declined. We've outperformed those markets, but units have declined significantly. The circuitry business, the semiconductor business, those will continue to grow nicely into next year.

Okay, thanks. I guess, did I hear you correct in that you haven't seen inventories? Inventory destocking has been in effect yet to date this quarter. In those businesses, I guess I thought that some of that would be you know, some of the headwinds that you talked about in terms of your guidance sequentially?

Yeah, it's a good question, Josh. And so maybe I can frame the guidance a little bit in response to that, right? So I think the place to start around our guidance is that our culture is one of delivering on our commitments, right? And in an uncertain environment like this one, you know, that leads us to set our targets conservatively. So our most impacted end markets are recovering There's still a risk of setbacks in that recovery. Those are macro risks. They're not company-specific risks. And so that is what's, you know, driving us towards a more conservative guide of at least $80 million of EBITDA. Part of that is also an abatement, sort of an abating in the strength we saw in the circuitry and semi-businesses. I would say that July was stronger than our forecast coming into the quarter. And so we've built some additional cushion to the outlook. It was stronger both in the auto business, recovering, I'd say, modestly better than we had expected, and that abating in electronics hasn't come through in July. The first few days of August have seen a continuation of that trend. So from where we stand today, we've built some cushion relative to the guidance that we've given. And we feel pretty good about that.

Okay, thank you.

And once again, to ask a question, please press star 1 on your touchtone phone. One moment while we queue.

And once again, that is star 1 on your touchtone telephone. One moment while we queue. We'll take a question from Anthony Walker of Goldman Sachs. Your line is open. Hey, good morning, guys. Thanks for the question.

Good morning. Just to follow up on the question related to guidance, I can understand the unwillingness to capitalize the improvement that you saw in July. But if we did see sustained volume improvement, how should we think about the incremental margins that you could produce on the lower autumn soil fixed costs?

Yeah, it's a good question, Anthony. And so a couple of variables to discuss in that regard. You know, on the one hand, Some of the OPEC savings that we recorded in the second quarter won't recur, right? So we've rolled back some of our salary reductions, some of the subsidies that we received from a variety of governments around the world where we operate. You know, we're not counting on those coming through as well. So those are real. You know, we talked about 5-ish percent top line growth into July. Some of that growth is coming from recovery in the more industrially oriented businesses, which are slightly lower margins. But we're still seeing continued resilience and performance from the higher margin electronics businesses. So, you know, our thoughts around cost are that cost doesn't come unless there's revenue. So margins should maintain at these levels with that cost coming in and with that revenue growth. If not, on the margin improve.

Got it. And then maybe just drilling down into those comments around your profit expectations. As you mentioned, I assume those higher sales result in some operating leverage. Could you just maybe break out the magnitude of the lower subsidies, the furloughs that you expect to reduce, and how those compare to the additional structural cost opportunities that you identified and expect to take out in the second half? Thanks, guys.

Yeah, sure, Anthony. So OpEx was down $16 million year over year. You know, about a third of that is lower G&E, right? So we're traveling far less given the pandemic, and we would expect that to persist into the third quarter. The remaining $10 million is split between compensation actions and some of the government subsidies. The government subsidies are you know, $4 or $5 million and the rest is compensation actions. Not all of those compensation actions have been unwound, but a good portion of them have been. So, order of magnitude OPEX, you know, growth sequentially should be, you know, more than $5, less than $10 million. And then the permanent improvements that you spoke to, there's a couple million dollars of that in the second quarter. And we're working very, very hard to improve the cost structure of this business to get better quality outcomes at lower costs through the implementation of technology. We're making great strides in that regard, but there's no silver bullet. And so that continuous improvement is a journey that will be on for several years. The opportunity associated with that is tens of millions of dollars, but it will come in small chunks over time.

Great, thanks, guys. Thank you.

Our next question is from John Tanwantang of CGS Securities.

Your line is open. Sir, your line is open. Oh, can you hear me? Hey, John. Yeah, we can hear you.

Can you hear me now? Yes. Oh, great. Good morning, guys. Thank you for taking my question. My first one, I heard your comments on the auto industrial business being strong through July and into August. I'm wondering, just in your discussions with customers, have you heard them telling you that they plan to be producing through what will be normally seasonal downtimes in Q3? We've heard that some of those auto OEMs are doing that industrial. They might be going through some restocking. Just wondering what kind of commentary you're hearing from your clients in that regard.

Yeah, it varies by region and by customer, John. It's a good question. You know, in the U.S., we heard that the major OEMs, some of them were going to have their summer shutdown, some weren't. That was a good signal, and we still believe that. In Europe, by and large, the summer shutdowns will occur. So August should be slower than July. That's our expectation. And, you know, it's too early to say anything different just four days into the month.

Got it. And so to be clear, the conservatism you're, I guess, referring to in your outlook on the sales side is coming from the electronics business where you maybe there might be a destocking situation going forward.

I put it in two buckets, John. One is, you know, as I said earlier, We attribute some of the strength in the first half in electronics to inventory builds. And as I said earlier, we haven't seen that play out in July or yet in August, though it's early. And some of it is just associated with the macro risk and the uncertainty of the global economy. You know, as we said in our prepared remarks, we don't want to underwrite to an up into the right recovery in demand given how fast-moving you know, the pandemic, the virus has been, you know, we're a company's culture is delivering on its commitments. And so we want to give ourselves that opportunity in multiple different scenarios for the demand recovery.

Okay. And then I may have missed this earlier, but can you give us a little more color on the oil field in the CP market? I noticed in the press release that, or maybe in your slides, they were a little bit weaker in the quarter. I'm wondering what the update there is. Especially in oil field, I thought you'd expect a fairly strong demand in the back half of the year just based on what your customers are producing, not necessarily.

Yeah, so on the energy business, two dynamics I would call out.

The first is that our customers have inventory of our fluids, and so they've been using that inventory, and they didn't replenish as much in the second quarter. That's a one-time impact, right? That's just cash preservation from customers that are struggling in a market that's struggling. The customers will be fine, but they're trying to preserve cash. And the second, there's an FX impact, a disproportionate FX impact in that business. We do a lot of business in Brazil, and obviously the RAI has moved pretty significantly. And so that's impacted results in the energy business. With energy price volatility, we do expect to see some tapering off of drilling activity in the back half. But the production activity should be steady. And so the customers will have to replenish their inventories and get back to a more normal ordering pattern. And so we still believe that to be the case. And so Q3 should be stronger than Q2 in that regard. With our graphics business, Obviously, Q1, there was a huge surge in that business driven by consumer behavior. What we're seeing is that the major CPGs are delaying launching of new package designs, just given the economic environment. New package designs translates to more orders for us, and so that business is a little softer from an outlook standpoint. And so that explains those two comments, John.

Back later this year, and it's just a timing thing, or is it maybe something that might be pushed out?

I think that it's likely a next year recovery, right? I don't see – these package design launches take a while, and we don't expect them this year. Okay.

And once again, to ask a question that is star 1 on your touchtone phone. That is star 1 on your touchtone phone. We'll move next to Jim Sheehan from Chewist Securities. Your line is open.

Good morning, Ben. Could you discuss the reasons why you maintained your head count through this downturn? And were your competitors able to do the same?

We maintained our headcount through this downturn because, you know, our business is a people-based business. There's a huge amount of expertise and capability in our team and we believe these markets will recover. And we want to have the same capable people calling on customers and providing them service and innovating for us when they inevitably do recover. You know, we've got a lot of conviction in that and we believe we've got a great team And we want to preserve it and we're able to do so. I can't speak to how customers are reacting. You know, I feel good about our balance sheet position and the health of our business. And some of our competitors don't have that same level of flexibility that we do. And so, you know, I'm confident that we will be in as good of a position if not better when things recover based on the actions that we've taken. And the way the team has come together, as I said, on the prepared remarks, we have permanently improved the way we as a team operate, built a lot of goodwill with our workforce based on preserving jobs and other actions we've taken. And this is a long-term game for us, and we've made some good bets in that regard and good investments in that regard, and we feel good about that.

Thank you. And just capital. Your returns efficiency is already quite substantial relative to your peer set. What's your outlook for return on capital going forward, and how do you create further separation?

Yeah, it's a great question, Jim, and that's something we think about and talk about a lot. You know, the quality of this business, the amount of cash flow it generates from a rather modest set of fixed assets and capital invested in the business, and that should improve. because the business is going to grow organically, and it's a business that doesn't require significant capital investments to grow or to maintain its margins. So the returns generated from the growth we can get relative to the investment we have to make is great. And so the incremental returns on capital should be improving. And we've got plans. So we've got a collection of great businesses on that basis, and we're running them better every year, right? As we talked about earlier in one of the questions earlier, getting better quality outcomes at lower cost by using technology to run these businesses more efficiently. That's different than taking out cost when sales are down, right? That's continuous improvement, permanent improvement in the cost base, in the business of running the business. And we've got a multimillion-dollar opportunity, and we're chipping away at that every quarter. One of the comments I made in the prepared remarks about managing through this pandemic without losing focus on longer-term projects and objectives. You know, we've done a really good job. The team has done a really good job of continuing to execute on our shared services project, other IT projects that will make this business more efficient. And all that will translate to, as you said, further separation, you know, from what's called the industry standard, the industry median returns on capital, which is how we measure ourselves.

Terrific. And maybe you could talk about the U.S.-China trade relationship. How are you planning to mitigate the risk of further deterioration in U.S. trade conditions and relationship with China?

Yeah, so, you know, that dynamic is out of our control, but how we position ourselves relative to it is something we think about a lot. First of all, we look local. So we've got local teams on the ground, local facilities, local manufacturing, local suppliers, local technical service people. So we look local everywhere we're doing business. Another way that you mitigate that is through innovation and being on the bleeding edge and offering capabilities that are differentiated such that should there be preference for local suppliers and our looking local isn't adequate, you know, there isn't a good alternative to us. And so obviously continued investment in innovation is a focus area and helps mitigate that risk. And the third thing is being in a position such that should supply chains move out of China to mitigate that risk for themselves, right? So our customers and OEMs, you know, being ready to absorb that demand and that work. And so we are a global supplier. We can provide the same level quality and capability you know, wherever our customers may move, we're there already. And that is a margin tailwind for us because margins are better outside of China in these businesses than inside. And so we spend a lot of time thinking and planning about that and are well positioned in that regard.

Thank you very much. Thanks, Jim. Our next question is from Sean Gilmartin of Barclays.

Your line is open.

Hi, guys. I'm for Duffy this morning. Good to hear everyone's voices. Just a quick one from me and understand completely, it's probably a combination of what's already been talked about, but you specifically called out kind of a tough year-on-year comp within the circuitry vertical. Could you maybe just remind us what was driving that strength in Q3-19 and how we should think about maybe kind of maybe lower sales or more difficult sales profitability there impacting the electronic segment in Q3?

Yeah, absolutely. Thanks for that question. And it's a good point, right? Q3 of last year had very, very strong margins. That was driven by the fact that there was a pretty big buildup in high-end circuit boards for smartphones coming out of 2018 and into 2019. And the smartphone market specifically certain OEMs had very strong results in Q3 in the back half of 2019. And so there was a surge in demand for very high-end circuit boards for the mobile market in Q3 of 2019. That's a high-margin product for us. And so it translated to a very strong quarter in Q3 of 2019, which makes the comp more challenging this year.

Got it. That's super helpful. Thanks, guys. For sure. Operator, any questions? We do. We have a follow-up from Josh Spector of UBS.

Your line is open. Yeah. Hey, guys. Thanks for letting me follow up here. Just on industrial, your declines in the quarter were somewhat consistent, I think, with auto demand declines. Do you expect that to be the case in 3Q as well, or do you expect any lag in that recovery or perhaps any lead on that recovery on some potential restocking activity?

Thanks for that question, Josh. Our goal is always to outperform our markets. The primary market in that industrial business is the auto market, and it's the best indicator. So I would look to the auto market as a gut check and that's what we look to when we, you know, do our forecasting and planning exercise.

Okay, thanks. And then just the last one on you acquired Tester at the end of last year. I was just curious if there is any significant deviation in performance of Tester relative to your heritage assembly business.

Bifurcated. The Kessler business that's in the core sort of traditional assembly market has performed similarly, I would say, to our core assembly business. And there was a small piece of the Kessler business we called out when we acquired it that's in the semiconductor market, and that business has grown exceptionally well at high margins. So that's been a great story for us, and we're very, very pleased with its performance.

Okay. Thank you, guys. Thank you, Josh.

And our final question is a follow-up from Steve Byrne of Bank of America. Your line is open.

Yes, thank you for letting me get back in the queue here. I wanted to ask you if you expect any changes in the geographic distribution of your end markets, whether you are seeing any trends towards reshoring initiatives from any of your customers

So it's a good question, Steve, and we have seen some parts of the supply chain begin to invest, particularly in electronics outside of China in places like India and Southeast Asia. There's been automotive investment also in Southeast Asia. You know, for us to put up a facility is not so complicated on a relative basis. It's a few million dollars. It's warehousing and blending tanks. For our customers, it's tens if not hundreds of millions of dollars. And so it takes a while. We're starting to see some of that, but, you know, it's not in full effect as yet, I would say.

Okay, thank you. Sure, thanks.

This does conclude our question and answer session. I'd be happy to return the call to Ben Glicklage for any concluding remarks.

Thank you very much. Thanks to everybody for joining this morning. We look forward to speaking with you in the coming days and weeks. And please stay safe. Thank you.

This does conclude today's Element Solutions Incorporated Q2 2020 Earnings Conference Call. You may now disconnect your lines. And everyone, have a good day.