Element Solutions Inc.

Good morning, ladies and gentlemen, and welcome to the Element Solutions Q4 and full year 2021 financial results conference call. Later, you will have an opportunity to ask questions during the question and answer session. You may register to ask a question at any time by pressing the star and one on your touchtone phone. You may withdraw yourself from the queue by pressing the pound key. Please note, this call may be recorded. I would now like to turn the call over to Varun Gokhan, Senior Director of Strategy and Finance. Please go ahead.

Good morning, and thank you for participating on our fourth quarter and full year 2021 earnings conference call. Joining me this morning are our Executive Chairman, Sir Martin Franklin, CEO, Ben Glicklich, and our CFO, Kerry Dorman. In accordance with Regulation FD or fair disclosure, we are webcasting this conference call. Any redistribution, retransmission, or rebroadcast of this call in any form without 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 risks and uncertainties. Please refer to our earnings release, supplemental slides, and most recent SEC filings for a discussion of material risk factors that could cause actual results to differ from our expectations and predictions. These materials can be found on the company's website in the Investor section under News and Events. Today's materials also include financial information that has not been prepared in accordance with U.S. GAAP. Please refer to the earnings release and supplemental slides for definitions and reconciliations of these non-GAAP measures to comparable GAAP financial measures. It is now my pleasure to introduce Sir Martin Franklin, Executive Chairman of Element Solutions. Thank you, Varun, and good morning, everybody.

Thank you for joining. Today, we're reporting results from another outstanding year for Element Solutions. This is a company hitting its stride in terms of execution, capital allocation, and culture. In the three years of our journey as Element Solutions, this company has faced and managed through a myriad of headwinds, from COVID-related disruptions to supply chain issues. These experiences have both forged this leadership team's capabilities and proven them out. And the results have been very good. Today we reported adjusted EPS that delivers on our initial five-year commitment in just three years. The leadership team is delivering for shareholders with a focus on long-term strategic breakthroughs without taking its eye off meeting its short-term commitments. We've outgrown our markets through strong execution. We have driven operating leverage on that growth through a thoughtful approach to cost and investment. That solid execution and prudent strategic capital allocation has compounded earnings per share at a 27% CAGR over three years. Underpinning this financial performance is a highly motivated culture that the leadership team has created and which fostered balancing ambitious goal setting, delivering on commitments, and caring for all stakeholders. This culture is a solid foundation for continued outperformance. Our company has made enormous strides in a relatively short period of time. This is a uniquely positioned business that generates industry-leading returns on assets that we believe have not yet been properly appreciated by the market. Its growth requires relatively low capital investment, and it is positioned in some of the most exciting addressable markets in the specialty chemicals arena. We're very much looking forward to providing a more granular outline of the opportunities for growth at tomorrow's Investor Day. I'm looking forward to seeing many of you there. With that introduction, let me turn the call over to Ben to take you through the quarter and year in more detail. Ben?

Thank you, Martin. Element Solutions had an exceptional year. We're executing at a high level through an unusual backdrop of both record demand in our end markets and severe disruptions in raw material supply, logistics, and labor. The company delivered strong sales growth, adjusted EBITDA, adjusted EPS, and free cash flow. Each of these were annual records since we became Elliman Solutions in 2019. Our culture of embracing challenges and delivering on our commitments has been tested through the unprecedented operating environment of the last three years, and we feel proud of the results. We entered 2021 with the mantra of winning now, winning later, as we sought to capitalize on the strength in many of our key markets, while also increasing our investment in the capabilities that should allow for longer-term success. To that end, we focused our energy on strategy development and implementation, and on commercial execution across both our electronics and industrial portfolios to leverage our scale and win larger opportunities with strategic accounts. We enhanced our operational processes to focus on better planning, pricing, and supply chain management to more effectively respond to changes in our markets. We also accelerated investment in internal capacity in both manufacturing and technical capabilities in focused growth areas such as power electronics, advanced semiconductor packaging solutions, and leading edge printed circuit board technology. As we invested in future growth, we also delivered on our financial commitments in 2021. Our business grew net sales organically 13% for the year, evenly split across both segments. We grew adjusted EBITDA by 20% in constant currency terms. We delivered $280 million of free cash flow, a 12% increase over last year, even after making larger investments in strategic capex and in working capital to ensure reliability of supply to our customers. We closed two exciting acquisitions and increased our quarterly dividend. Finally, we achieved $1.38 in adjusted EPS, exceeding our initial five-year target to double adjusted EPS in just three years. When we launched Element Solutions in February 2019, we espoused a strategy balancing operational excellence and prudent capital allocation, running our high-quality businesses better every year and deploying the strong cash flows they generate in long-term value-enhancing ways. Last year, we were excited to have the ability to deploy a significant amount of capital with high expected returns in strategic markets that we know very well. We believe the acquisitions of Coventia and HK Wentworth position our business for higher growth in our core markets, while providing expansion opportunities into attractive adjacencies. With Coventia, we enhance our position in industrial metal finishing with significant global scale and product breadth to support customers. We're on track to exceed $15 million of run rate synergies, which, as we previously communicated, we expect to achieve by the end of 2023. We further grew our industrial solutions business with the acquisition of HSO in January of this year, a more regionally focused company with strong manufacturing and research talent, and a highly complementary, environmentally friendly surface treatment offering. HK Wentworth, and in particular its Electrolube brand, provide us with an expanded portfolio of high-end electronics products, including conformal coatings, encapsulation resins, and thermal interface materials. These polymer-based adhesive products are increasingly critical in high-end electronics, as thermal management and enhanced durability become ever more critical performance attributes. We've seen strong interest from our existing semiconductor and assembly customers for these products, and we see a path to double that business over the next several years. We funded these acquisitions without additional equity and finished the year with the same leverage ratio as we entered it. In 2021, we also made great strides on the ESG front. We started the year by publishing our inaugural ESG report, which provided more transparency on the way our business is driving more sustainable outcomes in customer supply chains and our own. In the coming days, we'll be publishing our ESG goals, in which we commit to improving across four key pillars of ESG, emissions, safety, DE&I, and sales of sustainable solutions. This is another step forward in our commitment to ESG. We've also significantly expanded our employee volunteerism and charitable giving programs and launched several new talent and career development initiatives to expand opportunities for our people. Overall, we're very pleased with the culture that's taken root at Element Solutions and believe that these values will continue to serve as a competitive advantage for the company in the years to come.

Cary will now take you through the financial results in a bit more detail. Cary? Thank you, Ben. Good morning, everyone. Our fourth quarter results are summarized on slide four. Net sales of $647 million in the quarter were a record since our launch and reflect our first full quarter with Coventia. We grew net sales organically by 2% despite a difficult comparison to the fourth quarter of 2020 when we saw an initial post-COVID manufacturing recovery and the timing of smartphone launches drove a surge in growth in our electronics segment. Our electronics business grew net sales 1% organically in the fourth quarter compared to Q4 of 2020. However, when compared with the same quarters in 2019, Our organic net sales growth over the two years accelerated from 13% in Q3 to 17% in Q4. Demand in our electronics business inflected positively in 2020 and has been persistent since then. The secular inflection of growth in these end markets should continue in 2022, and we believe these trends driving it remain in the early stages. Net sales in the industrial and specialty segment grew 4%. This was driven by strong European construction and general industrial end markets. High single-digit organic growth in our graphics business and a return to growth in our energy business that more than offset a decline in automotive end markets in the quarter. We began to see inflation in our supply chain in early 2021, which continued through the fourth quarter. We experienced inflation in raw materials, logistics, and pass-through metals. The metal prices impact only margin percent, not margin dollars. Overall, adjusted EBITDA margins were down 460 basis points when compared to Q4 2020, which is a tough comparable given it was an unusual and strong period. Approximately 150 basis points of the adjusted EBITDA margin change is explained by the pricing impact of path-through metals, and a further 70 bps is explained by acquisitions. The rest is driven by mix, raw materials, logistics, and OPEX growth. Approximately 10 million of this OPEX growth is associated with above-target annual incentive compensation, which is not planned to carry over into 2022. Excluding the impact of assembly pass-through metals revenue, adjusted EBITDA margin would have been 23% in the quarter. Turning now to our full year of 2021 financial results on slide five. We delivered 13% organic growth on the top line, and we converted that improvement in sales into 20% constant currency adjusted EBITDA growth, or 17% growth when excluding the $11 million contribution of Coventia in the last four months of the year. Full-year adjusted earnings per share grew 44% as our strategic capital deployment compounded our strong operating results. On slide six, we provide additional full-year details by segment. Electronics net sales grew 13% organically year over year, with strong performance in each vertical. The assembly vertical grew the top line 15% organically, even after adjusting out the large impact of metal prices. Assembly was down modically in 2020, primarily due to its automotive exposure. We benefited in 2021 from the beginning of an automotive recovery, as well as the increased penetration of electric vehicles and power electronics, where our business has a strong market position and product portfolio. Sales and assembly, including the impact of metal prices, increased 44%. The increase in tin and silver prices, which we contractually pass on to customers, impacted sales by $143 million in the year. The pass-through nature of these increases protects profitability in dollar terms, but has a large impact on reported margin percent. The semiconductor business delivered 13% organic net sales growth in 2021. We continued to seize the higher demand opportunity in the advanced packaging market and benefited from increased demand in semiconductor markets driven by computing, mobile, telecom infrastructure, and vehicle electrification. This growth in 2021 followed a 17% organic growth in 2020 versus 2019. The circuitry business grew net sales 10% organically in 2021. This business is driven by high-end electronics, like next-generation mobile devices, which continue to grow nicely. We also sell into data storage markets, which had another strong year driven by demand for network and computing infrastructure. Overall adjusted EBITDA margins in the electronics segment were down about 90 basis points year-over-year in constant currency, negatively impacted by almost 240 basis points of pass-through metals pricing. Excluding this impact, positive mixed benefits and pricing actions more than offset the increase in other raw materials and logistics costs for the full year. These headwinds were more acute in the second half, and we are actively working to further offset these pressures in line with most of our industry. Organic net sales in industrial and specialty also increased 13%. We capitalized on the strong recovery in most of our end markets against the weak macroeconomic backdrop in 2020. The industrial vertical grew organically 18% year over year, which excludes any impact on the acquisition of Cleventia. The business has been down around 10% in 2020, mainly driven by COVID related manufacturing shutdowns. As the COVID impact on manufacturing eased into 2021, we saw our sales growth recover. Our automotive business grew into double digits despite lower than anticipated underlying unit production. Our graphics business grew net sales 6% organically in 2021 with strong sales execution and new wins across the Americas and Europe. The investments we are making in expanding our product portfolio, strategic account management, and in our go-to-market strategy are all delivering. In offshore, net sales declined 6% organically for the year, but grew 6% organically in the fourth quarter versus Q4 2020. Demand picked up later in the year as new drilling rigs began to come online. This bodes well for 2022. Adjusted EBITDA margins in the INS segment were down 170 basis points year-over-year. This decline was largely driven by mixed impacts, cost inflation around materials and logistics, and the contribution of Coventia at lower than average segment margins before synergies. We expect Coventia to contribute at least $15 million of annualized synergies by year-end 2023, and therefore add approximately 200 basis points of adjusted EBITDA margin to the segment, all else equal. Turning to slide 7, we generated $280 million of free cash flow in 2021, an increase of 12% year-over-year, despite a significant full-year investment in working capital to support stronger sales growth and inventory safety stocks. While we began to work through this safety stock in the back half of the year, we are still operating with elevated inventory and will likely continue through most of 2022. We increased our capital expenditures this year to $46 million as we invested in capacity to support strategic growth projects in power electronics, semiconductor, and graphics. In 2022, we are continuing to invest to support growth in new high value areas. We are happy to have the opportunity to make these types of high returning capital investments and find growth in adjacent markets. In 2022, we expect capex of approximately $60 million, including these growth investments and several Cobencia integration initiatives. The maintenance capital needs of our business are largely unchanged at around $20 million, and we do not expect total ongoing annual CapEx to remain at these higher levels. Finally, interest and cash taxes both came in slightly better than our last forecast for 2021, and we expect cash taxes to grow roughly in line with earnings in 2022. Our net leverage ratio exiting 2021 was 2.9 times adjusted EBITDA, including the full-year contribution of Coventia. We deployed a significant amount of capital in the year, including two acquisitions, over $60 million in dividends, and repurchasing approximately 1 million shares of our common stock. Nonetheless, we held our year-end leverage ratio constant from year-end 2020, a testament to the cash-generative nature of our business. Without further capital deployment, we would expect to be levered organically into the mid-twos in 2022. This should leave us plenty of capacity to continue to invest prudently to drive shareholder returns. And with that, I will turn it back to Ben to talk more about 2022. Thank you, Gary.

Our full year 2022 financial guidance reflects a continuation of the dynamics we experienced in 2021 into the first half of 2022. Our end markets remain healthy, and our teams are executing well in what remains a dynamic supply environment. We believe this year presents significant opportunities for growth, from current macro tailwinds, continued execution, and expected improvements in supply constraints towards the second half of the year. Our full year guidance for adjusted EBITDA is a range of between $575 and $590 million, representing constant currency growth of 13% to 16%. We expect to deliver adjusted earnings per share between $1.55 and $1.60, representing 12% to 16% growth year over year. Net sales growth in 2022 in both of our segments should be above their long-term rates, buoyed by the expected cyclical recovery in auto and industrial end markets and ongoing strength in the electronic supply chain. We expect to benefit from increasing content opportunities driven by the wider adoption of 5G, increased production of electric vehicles, and the broader electrification of the automobile industry. Given end of January 22 exchange rates, we anticipate FX will be an approximately 3% headwind to sales and a roughly $15 million headwind to adjusted EBITDA for the full year. Year-over-year earnings growth will likely be weighted to the second half, given continued constraints in automotive supply chains and the fact that raw material prices increased throughout the first half of 2021, which represent a year-over-year headwind. We continue to take action to offset raw material inflation. For the first quarter of 2022, we expect constant currency adjusted EBITDA to be approximately flat compared to the prior year. We've demonstrated in our first three years as Element Solutions that our business is able to generate strong cash flow in a variety of markets, and we expect this year will be no exception. We expect to generate a record $310 to $325 million of free cash flow in 2022, despite adding significantly to our capital expenditure plan and funding certain one-time integration-related activity. This cash generation ability creates flexibility for further prudent capital allocation to compound long-term earnings. To wrap up, I'd like to thank all of our stakeholders for their continued support of Element Solutions. We've delivered on our vision and commitments in our first three years at Element Solutions, running our excellent businesses better and deploying their strong free cash flows to become a better supplier to customers, create more opportunities for our people, and compound per share earnings for our investors. In early 2019, we announced our goal to double adjusted earnings per share over five years and implemented leadership incentives to help us achieve this goal in four years. We achieved this target in three years. In 2022, a new incentive target has been established to double earnings per share again from the prior $1.36 target to $2.72 by the end of 2026. We see multiple levers for driving the company to superior returns and look forward to detailing this at our Investor Day tomorrow. I'm grateful to all of our employees for their commitment and happy to share that our team is more excited and engaged than ever and on board for this next leg of our journey.

Operator, please open the line for questions.

At this time, if you would like to ask a question, please press the star and 1 on your touchstone phone. You may remove yourself from the queue at any time by pressing the pound key. Again, let us star and 1 if you would like to ask a question We do ask that you please limit yourself to one question and one follow-up. And we will take our first question from Bob Cort with Goldman. Your line is now open.

Good morning. Thanks. This is Mike Harris actually sitting in for Bob this morning. When we look at the range of the 22 EPS guide, what are the swing factors or, I guess, scenarios that would determine the whether or not you came in at the high or the low end of that range, and maybe speak to what macro assumptions or share count reductions you have baked in?

Yeah, absolutely. Thanks for the question, Mike. So, our EPS guidance range doesn't correspond exactly to our EBITDA guidance range. There's a modest amount of capital allocation required to get to that EPS range. The big drivers, as we think about that range, are specifically that capital allocation, you know, how we deploy the substantial cash flows that this business generates over the course of the year. And the other critical variables are the timing and magnitude of the auto recovery. In our guidance, we're assuming it's back half weighted, right? And so the supply chain constraints that have been weighing on automotive production start to ease in the second half. FX is obviously a variable that's been increasingly volatile. And then, you know, we believe that there will be persisting strength in electronics through the course of the year. And we have a lot of conviction that's going to continue. But could it even accelerate further? And that would obviously drive us towards the higher end.

Okay, thanks. And then just as a quick follow-up, you know, looking at the industry consolidation that's going on and perhaps a change in competitive landscape, Can you speak to if or how that may change your business strategy or M&A appetite?

Yeah, absolutely. So we've always said that from a strategic perspective, consolidation in let's call it electronics materials and in our markets doesn't impact us. We're fortunate to be market leaders in the markets in which we participate, and that position hasn't been diminished by the consolidation that we've seen. Surely other vendors to shared customers have consolidated, but not in our product portfolios. And so that consolidation does not drive any change in our strategic framework, in our capital allocation decisions at all. We've got great moats around our business leadership positions, and that's been unchanged and will continue to be unchanged. If anything, we're consolidating our leadership position through capital allocation and execution. which has been driving our market outperformance through share gain and some of the new markets we've been able to enter through organic and inorganic capital allocation.

Okay, thanks for taking our question.

We will take our next question from Chris Capiche with Loop Capital Markets. Your line is now open.

Hey, good morning. Thanks. So one question is, Ben, you mentioned when talking about end market growth tailwinds for 22, you highlighted 5G first. ahead of EVs and just broader strength in electrification of autos. But I think investors probably can get a reasonable calibration on smartphone builds and content per 5G enabled smartphone. But it's hopeful to hear if there's a way you could quantify parameters around just more of the 5G ecosystem build out, including base stations more generally. What's the opportunity here? How does ESI feed into that?

Yeah, it's a great question and a great observation. Units are growing in the mobile phone market, and the percentage of those units that are 5G enabled is also growing. We've got a 15% content uplift on a 5G phone versus a legacy technology phone, so we see growth in the underlying units and in the content. But there's also a huge opportunity in the mobile infrastructure, right? The base stations that are required and able to support 5G technology. And we see an opportunity order of magnitude three times the size of the number of base stations that are being built in 2021. you know, over the next five years to support the rollout of 5G capability such that it's able to service all the 5G phones that are going to be sold. And that's a big opportunity from a content and unit perspective for Element Solutions electronics business.

That's helpful. I appreciate it. And then the follow-up is maybe just a bigger picture question about the evolution of the printed circuit board industry and your role over time and feeding into that. So when there was a period of time when that industry manufacturing was more global in nature than it, as the industry matured and became at a lower cost, it was concentrated more in China. But now the growth drivers that you're talking about in terms of you know, just the overall electrification of the economy, it's driving the pendulum shifting back to higher end. So I guess the question is, is the notion that only sort of the elite suppliers like yourself are feeding into the higher end electronics, is that supposition still valid for this evolution and strength in the electronics industry today?

Yeah, it's a good observation, Chris. there are only a few vendors in our tier that are capable of delivering the highest level technology to meet the needs of next generation circuit boards and IC substrates. And so as the technical requirements for higher end electronics become more challenging, that drives more of the market and more of the market value to folks like us, which is a market share driver for us. And we're accelerating investment to ensure that we participate over and above our current share in those higher-end applications, which are growing faster, have higher margins, and wider moats. And so that does explain some of our outperformance relative to our markets and some of the really exciting trends that are going to propel this business for the next many years.

Thanks for the call. I appreciate it.

We will take our next question from Steve Byrne with Bank of America. Your line is now open.

Ben, I wanted to drill into this new five-year target to WPS. perhaps you would like to do that in three years, but more importantly, really would like to hear your view as to what gives you the conviction that you can do that, and maybe you can rank these potential drivers. Is it the strength in these end markets that you sell into? Is it your expectation for bolting on more acquisitions? versus your internal initiatives, either on the cost side or cross-selling into new markets and geographies? How would you rank those?

Steve, thanks for the question. We're going to spend two hours on that tomorrow at our investor day, and so I don't want to steal too much of its thunder. A few things. You know, we set our internal target a little bit outside of our external target, and so we're going to communicate our external target tomorrow, and we're going to talk about the compelling path forward we have to deliver on that. And it's comprised of all the things you said. We're participating in markets that are growing secularly, you know, at faster growth rates than what they were growing three years ago, and we believe that's sustainable. We're running the businesses better every day, every year to convert that sales growth that we're going to get from the secular growth and our execution at higher rates from sales into profit. And we're going to generate billions of dollars of free cash flow to deploy to compound earnings per share. And so, you know, the model we espouse at Element Solutions is operational excellence and prudent capital allocation. We've done it for our first three years, and we intend to do it for the next five years, and that's how we get to that stretched target. We like setting ambitious goals, and we certainly like delivering on them.

I also wanted to ask you about these – the comments made about higher logistics costs. We've had the impression that your manufacturing base is generally close to your customers. So can you provide a little more explanation as to what is causing the higher logistical costs? Is it Is it you're trying to source the raw materials, or is it delivery to your end customer? And what mode is primarily that issue, and is it getting any better?

Yeah, so higher logistics costs are driven by the fact that basically all modes of transport are many percent, if not multiples, from a rates perspective of where they were a year or so ago. And we use all modes. A lot of trucking, we've had to do some air freighting to get products to customers on time given logistics unavailability. And that's just become significantly more expensive over the past year or so. We historically haven't passed on logistics costs actively through price. It's something we're considering. And we don't see logistics costs abating. So we do have, as we look to our guidance, about a $20 million headwind to EBITDA from logistics costs that's taken into consideration. And obviously, we're taking action to try to offset inflation, both in raw materials and in the broader cost base, actively to preserve margin.

Thank you.

We will take our next question from Angel Castillo with Morgan Stanley. Your line is now open.

Hi, good morning, and thanks for taking my question. I just was wondering if you could unpack a little bit more in terms of the organic growth that you saw during the quarter and as we think about maybe what's embedded in kind of the guidance for both 1Q and 2022. In particular, I was wondering if you could talk a little bit about maybe assembly and circuitry. It seems like if I, from my analysis, right, I guess it would seem to suggest that assembly was maybe negative in the fourth quarter and circuitry was maybe a little single digit. So I assume a lot of that is probably autos, but just if you could give us a little bit more color on those and how those kind of fit in as well into the guidance.

Yeah, the fourth quarter of 21 is comping against an anomalous quarter in the fourth quarter of 2020. The COVID-related manufacturing shutdowns we saw in 2020, the second and third quarters, really pushed a lot of volume into Q4 of 20 and into Q1 of 2021. It's very odd that the first quarter of a year is our biggest, which was the case in 2021. But we still grew organically, and that was driven by strength in our assembly business, the mix. Some of that was, and strengthened our semiconductor business. The industrial business also had a strong fourth quarter lapping, despite, rather, automotive weakness, but driven by strength in our other industrial, in our other pockets of the industrial business, construction and engineering and heavy equipment and building products. Rolling into the first quarter of 2022, there's persisting strength in electronics. We should see growth in our electronics business. There's also persisting strength in industrial in those same pockets. Some of our smaller businesses like the offshore business should grow and the graphics business should grow. And overall, it remains a buoyant environment from an electronics perspective. And so we expect... pretty stable and consistent growth across the portfolio in the first quarter, offset by some margin pressure, which will continue because we're lapping a period where we didn't see the same raw material inflation and logistics inflation that we saw in the back half of 2020. 2021, excuse me.

And for the full year of 2022, as we think about that growth, what's kind of the, within kind of the brackets, what's kind of the organic growth that assumptions underneath that?

So we're expecting above average above the average long-term growth rates for most of our businesses in 2022. So you should think about mid-single-digit top line. And that's pretty broad-based, but there's a phasing aspect to it, right? So the industrial business, for instance, will see a pickup in the back half as, you know, we expect the auto supply chain to ease a bit, whereas the electronics business should be pretty consistent through the year.

Yeah, I think if I could quickly sneak one last one, and just what kind of the share count assumption, you know, this cap allocation embedded in within EPS?

Sure, this is Kerry. So I think as a baseline, the $251 million we're using for adjusted EPS for 2021 is a good assumption for 22x capital allocation. If you do the walk from EBITDA to EPS, you'll see that you need about two or three cents of capital allocation to get to the same equivalent range from EBITDA to EPS. So it's either shares or buying earnings.

Very helpful. Thank you.

We will take our next question from John Tanawag with EJS Securities. Your line is now open.

Hi, guys. I think that's me. First of all, congrats on hitting your long-term targets after a really wild ride over the last couple of years. I know you'll talk about this more tomorrow, but is there any reason why you can't double earnings again in three to four years? You know, just given your end markets are going faster than you expected, and are there any incentive structures in place to achieve that, you know, faster than five years?

John, thanks for the question. We would absolutely love to achieve this target sooner than five years. The base is bigger and the levers at our disposal are more modest, right? So, you know, some of our earnings growth was driven by balance sheet optimization. We've got the balance sheet in a really good place and hard to see a lot of avenues for improvement from a cost of debt perspective. Some of it was from tax rate optimization. We've done a very good job improving that as well, and that's not an arrow in our quiver. So, the levers we have at our disposal are fewer. The magnitude, right? We don't need to add 68 cents. We need to add double that again. The magnitude is greater. And so, we think if we're able to do this in five years, it'll be a really exceptional outcome. Of course, if we can do it sooner, it would be more exceptional, and we'd love that, but it feels reasonably ambitious to set this as a five-year target. Not understanding the fact that we're dissipating in great markets and have, you know, great growth and faster growth, frankly, than we expected in 2019 at our backs, and here we are in 2022.

And we will take our next question from Josh Spector with UBS. Your line is now open.

Yeah, hi, thanks for taking my question. Just to go back to the cost inflation side of things, you size the logistics impact. I was wondering if you could quantify what you're expecting in terms of kind of total cost inflation for 2022, excluding pass-through items. And if you kind of walk through kind of the cadence of when you're thinking you could recapture that back, does that occur in late 2022? Or is this something that recovers in 2023? or maybe can it be something that's even recovered, or is just your cost to serve higher now than it was a couple years ago?

Thanks for the question, Josh. It's a multivariable analysis, right? We've been chasing inflation all year and continue to do so, or all of last year, and continue to do so. And so there are things in the equation that are within our control, but it's a good opportunity to really break out the Q4 margin impacts on a year-over-year basis so we can you know, explain the things that are within our control and what we're doing and what, you know, and what else has happened. So if you look at our margin progression, Q421 over Q420, there's some 400 or so basis points of margin decline. Over 100 of that is just metal pass-through, right? Metal tin, for instance, is at an all-time high. Prices have doubled. That's dollar for dollar. So a dollar increase in tin is a dollar increase in sales without any attributable profit. It's not eroding the profit dollars. It's just increasing sales and has an optical impact on margins. And the Coventry acquisition we made is another roughly 100 basis point impact to margin. That's a below average margin business prior to synergies. And once we get our synergies, which we're beginning to realize and we'll realize a lot of in 2022, it'll be an above average margin contributor. So between those two, you're at about 200 basis points. We talked about – Carrie talked about OPEX and incentive comp, which in the fourth quarter was about 100 basis point headwind as well. That will go away because it was above target, and we expect in 2022 target levels of compensation. So what you're left with is about 100 basis points. And what's in that 100 basis points of headwind is logistics and raw material inflation offset by mixed improvements and price. And so the way you could think about that is that there's about a point that we're behind from a price perspective. We're pursuing that with actions in the first quarter and second quarter. But raw material inflation could make that point higher and increase what we need to do. I expect us to recover that point over time. Mix will help, as will price, and we're hopeful that the inflationary environment we've been existing in doesn't persist, such that we don't have to continue to pursue this, but we have a history of getting price when we've needed to, and there's nothing to suggest we shouldn't continue to be able to do so.

And Josh, I would just add on the raw material front, we have seen some stabilization on prices of raws, excluding the metals that have been mentioned over the course of the year. So while we saw something like a 10% increase on our raws X metals 2021 versus 2020, by the fourth quarter, that was starting to moderate. We only saw a sequential increase of a few percentage points. So our assumption is that there's not further increases in raw material prices X metals, but obviously we're going to continue to take price try to offset that or logistics.

Thanks. That's all helpful. And I was just wondering if you could provide some context on your increasing CapEx, the projects that you're ramping up, what businesses is that targeted at? And then the deck also had a comment on increasing investment and financing of customer equipment. I guess what changed in that arena?

Yeah, so we're really excited by the opportunity to invest more behind our businesses and very high returning organic opportunities. We talked about execution in, you know, existing in some new markets that are attractive adjacencies that our customers are frankly pulling us into. We're investing in capacity expansion for our power electronics business, which is a really differentiated, high value, critical enabling technology for electric vehicles. We've got a great mousetrap there and it's growing Very, very quickly, we'll talk about that more tomorrow. So we're doubling capacity there. We're adding an applications lab for our semiconductor business in Taiwan, which is a highly concentrated semiconductor market. We've had really great wins in the semiconductor business, and this is going to support and accelerate that. We're doubling capacity in our graphics business, where we've had some really big wins and need this capacity in order to support that growth. These are sub two-year payback type investments. We don't believe that the capital requirements for this business have re-rated or increased permanently, but this year there are some really good opportunities to support an acceleration in growth and we're excited about them. With regard to customer equipment, As we're making entrees into higher technology applications in the circuitry business, we are supporting that with customer equipment, which is also a very high returning investment for very sticky high margin business. And we're very interested in supporting our customers with our technology, with our technical service, and with our balance sheet, which will also help accelerate growth. So notwithstanding that incremental investment, we're still growing free cash flow year over year, and the guidance is for another record year of free cash flow in 2022.

And one just important point on the customer equipment financing, that is not equipment that we're manufacturing, right? That is third-party equipment that we're just financing for the customer in exchange typically for contractual sales.

Okay. Thanks, guys.

We'll take our next question from Karen DeBruyne with Mizzio. Your line is now open.

Hi, good morning. You know, I think you mentioned the HSO acquisition while you were talking about opportunities and kind of these environmentally sustainable products. It seems that the industry is really shifting in that direction. I'm sure you'll talk about it more during the investor day, but any color you can give in terms of how we should think about the growth profile of that environmentally sustainable product group and the mix profile as well as we think about your business going forward and your opportunities in that area. That would be helpful.

Yeah, sustainability is not a single product category. We have sustainability initiatives in every single one of our businesses. It is a secular growth driver in and of itself, and it is an area of investment in and of itself. We have, with regard to HSO, what they bring to us is some really good product technology that eliminates some hazardous chemistries for the industrial plating market. HSO is a wonderful niche business, entrepreneurial, family-owned, excited to have them on the team. They bring great capabilities and really good customer relationships as well. In addition to that product technology, we've been investing in similar technology to eliminate hazardous chemistries, and we're really concentrating, solidifying our leadership position in these technologies, which will drive share our way at high margins. We're also investing in water treatment, the EnvioSolutions business, which we acquired. It was a business called DMP. We've rebranded it McDermott EnvioSolutions. That pipeline continues to grow, and customers continue to be interested in our ability to provide more solutions than simply plating technologies, particularly in the industrial side, but also in the circuitry side of the business, where our water treatment capability is value-added to our existing product portfolio. We're glad to see recognition from the initiatives we've made from a sustainability standpoint, and the transparency we provided with our ESG report last year. We're going to be publishing our ESG commitments and targets in the week to come. Newsweek ranked us the 46th most sustainable company out of 2,000, which was something we're really proud of, and seeing the traction from these initiatives, both commercially and from a transparency perspective and internal supply chain perspective, sustainability is a way that we differentiate ourselves in the market, and it's great to be recognized for that.

Great. And maybe just a quick follow-up. I mean, you've kind of answered all of these in a different way throughout the course of the call, but if you can help us, if we take the $525 million of EBITDA that we ended the year at, then you can just help us bridge the different pieces, whether it's the Coventry acquisition, the Coventry synergies, you know, the different components of organic growth and any additional initiatives and how that gets you kind of into that 575 to 590 range that would be helpful.

Absolutely. So, the 525 is the right place to start. There's a $15 million FX headwind, so that gets you to about 510. We get a full year contribution from Coventia before synergies, which adds $20 to $25 million. So that gets you to 535. Seven to 10 million of synergies from Coventia should hit the P&L this year. So that gets you into the 540s. And the rest is organic growth. Six or so percent on the top line, we said mid-single digits, with some margin pressure as we lap the first half. The phasing of that organic growth will come to the back half, just driven by the auto cycle. But, you know, we see multiple paths to get there. That's the nature of this business and have a high level of confidence in our guidance range from where we sit today. Great. Thank you.

We have no further questions on the line at this time. I will turn the program back over to Ben for any closing remarks.

Thanks very much, everybody, for joining. We're looking forward to seeing many of you tomorrow at our Investor Day. And those who can't attend in the weeks and months ahead, stay safe, and thanks again.

This does conclude today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful day.