Element Solutions Inc.

Ladies and gentlemen, good morning. My name is Abby and I will be your conference operator today. At this time, I would like to welcome everyone to the Element Solutions Incorporated third quarter 2022 financial results conference call. Today's conference is being recorded and all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, simply press star 1 once again. Thank you, and I will now turn the conference over to Varun Gokarn, Senior Director, Strategy and Finance. You may begin.

Good morning, and thank you for participating in our third quarter 2022 earnings conference call. Joining me are our CEO, Ben Glicklich, and CFO, Kerry Dorman. In accordance with regulation FD, we are webcasting this conference call. A replay will be made available in the investor section of the company's website shortly after completion of the call. 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 discussion of material risk factors that could cause actual results to differ from our expectations. 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 Ben Glicklich, CEO of Element Solutions.

Thank you, Varun. Good morning, everyone. Thank you for joining. In the third quarter, Element Solutions produced solid top and bottom line organic growth, despite an environment where macro fundamentals declined. Key end markets, such as consumer electronics and mobile phones, softened further. Automotive did not recover in line with expectations, and the continued strength of the U.S. dollar drove additional foreign exchange translation headwinds. Despite these challenges, both of our operating segments delivered organic growth in the mid-single digits. as pricing actions, new business wins, and a focus on high-growth electronics applications help to offset declining volumes. This is significant outperformance against our end markets. On the bottom line, cost management from synergies and actions taken in the quarter contributed to sequential margin expansion and adjusted EBITDA growth. Demand across the electronic ecosystem deteriorated in the third quarter, and the typical seasonal pattern of sequential growth from Q2 to Q3 did not materialize. In September, European activity levels did not ramp following August holidays. Global handset volumes declined an estimated 12% year-over-year in the third quarter, a deceleration from a 7% year-over-year decline in the second quarter. What started earlier in 2022 as weak demand in the local Chinese market, where we have more limited exposure, has penetrated demand for ex-China mobile OEMs. While we expect to see continued robust growth in our power electronics portfolio and the benefits of pricing actions we took earlier in the year, our outlook for the rest of 2022 across the electronics portfolio is for current trends to continue. Secular growth is not linear. and we believe the current trend is not reflective of any permanent change in the industry. The growth opportunities we have in power electronics, 5G-enabled devices and networks, and sustainable chemistry are substantial over time. We are not slowing our investment in these longer-term growth opportunities. In our industrial portfolio, where automotive is our largest exposure, we see a structurally undersupplied global market where production recovery is more a question of timing than magnitude. OEMs continue to miss their forecast production rates given supply constraints. However, given economic softness, particularly in Europe, we believe that the recovery will occur over a longer timeframe than was previously forecasted. While unit production improved sequentially in Q3, the recovery was subdued relative to industry expectations. Here, too, the long-term trend appears positive. as reflected in the elevated levels of customer engagement and new business winds our commercial teams have closed year to date. We're well positioned as a leading technology enabler for the automotive supply chain and expect to benefit disproportionately when production volumes inevitably recover. Even with a modest recovery in Q4 2022, the automotive production this year will end more than 15% below 2018 levels. In slide three, you can see a summary of our third quarter financial results. We grew the top line 5% organically. A significant portion of that organic growth was driven by both surcharge-based and negotiated price increases. On a constant currency basis, adjusted EBITDA grew 11% year-on-year. Adjusted EBITDA margin improved 40 basis points, with lower pass-through metal prices driving roughly 60 basis points of margin tailwind year-over-year. The steep and fast decline in TIM prices mid-year left us with purchases well above our eventual selling price. This had a negative impact on gross profit in the quarter, but the losses were largely offset by metal hedge gains captured in adjusted EBITDA. This is how our metals pricing and our hedging program are designed to work. Foreign exchange fluctuations drove sizable reductions to our earnings in the quarter, representing a roughly $12 million year-on-year headwind to adjusted EBITDA. Excluding the impact of $93 million of pass-through metal sales in our assembly solutions business, our adjusted EBITDA margin would have been 25% in the quarter. Adjusted EPS grew 6% on a reported basis, despite a negative 9% impact from FX translations. Carrie will now take you through our third quarter business results in more detail. Carrie? Thanks, Ben, and good morning, everyone. On slide four, we share additional detail on the drivers of organic net sales growth in our two segments. Organic growth for electronics was 5% year over year in the third quarter, as pricing and growth in power electronics generally offset consumer electronics softness in Asia. This compares favorably to the overall electronics and mobile end markets that were down in the low single-digit and low double digits, respectively, year over year. Our servitory solutions vertical grew 1% organically, with price action offsetting a sharp slowdown in the memory disk market, as well as slow customer activity throughout Asia. Semiconductor solutions grew 3% organically, and the business saw continued end-market demand for our wafer plating, advanced packaging, and advanced assembly products. This was tempered, however, by software demand in mobile. Both circuitry and semiconductor benefited from higher surcharge revenue, driven by increases in raw material costs, which account for roughly 2% of the organic growth in the overall electronics segment. In our assembly business, we saw sustained growth in higher-end applications, which drove a 9% increase in organic sales. On a year-over-year basis, adjusted EBITDA margins in our electronics segment expanded 20 basis points. Lower metal prices had a positive year-over-year impact to margins. At the same time, gross profit dollars were negatively impacted by the timing of sharp declines in PIN prices within the quarter. The offset to this was over $5 million of realized metals hedge gains that are reported through other income and are included in our adjusted EBITDA. The product mix was also a headwind, with assembly growing faster than circuitry and semiconductor in the quarter. Organic net sales in industrial and specialty increased 6% year over year. The growth trend converged across the three businesses within the segment. Industrial solutions grew 7% organically, which was driven primarily by pricing actions and surcharges. Dozen to auto, which is roughly 40% of the business, grew mid-single digits. We also saw some sequential softening in European construction and industrial end markets that had been resilient in the first half of the year. We anticipate this trend will likely continue to the fourth quarter, given the dynamics in the region. Graphic solutions declined 3% organically year over year. Despite new business that contributed to sales and the impact of additional pricing actions, we have seen a slowdown in new package designs in Europe and North America. We are making progress on multiple initiatives designed to accelerate sales and improve margin in this business in 2023. Energy solutions grew 15% organically. Despite a longer than typical lag along increased energy prices, momentum in this business is picking up. We are seeing increased drilling activity, which has led to increased production as well. Industrial and specialty grew adjusted EBITDA 38% on a constant currency basis, including the contribution of the Copantia business and synergies from recent acquisitions. Margins improved by 160 basis points year-on-year. Similar to electronics, cost management in the quarter helped to offset the combination of increased logistics costs, negative mix, and raw material inflation in our smaller INS businesses. A substantial portion of our operating cost reduction in the quarter came from reduced variable compensation expense assumptions that reflect the change in our near-term outlook. Our bonus program structurally offsets deviations in earnings from our plan and is working as designed. Moving to slide five, we cover cash flow and the balance sheet. We generated $116 million of free cash flow in the quarter, reflecting a significant release of working capital, a sequential sales decline, and safety stocks moderated. We expect a higher level of working capital release in the fourth quarter as both these trends continue. Our other use of cash in the quarter, including cash taxes, CapEx, and interest, all came in better than our expectations. We increased our share repurchase activity in the quarter, buying back approximately $55 million of stock, or roughly 3 million shares. As of the end of Q3, we had repurchased more than 6 million shares this year, or well over 2% of our shares outstanding. Our remaining stock buyback authorization was $616 million as of September 30th, and we continue to be active in the market. Our net leverage ratio improved in the quarter 3.1 times, despite returning over $70 million of cash to shareholders. All our floating rate debt is swapped to fix through the end of next year, so rising interest rates are actually improving our cash interest expense as we earn more income from our cash balance. These term loans are also swapped to Euros, and that cross-currency swap was approximately 150 million in the money at quarter end, effectively reducing our leverage ratio to 2.9 times. Our balance sheet and liquidity position are very strong.