Element Solutions Inc.

one again. As a reminder, today's call is being recorded. I will now turn the call over to Varun Gokarn, Senior Director of Strategy and Finance. Please go ahead.

Good morning, and thank you for participating in our third quarter 2023 earnings conference call. Joining me are our Executive Chairman, Sir Martin Franklin, CEO Ben Glicklich, and CFO Carrie 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 Element Solutions CEO, Ben Glicklich.

Thank you, Varun, and good morning, everybody. Thank you for joining. Element Solutions had a solid quarter as our electronics end markets began to recover from their second quarter trough, and easing raw material prices drove favorable margins. We continued to deliver against important strategic initiatives and generated strong free cash flow. The overall macro environment remains a challenge. Declining economic activity in Central Europe, a slow post-COVID recovery in China, and the ongoing UAW strike are headwinds compounded by the once again strengthening dollar. On the other hand, the green shoots in the electronics market are growing taller, and we have reason for optimism as we prepare for 2024. Another source of that optimism is margins. Gross margins improved nearly 500 basis points year over year on a constant currency basis, despite lower volumes, as we benefit from declining raw material inputs and logistics costs and continued synergy actions. These cost trends are encouraging, setting us up nicely as demand rebounds. On our last call, we talked about uncertainty around Q3 versus Q4 timing, given the ongoing recovery in the electronics market and what that might mean for phasing of earnings. The third quarter proved to be better than planned, and we now expect to see a more normal seasonal pattern in the fourth quarter. This means a sequential slowdown in electronics, but we do not view this as end market softness just ordinary course seasonality. Demand in our industrial portfolio is impacted by the macroeconomic factors mentioned earlier, but improvement in both cost of goods and OPEX are offsetting that impact. In the third quarter, we recorded an impairment charge on our graphics solutions business. We've had a few years of challenging markets driven by CPG packaging trends, skew rationalization, and stubborn raw material inflation. We do not believe our demand experience in this business diverges from the competition, and we have several work streams underway to improve its profitability in the years to come. This impairment is the primary driver of the difference between reported and adjusted EPS this quarter. We're very pleased with our progress on the transactions we announced in June to enhance and grow our high-end electronics portfolio. The Viaform distribution rights we reacquired are already driving deeper commercial engagement and unlocking new sizable pipeline opportunities with the largest semiconductor manufacturers in the world. We're on track to complete the integration of customer service, quality support, and inventory management for Viaform later this quarter. We believe this front end of line offering is well positioned for growth beyond our initial expectations and have traction on both leading and legacy nodes. These products complement our back end of line advanced packaging solutions that enable the increasing complexity in chiplet design, which should drive the next leg of computing performance improvement for data center, AI, IoT devices, and industrial automation. We're confident our semiconductor business is poised to deliver significantly above market growth, even as the market rebounds in 2024. The customer response to the nanocopper technology we acquired with Couprion has been outstanding. Many large electronic component and semiconductor manufacturers are eagerly working with us on applications development. The team is busy driving commercialization of the technology and progress on product qualification. We're ahead of our expectations from the onset of this transaction, and the business may begin to contribute to profits as early as the second half of 2024 and should drive growth in 2025. Taken together, our electronics businesses will bring an increasingly differentiated set of solutions to market in 2024 with a powerful and unique breadth of enabling technologies for a global semiconductor industry that is rebounding from a deep cyclical trough, is experiencing robust support and investment, and has been reinvigorated by the promise of generative artificial intelligence. Looking through any near-term noise, The next few years promise profound opportunities for Element Solutions. Kari will now take you through third quarter business results in more detail. Kari? Thanks, Ben. Good morning, everyone. On slide four, you can see a summary of our third quarter financial results. Net sales declined 3% on an organic basis, primarily reflecting continued year-over-year electronic softness throughout Asia, where most of the business resides. Reduced commodity costs and stable pricing drove significant gross margin improvement, leading to constant currency adjusted EBITDA growth of 2%. Excluding the impact of a sizable bonus accrual reduction in Q3 2022, adjusted EBITDA growth would have been 8%. Relative to the second quarter, our reported revenue improved 2%, while adjusted EBITDA improved 16%. Though there were pockets of improvement in the electronics segment compared to the particularly weak end market in the first half, overall consumer electronics demand in Asia was still weak relative to the prior year. This drove a 5% year-on-year decline in organic sales. Our industrial and specialty business declined 1% organically. A soft industrial demand in Asia and Europe offset double-digit growth in our offshore energy business. In constant currency terms, adjusted EBITDA margin improved 110 basis points year-over-year, or over 250 basis points sequentially. Electronic segment adjusted EBITDA margin benefited from lower pass-through metal costs and mix within our circuitry business, driven by sales from the higher margin smartphone supply chain. Industrial segment margin improved 70 basis points in constant currency due to positive mix from energy solutions, as well as ongoing synergy realization, pricing benefits, and input cost deflation. Excluding the impact of the $94 million of pass-through metal sales in our assembly solutions business, our adjusted EBITDA margin would have been 27% in the third quarter. Adjusted EPS was flat year-over-year with the graphics impairment Ben mentioned, the primary driver of the year-over-year difference in the gap figures. On slide five, we share additional detail on organic net sales. Our electronic segment results were driven primarily by mobile phone and consumer electronics markets in Asia. Consistent with the first half of the year, our automotive electronics business remained resilient, particularly for power electronics applications in electric vehicles. Assembly solution sales were flat organically, as new business growth and traction with new, higher reliability alloys for use in automotive end markets was offset by soft consumer electronics. Semiconductor solutions declined 6% organically, better than recent trends for semi-MSI. Circuitry solutions declined 12% organically, as China consumer electronics activity remained subdued, and some commodity-related surcharges rolled off. The overall PCB market is improving sequentially, but remains soft in comparison to prior year activity levels. We believe our third quarter performance outpaced the broader PCB market, and are heartened by supply chain commentary of much improved inventory levels. Our business with memory disk customers was notably weak, and drove a significant portion over the organic sales decline. For the third quarter, organic net sales and industrial and specialty declined 1% year over year. Industrial solutions declined 2% organically, as demanding global construction and industrial markets remained soft, and commodity-related surcharge revenue for palladium fell versus Q3 of last year. Energy solutions remained the bright spot, with sales again growing 11% organically in the quarter, despite difficult comps from Q3 of 2022. Production and drilling activity has sustained their rebound, and price actions continue to benefit sales. We expect continued growth from this business throughout the year and into 2024. Slide six addresses cash flow on the balance sheet. We generated $75 million of free cash flow in the third quarter. Working capital was relatively flat sequentially, reflecting increased sales that were offset by modest inventory improvements. Net capex year-to-date was $35 million. and we expect our fourth quarter investment to be approximately $20 million as certain growth projects and integration initiatives progress. We now expect to spend approximately $55 million on a full-year basis. Turning to the balance sheet, our net leverage ratio at the end of the quarter would have been 3.6 times with the estimated full-year benefit of the Viaform product line, for which we reacquired distribution rights in June. We continue to expect to be below our targeted ceiling of 3.5 times by year end. As a reminder, the swap maturities on our term loans are split over the next three years, and our capital structure is 100% fixed until 2024 and more than 80% fixed until 2025. We have no debt maturities until 2026, and our liquidity position remains strong. And with that, I will turn it back to Ben. Thank you, Gary. We're pleased our results have inflected positively here in the second half. We've seen what we considered the trough and are beginning to recover from it. We didn't know what to expect in terms of the slope of the recovery, and the sequential seasonal slowdown we expect in electronics in Q4 suggests that while we will not see a sharp immediate recovery, we will continue to improve from the cyclical trough. Against our last guidance, we've seen an incremental $5 million of FX headwinds to adjusted EBITDA due to the strengthening dollar. Slightly less than half of that headwind was in the third quarter. That, together with timing of sales associated with our Viaform transition, lead to a modest reduction in our full-year adjusted EBITDA guidance of approximately $485 million. The Viaform impact is timing related to idiosyncratic customer ordering and inventory management around the transition. Given this timing impact, we now expect a greater contribution from this transaction in 2024 on a year-over-year basis. Gross margins for the company are back over 40%, and cash flow conversion remains very strong. Even with the second half recovery we're seeing in electronics, semiconductor production and high-end electronics markets remain far below their long-term averages. Overall, we've seen soft volumes across nearly all of our businesses for over a year. This is not a reflection of share, but of inventory destocking and economic malaise. The current situation suggests substantial room for margin accretive growth in the years to come. However, we're not waiting idly by for that broader recovery. We've identified in action $10 million of cost savings to impact next year, and we've invested and gained real traction in the technologies and market niches that we expect will propel market growth. Advanced packaging, new semiconductor node transitions, expanding vehicle electrification programs, and thermal management. We believe it's reasonable to expect the business to deliver adjusted EBITDA growth north of 10% in 2024 and to continue to grow from there. As you can tell, we're enthusiastic about the future and have evidence that the growth we've come to expect from our business is returning. Our team is doing a terrific job navigating the complicated macro environment and continuing to deliver reliable, high-quality solutions for our customers and newly emerging needs. I'm very grateful for their energy and effort this quarter and going forward. With that, operator, please open the line for questions.