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.

At this time, if you'd like to ask a question, press star 1 on your telephone keypad. If you'd like to withdraw your question, press star 1 again. Please hold for your first question. Your first question is from the line of Babish Ladoya with BMO Capital Market.

Babish Ladoya Thanks for taking my question. So in the third quarter, we saw a nice margin expansion across both your segments. There appears to be a case of you holding on to price as your input costs and all of the logistics, some of those have moved lower. So can you help us provide more color on what's driving the success there and how should we think about your EBITDA margins as you see volume growth come back in next year?

Yeah, thanks for the question, Bhavesh. A few things contributed to the margin expansion. Price relative to cost was a big one. We've always said that this is a business that has sticky pricing actions and that's been made manifest in the quarter. We have not seen real price asks as our raw material prices have come down, which is what we would have expected. Another large contributor is just mix. So last year, at this time, with high metal prices, a decent portion of sales were coming from surcharges, which are much lower margin than we'll call it proprietary chemistry sales. And so those surcharge sales of metals have fallen away as metal prices have come down and been replaced by higher value sales of proprietary chemistry. So that explains a chunk of the margin expansion that we experienced in the third quarter. As we look forward, you know, volumes are still low. Year over year, volumes are down. And as we see volume growth, we should get greater facility utilization and see incremental margin expansion. Our metal-adjusted EBITDA margin in the quarter was 27%. It peaked at 30% in 2021. We see room for margin expansion from here.

Got it. And as a follow-up, so I believe you mentioned EBITDA growth of 10% for 24 is possible for 24. Given what we saw in the third quarter and your implied guide for the fourth quarter, would you say analyzing the second half of this year is a good baseline for the business? Or are there some other puts and takes, maybe around wire form?

Yeah. So... Simple rule of thumb, right? It's early to get guidance. It's a short cycle business. Visibility, especially into the second half of 2024, is limited. But historically, we've said that the second half of the calendar year is a pretty good indicator for the first half of the subsequent calendar year, and that remains to be the case. The timing of the second half's ramp is unpredictable, as we saw this year. So, you know, starting with annualizing the back half seems reasonable. We do get a contribution from Viaform, which is, you know, an incremental $10 million going into next year. There's a little bit of an FX headwind. We've talked about some cost actions we've taken, and those are the puts and takes as we start plotting 2024. But, you know, there's a case to be made for, you know, 10 plus percent EBITDA growth, as we said in our prepared remarks.

Your next question is from the line of John Kilwington with CJS Securities.

Hi. Thank you for taking my question. First, what's driving the Viaforma and Tegra's inventory dynamic and the reduction this year? And how does that set up your position in going into next year with pricing and service levels and just the demand recovery that you probably could expect to see in semiconductors?

Yeah. We reacquired the distribution rights for this product line, and we reacquired them from Integris, and they were holding our inventory. We took the decision to stop selling during this transition period. It just simplified logistics, and so those sales basically stopped for several months, and that's not lost sales. It's just delayed sales. You know, the customers expect us to hold a certain level of inventory, and we will, you know, and we are in the process of rebuilding that inventory now that we're in that transit, now that we own it, we're just not realizing the value for it in this calendar year. So that's really what's driving it. It's a decision we took, and it's deferred revenue. It has no bearing on our expectations for this business. Frankly, our expectations for the business or for the product line are higher today than they were when we announced this transaction.

Okay, got it. And then just a question on inventories versus demand. Are you shipping to end demand levels now in electronics, or is there some element of restocking going on in the industry now, you know, after inventories have troughed? How should we think of that dynamic and where you're actually at, you know, versus what is being sold through?

Yeah, so sell-in was lower than sell-through through the first half. Units of smartphones are down year on year still in the third quarter, and our volumes are down still in the third quarter. There is, as we, as our customers begin to ramp for production, there is a restock, but it is not what's driving the performance in the business. It's units. If you look at smartphone units in the third quarter, You know, they were still down mid-single digits year over year, but they were up sequentially. The forecast is mid-single digits. Our circuitry business was also up mid-single digits. So, you know, this bump in performance, the ramp in performance, is not an inventory restock. It's driven by underlying demand.

Your next question is from the line of Chris Kapapsch. with loop capital markets.

Yeah, good morning. Good morning, Ben. So it sounds like a key part of the story in the third quarter is the subtle inflection, more about the cyclical recovery than the secular story and drivers. So I guess my first question is, is that a fair characterization? And then more importantly, if I revisit say your early 22 investor day event, a key theme there was, of course, the secular drivers. So I'm just curious how you see these opportunities developing against the backdrop of a world that's changed since then, obviously. Are those still valid drivers for a multi-year progression for ESI? I know in your formal remarks, you highlighted advanced packaging. So maybe that's where visibility is greatest, but maybe you could touch on 5G and the automotive electrification, those growth factors, and just your competitive positioning generally addressing those secular drivers. Thank you.

Thanks for the question, Chris. It's a compound question. So first, you know, with regard to the, you know, cyclicality versus secular growth, we've always said that secular growth isn't linear. There's volatility around the upward trend. And that's clearly what we've been living through for the past 18 months or so. The recovery we saw in the third quarter was a recovery in high-end electronics. Volumes are still down. We are way off of peak. So we're still in a recovery. And that recovery will take us to a higher value end market because of the secular growth we're seeing from trends around artificial intelligence and vehicle electrification and all the things we called out earlier. So I do think the third quarter is more of a cyclical recovery, but the longer legs in this end market are from secular growth, from new markets and new technologies. And advanced packaging is a great example of an emerging application where Element Solutions brings a really differentiated breadth of capabilities. Those capabilities come from the legacy businesses that Element has owned and has been investing in innovation around and also from new things like what we're bringing to market in Couprion. You know, most of the engagement that we've been talking about with Couprion is for next generation artificial intelligence applications And customers are spending a lot of time on it. And the order quantities today are small from a volume perspective, but growing incredibly quickly. And that shapes our perspective on the contribution from Couprion, both the speed at which it will contribute and the potential, you know, sort of medium-term substantial earnings that that technology will bring. In addition to the existing high-quality offerings that we're already providing, in advanced packaging applications.

That's helpful. Maybe if you could touch on how the competitive positioning is evolving, if anything's really changed there in addressing some of these technical drivers.

Thank you. Yeah, so the core of our business in electronics is stable from a competitive perspective, the things that have worked continue to work. As we get to some of these leading nodes, we are starting to see exploration of new materials, and Couprion really helps with that. Viaform and some of the innovation that we've done there is improving our competitive positioning as new nodes come online. And we have a real expectation we'll be gaining share in copper deposition and in I see substrate markets because of the new technologies we're bringing to bear. This isn't a market where share shifts radically from one year to the next. The way that we grow our shares by getting a disproportionate amount of emerging applications, we feel very well positioned for that. And those emerging applications are going to be coming online in 2024 and 2025. And that speaks to, you know, our ability to continue to grow well above market in that timeframe.

Your next question is from the line of Steve Byron with Bank of America. Hi.

Rock Hoffman on for Steve Byron. In terms of the Vioform, do we think it has potential to drive cross-selling of other products to semiconductor fabs?

It's a great question. Thank you for it. And the answer is absolutely yes. We've been really pleased to see the change engagement level with the front end of line technologists at the largest semiconductor fab since we completed this transaction. And so we have ongoing more robust dialogues than we did before. Understood.

And just to follow up, what are the growth opportunities for you in electric vehicles that are different than internal combustion engine vehicles? And any update on the flexible circuit technology that you've had in development?

Yeah, really good question and really exciting area for us. Electric vehicles have a lot more electronic content than internal combustion engines, and we have some really special capabilities in power semi applications. So these are the materials that are used in the power semiconductors that regulate the flow of energy from the battery to the motor. And what we provide in that market is enabling technology to the high-end electric vehicle supply chain. We've got differentiated technology that is currently in use in a very large portion of high-end electric vehicles. And the traction for that technology is growing in the automotive supply chain, both in the West and in Asia. You know, we see about one and a half to two times the value in an electric vehicle versus a conventional ICE. And so, you know, we see, again, the business is driven by units, but there's a content story over and above units, and that's one of the key levers that's giving us incremental content, incremental growth relative to unit growth in the automotive supply chain. With regard to the flexible, formable, printed electronics, That is a nascent technology that we've had some really interesting breakthroughs and have a lot of hope for in the medium term. It's not a material contributor to profits today, but it's an emerging frontier for electronics hardware and one where we believe we've got a right to play and win.

Our next question is from the line of Josh Spector with UBS.

Yeah. Hey, guys. So first, I just wanted to ask on I mean, you made a comment in your prepared remarks about the green shoots getting taller for next year. I mean, obviously, the seasonality and second half shifted a little bit, but it's somewhat unchanged. So what's looking more positive to you now versus a quarter ago where you have confidence to even frame what 2024 might look like?

So we're pretty transparent about the fact that it's a reasonably short-cycle business, and so it's not an order book, but it's tone from the supply chain. It's tone from large semiconductor fabs who remain bullish about 2024, market research who are pointing to mid-single-digit growth in smartphone handsets, and general industry expectation for a recovery next year.

I appreciate that. And I actually wanted to follow up on advanced packaging and how to think about what that means for you. So you're talking about some of the newer, smaller businesses, but there's also some impact on your existing business. And I think if I look at your different opportunities, we can kind of size the content opportunity in smartphones, EVs, et cetera. Advanced packaging is a bit harder. So I don't know what you think that does in terms of industry grows X, MSI grows X, your content grow Y as a result of a shift in this technology. Is there any way to quantify that so we can better incorporate that into our models?

Yeah, it's a difficult thing to parse out because we've got technology in all of our electronics businesses that supports advanced packaging applications. whether that's, you know, in our circuitry business, IC substrate markets, in our assembly business, some of our advanced interconnect materials, and, of course, in our semiconductor business in multiple areas. So, you know, there's not one line I can point you to, and some of the chemistries we're providing to IC substrates, we're also providing to high-density interconnect markets. So, it's not clean. I think that the simple way I would characterize it is You know, we say we can grow a point or two faster than our underlying markets. And, you know, we believe that we're investing both dollars and R&D to grow our leadership from a technology perspective in these markets. And, you know, that plays into the underlying growth algorithm we've talked about. You know, call it mid-single-digit growth through the cycle on the top line. This is contributing to it.

As a reminder, if you would like to ask a question, press star 1 on your telephone keypad. If you would like to withdraw your question, press star 1 again. Your next question is from the line of David Silver with CL King.

Okay. Good morning. Thank you. I'd like to go back to, I guess, Ben, your comments about your front end of the line opportunities. And I believe the quote was growth beyond initial growth. expectations. So just a couple of things. But, you know, keeping with that theme, I'm just scratching my head and I'm wondering if you could maybe discuss, I guess, in regards to via form, you know, where that incremental growth might be now that you've, you know, brought the distribution rights in-house. In other words, was the original arrangement kind of suboptimal in terms of exploiting the full potential of Viaform. And then secondly, maybe a little bit more speculative, but if I understand you correctly, you're talking about meaningful commercialization on Couprion maybe being advanced, I don't know, 18 months or more from what we heard last quarter. And regarding that, I was wondering if you could just discuss a couple of things, maybe your intellectual property position there. And then is this a product that is best exploited by developing it or by handling the upstream in-house or to accelerate the deployment, would you contract the manufacturing or other aspects of commercialization of Couprion, you know, to others? You know, just how best to exploit that opportunity. Thank you. Sure. Absolutely.

Thanks for the question. So, you know, the partnership and distribution agreement we had with Viaform was a very productive one. It's a product line that grew massively in the 20 years during which we were partners with Integris and its predecessor organization. Since we, you know, now control that product line from, you know, manufacturing R&D through to the customer, we do believe there are incremental opportunities. And, you know, our partners also saw that and understood that there would be an opportunity from, you know, one party owning soup to nuts around that product line. What we found, you know, when we say opportunities in excess of our initial expectations is one, A lot of new semiconductor fabricators are coming online. New fabs are coming online. And we believe we've got a real opportunity to convert that at a higher rate than our current share of that market. And two, we're having conversations about backwards integrating our technology on existing lines, which is not something or in existing fabs to displace competitors, which is not something that would have been in our base case at all. You know, the qualification process is expensive and time consuming and not something that we typically see, but because of our technology and service levels, it's being considered, which would absolutely be upside. With regard to Couprion, the second part of your question, this is really special material. What we acquired was the technology, materials technology, and great people who know how to work with that material and and nascent applications for that material. And the work we've been doing has been refining that applications technology to meet specific customer needs to commercialize that technology. And the receptivity from our customer base has been really, really great. These are products that we know how to make already. They're not vastly different from manufacturing technology that we have in-house. You know, our IP, we have an IP position there, but there's also speed and customer intimacy that we bring to the table that is differentiated and solving an urgent customer need, frankly. We are going to manufacture this product ourselves most likely. The investment required to manufacture the product is not that substantial, such that you'd see a big lump in CapEx next year associated with it.

At this time, there are no further questions. I will now hand the call back over to the presenters for any closing remarks.

Great. Well, thank you for joining. Thanks for your questions, and we look forward to seeing many of you in the weeks and months to come. Have a good day.

This concludes today's call. Thank you for joining. You may now disconnect your lines.