Element Solutions Inc (ESI) Earnings Call Transcript & Summary

Okay. Welcome back. It's a pleasure for me to host this fireside chat with Ben Gliklich from Element Solutions. He's the CEO. I had the pleasure of hosting a field trip to 2 of his sites in Connecticut last fall. We were trucking around Connecticut in a little van and had the pleasure of Ben's ear for a big chunk of that trip. It was really insightful for me. I'm an old chemical guy, but the electronics industry has not been exactly my wheelhouse. And so, I learned a great deal from that trip to Connecticut. It was an R&D center and a semiconductor manufacturing plant, and Ben was with us the whole time. So it was a great trip, learned a bunch. They had a really good investor event down here last week, learned a bit more about the platform and really admire what Ben has accomplished at Element Solutions these last few years. So, Ben is going to give us a few introductory remarks, and then we'll jump into Q&A. So over to you, Ben.

Thanks, Steve. Good morning, everybody. Thanks for joining. It's great to be here with you in person. And thank you, Steve, for your ongoing support. That was a great field trip. That was a lot of fun. And our Investor Day last week was also a milestone for us. It's the first one we've done in 3 years since we launched this company. And I wanted to spend just a minute with a couple of selected slides from that Investor Day to summarize what we accomplished in our first 3 years of Element Solutions and what we're committed to accomplishing going forward here. So, 2021 was a watershed year for Element Solutions. It was a record for our company since we were founded or launched in 2019 in terms of sales, in terms of EBITDA, in terms of EPS, in terms of cash flow and in terms of CapEx. So we're spending more to position this business for accelerated growth. Importantly, we delivered on our initial 5-year commitment to double EPS in year 3. So, we're closing that chapter, that chapter of the first phase of Element Solutions and moving into the next chapter, which we'll talk about in a minute. In addition to really strong financial results last year, we deployed capital strategically. The mantra last year was winning now winning later, capitalizing on the very powerful trends that were propelling this business while also positioning the business to experience an acceleration, continued demand, continued outperformance. We acquired Coventya, which is a highly strategic acquisition, expanding our capabilities, broadening our strength in some of our core market categories and allowing for us to enter some new interesting adjacencies. And H.K. Wentworth as well, smaller business, inside of that company was a portfolio of products called Electrolube, which gave us a foothold in thermal management materials and adhesives, highly strategic category of products with significant growth as computing power proliferates in electric vehicles, things that our customers want to buy from us, we can now provide to them. As I said, 2021 was a capstone on this first 3 years as Element Solutions, and we've built a track record of strong performance. We've outperformed our business, our markets, on the top line in challenging times and in better times. So we're delivering results in excess of units. We're converting sales growth more efficiently into profits. So you can see EBITDA margin expansion and growth in EBITDA in excess of the top line. And we're converting those profits at an accelerating rate into free cash flow. We generated more than $750 million of free cash flow in our first 3 years, growing every year despite a choppy environment, whether it was supply chain constraints, COVID or raw materials inflation. We doubled EPS in 3 years. So, EPS grew at 3x the rate of EBITDA. We delivered on that commitment 2 years early. The future for Element Solutions is very, very bright. We are positioned at the cross-section of several very strong secular growth trends. And we're in the early innings for each, whether it's next-generation wireless technology where our content is growing in a market that is growing, 5G phones, 5G infrastructure, we're in the early innings of that transition. Rising semiconductor intensity, whether it's in next-generation wireless infrastructure, whether it's in vehicle electrification, whether it's in Internet of Things and broader applications that will be only further enabled by dense, powerful broadband capacity. We're a key enabler of that market. And then, electric vehicles. We've got up to $100 content opportunity in electric vehicle. It's 1.5x what we have in a conventional ICE. And obviously the rate of penetration of the automotive fleet by electric vehicles has accelerated relative to our expectations just a few years ago. Significant content in all 3 of those areas, and of course the fourth is sustainability where our business is a beneficiary of a trend towards sustainability. Each of our business lines has capabilities that improve our customers' environmental footprint. If our customers want to do business or want to be sustainable, they want to do business with us. It is driving customer preference. What that all translates to is our 5-year growth algorithm, which was refreshed after our initial Investor Day back in May of 2019. The growth rate of the markets in which we participate has accelerated. It has inflected positively over the past several years. So the underlying market growth is 4% to 5%. We expect to do 1 point or 2 better. So the top line for this business over the medium-term should be a 5% to 6% grower. And that incremental margin that we've been able to generate historically, that dynamic is unchanged. So we expect this business over the medium-term to grow at a high single-digit EBITDA growth rate. With over $2 billion of free cash flow to be generated over the next 5 years, capital allocation is a key component of the value proposition, as it has been with Element Solutions to-date. Altogether, our commitment is to deliver $2.50 adjusted EPS by 2026. It's a 13% EPS CAGR. Our internal compensation target is in excess of that. It's doubling on the prior target to $2.72 by 2026, an ambitious but achievable goal in the context of what this company has delivered and the market trends that are propelling us forward. Our 2022 guidance, which we introduced last week on our earnings call, is for $575 million to $590 million of adjusted EBITDA. That's a mid-teens constant currency growth rate, $1.55 to $1.60 of adjusted EPS, again, a mid-teens growth rate, more than $300 million of free cash flow. A strong year in another choppy environment, but the trends behind this business are persistent and powerful. And the growth we've been delivering, we expect to continue to deliver on. With that, let's have a fireside chat. Thanks for your attention. Looking forward to your questions.

Very good. Thanks, Ben. So, on this field trip that we hosted in Connecticut last fall, Ben was sitting next to me on the bus for a part of it. And at one point, I leaned over to him and said, Ben, so what are you working on these days? And I thought he would say something like meeting with customers or acquisitions and so forth. And he surprised me with a comment where his focus was on driving these strategic objectives with everyone in the organization. And I found it really interesting and would like to hear you talk about it a little bit. But in my experience, the companies that I've covered over the years where there really has been a significant change in the organization with respect to driving productivity or situations where management has incentivized employees to affect their business, not the stock price, which most employees would have the view. Well, I'm never going to have any influence on that, maybe the CFO. But my sense is this initiative you have kind of drives that focus down to a level where your employees within the company can affect change. And I'd like to hear you talk a little bit about where it's headed.

I can talk about this for 2 days. So, let me see if I can summarize what we call, ESDI, element, strategy, development and implementation. In years past, you get to a budget meeting and every business unit would have strategic focus areas. There'll be a list of things that were happening in the market. And that's where folks were going to spend their time. And then you get 3 months into the year, and you'd ask, what's going on with these strategic focus areas. And you'd hear a list of other things that have been reprioritized, putting out fires in the business. The challenge of strategy is not finding out what's happening in the market. It's building plans that allow for you to implement strategies with a long-term focus. And so, ESDI is strategy development and implementation with the idea that there are, in every market, deep profit pools that we're underrepresented in and we're going to build plans that allow for us to grow our share with breakthroughs for a 3 to 5-year period, right? And it's not all about this year's results, right? If you're going to break through from a strategic perspective in 3 to 5 years, this year's results have to build that way. So, with a lot of thorough analysis and using some tools that we borrowed from companies we admired, some tools that we've developed ourselves, we figure out what are the 3 or 4 things in every business that truly matter over a 3 to 5-year period. We build a road map to delivering on that. So what's the 3 to 5-year goal that really represents a big breakthrough? And then, how do we know we're on track in year 1? And then, what do we need to do? What investment do we need to make in order to deliver on that year 1 goal? And then how do we know we're making progress against that on a monthly basis, right? And so turning big vision, big goals into monthly milestones is what ESDI is all about and then making sure that every person in the company understands how they can contribute to that. Our business is a people-based business. And if we can harness the power of 5,000 incredibly capable people working towards shared objectives, we will be successful. So, ESDI starts with these breakthroughs built on the back of really detailed market analysis and capability analysis. And then, it funnels that down into monthly milestones that every person in the company understands that they contribute towards and is measured against. Now we tie that to incentives. And it's really changed the way we look at the business, the way we manage the business, the way we incentivize people, that vocabulary has penetrated into the organization, and it's created an alignment and a focus that is driving the way we invest and is really turning into significant customer successes.

And speaking of invest, you also brought up this new metric that you're using, the CRI, which is conceptually logical to me, but not one that I've heard. Can you talk a little bit about that? And how has it affected your decisions on what to invest in?

Yes, absolutely. So, the hallmark of Element Solutions businesses is, they're stable strong margins and they're stable strong cash flows. And the returns on assets in this business are better than any business in our industry, full stop. And we view cash generation as the way to measure business quality. So we're not interested in pursuing very low margin sales and making big investments to win low-margin sales. We are interested in improving the quality of our business. CRI is a very simple, easy to understand, very comparable metric that allows for you to measure business quality and business quality improvement. And what it is, is it's cash return on investment. So it's EBITDA less maintenance CapEx. It's the cash that comes out of the business, divided by PPE plus working capital, the cash you have in the business. And the beauty of it is that it's a metric that you can improve in any year regardless of the macros. In a bad macro environment, you can take capital out of the business, generate more cash. In a good macro environment, you're investing, but you're still getting a high return. And so, we judge our businesses, it's becoming part of our LTI and we have an award for the business that improves its CRI the most every year on CRI. And it's also a powerful tool, easy to understand and easy to measure and one that I think is infusing the mindset of this company where we talk about operational excellence being one of the prongs of our strategy, operational excellence and prudent capital allocation. Operational excellence is making good businesses better. And CRIs and what you measure that we're making these businesses better.

And so, when you roll that out and you assess the 6 businesses that you have, did you conclude that some were better than others or that they were all equally able to improve?

So some of our businesses have much higher CRIs than others, but the beauty of the metric is you can improve your CRI regardless of the business here, right? And the winner of the CRI competition in the first year had a relatively low CRI and improved it by 15%, right? And so, yes, there are certain businesses that have higher CRIs, but some of the ones with lower CRIs have more growth. So it's not just CRI driven, right, it's quality and growth. But it allows for the businesses to focus on the levers at their disposal. Some businesses have more ability to run with less capital and to work on working capital, some have more growth opportunities to go [indiscernible] point. And we just want to drive CRI, right? And there are different tools in the toolbox for different types of businesses depending on where they are in their growth cycle and their investment cycle and so forth.

My sense is that you're somewhat agnostic to end markets, and welcome your comments on that. Is it really a matter of what potential acquisition or end market I can go into that I can get double-digit earnings growth out of not necessarily whether that is an end market that as a perception out there that's attractive because some companies seem kind of obsessed with this. So, I want to stay away from this area, and I want to go towards this area because it's -- the perception is it's a higher multiple end market where it seems like you're more agnostic to that and you're more focused on driving double-digit earnings. Is that fair?

It's partially fair. What I would say is that our business -- we've got great businesses in multiple different end markets. And there are opportunities to improve each of those businesses. We're not emotional about any of the businesses though. And so, we get this question all the time, why don't you sell this business or that business? Well, we've got an ability to make these businesses better organically. We've got compelling runway for them. But if someone wants to pass a great price for an asset, we're not going to stand in the way of that as fiduciary. With regard to outward capital allocation, we have a firm framework for how we deploy capital. We are not agnostic about markets. If we're not going to go into a market, we don't understand where we don't have a presence, right? So we're going to invest behind our businesses in businesses we deeply understand that are better inside of our company than outside of them, meaning their synergies. We're adding capabilities that will improve our solutions to our customers and that are available at reasonable prices, right? But we're happy to invest behind any of our businesses and transactions that meet that criteria with a compelling growth runway. We're driven by compounding intrinsic value of the company.

Your Head of Electronics had some remarks last Thursday on a couple of key areas of innovation. One of them I was familiar with, because we toured up in Connecticut. The other one was new to me. But the one that I wanted to hear your outlook for is, at least from my view, it's like a flexible film that has a circuit board on it. I don't know how to better describe it. It's circuitry that's on a film that you can then mold into an automobile part that doesn't have buttons, it's all incorporated into the mold. How much interest are you seeing from the OEMs on something like this?

We've seen a lot of interest. It's a really -- it's a nascent product technology or nascent product application, I would say, that has very significant traction with OEMs. What we're doing here, historically our business had a legacy hard-coated films capability, right? So these are plastics that can be hard-coated for a variety of applications. Some of them are in automotive screens. We've gotten into forming those films, right? So, creating componentry out of these hard-coated films. And on the other hand, we've got a capability to create printed circuit boards and assembles printed circuit board. So if we can turn a film, like a component, think about the piece of the roof of a car that controls the sunroof, right? If you can put the circuitry on that piece of film rather than having a cable that runs to some CPU or having a button that adds a lot of cost from a molding perspective. If you can turn that actual piece into the board that controls that, you're taking a lot of weight out of the car, you're taking a lot of cost out of the car. And we're uniquely positioned because of our hard-coated films capability, because of our molding capability because of our circuitry capability, our assembly capability to deliver that assembly. And with weight being such a huge issue now to range in electric vehicles and, to some extent, cost. There's a lot of traction with OEMs for not quite this generation 3 years from now. And it's a very interesting growth vector where we have a differentiated set of tools to bring to bear. I would assume a 3-year period would be about as short as it can get in a new model. I mean, if you're -- when you're talking about completely new designs as opposed to new model iterations.

Okay. And the other one that he talked about that really grabbed my attention was, what you referred to as power electronics or power transformation, but this transformation of direct current from a battery into an alternating current for an EV. And that piece is an area where Element has really an exceptional level of expertise, and it's a niche for you. Is that a fair characterization? How did you get this?

So this is a technology that is used in power electronics for assembling the power semi. Historically, power semi assemblies were done using conventional solder materials, given the voltage and the alternation of voltage, right, so discharge and recharge, legacy assembly materials struggled from a reliability perspective. They also had a lot of thermal heat loss. And so, we innovated a technology [ silver ] with specific types of molecules and a specific application processed as opposed to being melted and centered, which is heat and pressure that has world-class performance attributes. And it is truly enabling the latest generations of electric vehicles, improving their range and improving their reliability. It's been a product category that's doubled for us for the past 2 years in a row with a huge runway, just a huge runway. It came out of our Assembly Solutions business, which were our conventional solder materials and assembly materials sort of grew up. And originally, it was a product looking for a market. We got the seed of the technology in university collaboration, and we improved upon it and improved upon it. And then, the EV market opened up. We found this was the best technology and no one has been able to rival our performance with this product. And we're doubling capacity this year because demand is so strong, high margin, high growth, outstanding product. And it's in a way demonstrative of the transformation we've driven in this Assembly Solutions business. I think there's a misconception in our Assembly Solutions business that it's an older set of technologies, more solder, more metal, but we've driven almost 50% of sales in that business into higher-tech paces with specific alloys and specific performance of this product in power electronics, more into high-end devices, more into semiconductor markets. The margin contribution from those applications is about 2/3 to 3/4 of that business. It's a high-tech electronics materials business. It is not a legacy tin solder business.

And you've had some bolt-ons. And my question for you is, what's been your strategy on how to cross-sell, globalize and just drive more wallet share of your customers. How are you doing that differently?

So, there are 2 case studies. One is what we did in water treatment and the other is what we've done in adhesives and thermal management materials. In water treatment, our products would go in at the beginning of a [ blading ] process and we would be in all of the equipment until water treatment. Water treatment is an increasingly important issue for our customers. It's getting more and more attention. Why can't we help them solve that problem? And so we bought a small business that had good water treatment capability with existing customers and in other markets. We stood up manufacturing and sales around the world, prove to ourselves we can build the same quality and capability around the world as we had in this business we acquired. We're getting really good traction with customers where we can deliver a full soup to nuts from the water in to the water out with the chemistry. And that's something different than our competitors. In this thermal management and adhesives business, small acquisition, good technology, was a regional player, and we're getting pull now from big customers who are interested in our capabilities. So this wasn't -- let's stand up manufacturing all over the world, let's educate the market about our capability and show, hey, we can solve this problem too. We're not just going to give you the adhesive -- the metal adhesive that's used to put the chip on the board, we can give you the underfill, right, which is a polymer and touch more of electronics assembly than anyone else in the market. We've had really good traction in that market, new entrant focusing on big customers with a solutions orientation, not a list of products. So it's not a catalog company. It's what do you need from this. And with big accounts with large OEMs, how can we formulate to solve that problem in a collaborative mindset, which is different than what has historically been seen in the adhesives market, and it's working.

Anybody want to jump in here with a question for Ben?

It seems like a lot of innovation. Is that mainly acquired innovation or you have R&D? And if yes, what's -- how much you invest in R&D?

Yes. So it's an R&D-intensive business, but it's not breakthrough innovation. It's incremental product development, right? And so, our products are meeting the needs of the requirements from our customers and OEMs today. Their needs are only changing modestly from generation to generation. We're working with them through technology road map exchanges to figure out what it is our products need to do for the next generation. And it's generally just tweaks. And that actually is part of the big moat around our business. We've got thousands of years of experience in the people in our company and hundreds of years of experience in these markets. We know how to -- we've been solving the generational climb from a technology perspective, and we're in the pole position to solve the next set of requirements. We spend about 2.5% of sales in what is R&D, which is mostly incremental development, but we also spend a significant amount in technical service. And so, every manufacturing line has a slightly different set of circumstances, whether it's the equipment that's being used, whether it's the temperature, whether it's the flow rate. And so, we've got people on site helping make sure our products work in that specific application environment, which is also development in a sense. So, overall R&D is more like 4%, 5% of sales. And in different businesses, it's higher. So in the semiconductor business, obviously it's higher than it is in our offshore business, for example.

Here, please.

So, Ben, you touched a little bit on the wastewater treatment side, right? When you acquired DMP, you married it with the metal recycling business and it became like $20 million, I think that was where $20 million revenue kind of [ Enviro ] business. You haven't owned the DMP business for a very long time. I'm kind of wondering what early traction and acceptance of this new business platform has been, maybe where are sales now or where are sales expected to be in 3 years as you grow the...

It's a longer sales cycle than in our chemistry businesses. And it's had more of a supply chain impact because it's further downstream to more assemblies. And so, the way we're measuring it is in pipeline build and the pipeline is 3x the size of what it was when we acquired the company. The top line, again, was a little constrained by supply chain. But we should be approximately doubling in 2022 versus what we acquired. So there's good traction. It's still a small business for us. What that doesn't capture is the incremental commercial consumable sales that we have opportunities to exploit because we're leveraging this equipment. So we gave a case study last week of how we provided a turnkey solution to a company in the UK that really started with water treatment and now it's 100% our chemistry as well, displacing a competitor. And so, there's a lot of value from the sell-through of chemistry, which is recurring high-margin sales because of the capability in equipment. So you've doubled EPS in 3 years. When you look back at those 3 years and look at the end market growth of the end markets that you sell into, electronics and however you measure that, whether it's handset production or on the industrial side, OEM auto production, how much have you -- has your organic growth exceeded end market growth over those 3 years, because of the things that you're driving to get more wallet share, cross-sell and that kind of stuff. So, 2019 was not a great year from an end market perspective. There's a delay in 5G rollout. Automotive was softer in the back half of the year. And we were sitting there really excited about 2020 and then, of course, COVID hit. So we saw our end markets go backwards in '19 and '20 and then obviously '21 was a huge growth year. Electronics had growth in 2020 as well because I work from home and the inflection in 5G, so I don't have this number at the tip of my fingers. But I would say that our blended end market growth rate through our first 3 years annualized was low to mid-single digits, and we vastly outperformed that vastly.

So we should model that for the next 3 years?

Every year is a little different. Opportunities look a little different. We're committed to growing a point or 2 faster than our end markets. And we believe that is something that we can deliver on. We take our commitments very seriously.

Very good. And we're out of time. So, grab Ben here if you want to get any more questions, but I sure appreciate joining me in thanking Ben for this time. Thank you.