Element Solutions Inc (ESI) Earnings Call Transcript & Summary

Good afternoon. This is Tom Hayes, I'm Industrial Analyst for CL King and filling in for Dave Silver this morning. Happy to have everyone involved, happy to also be hosting this segment with Element Solutions management of Benjamin. [Operator Instructions] So again, happy to have Element Solutions here at our conference. Ben, I was just hoping you could provide, maybe, take a, call it, minute kind of do a brief intro for your company, maybe discuss your segments and some of your end markets, and then we'll get into some more of the detailed granularity questions.

Sure. Happy to do so. Thanks for having us, Tom. Glad to be here, and thanks, everybody, for joining. For those that are new to Element Solutions, we are a global provider of chemical technology. So our materials are used in the production of high-value, high-performance products in multiple end markets around the world. What we provide is not a material, but it's a solution. . So our chemistries are used in complex manufacturing processes. And based on the innovation from our front-end of line researchers and the technical service from our on-site professionals supporting our customers' manufacturing processes, our solutions deliver an outcome that enables the performance of high-value goods whether that's in the electronics market, in the automotive market or industrial markets. The overall value proposition is that our materials represent a small fraction of the cost of these high-value goods but are absolutely essential to their manufacturing. It's a very sticky business, very stable business, participating in attractive growth markets. So about 65% of our revenue is in our Electronics segment, with the remaining 35% in, what we call, Industrial & Specialty. Our Electronics business provides technologies that are used in manufacturing of electronics hardware. Think about the process of converting a piece of plastic into a printed circuit board. That's a series of mechanical and chemical process steps, and we provide the full suite of process steps that create that printed circuit board. Similarly, we sell into the semiconductor supply chain. And so our materials are used in the fabrication of semiconductors, both at the front end of the line, so wafer plating; and at the back end of the line, packaging or advanced packaging, which is an increasingly interesting end market, and I'm sure Tom will ask some questions about that. Our materials are also used in device assembly. So putting chips onto those printed circuit boards that I just spoke about. Our business is unique in that we're the only company in the world that can speak to the breadth of touch points in the electronic supply chain that we do from printed circuit board fabrication, semiconductor fabrication and assembly, all of the places the electron goes to form those circuit pathways. The Industrial & Specialty segment is primarily industrial surface treatment. So these are process chemistries that are used to protect or decorate industrial products and industrial end markets. About half of that is automotive, but with the remaining piece being building products, industrial equipment, fashion finishes for consumer goods or for sanitary. So think about the faucet in your bathroom. It's a piece of plastic with a thin coating of nickel or chrome that's our chemistry. And the business shares the attributes that I went through with our electronics portfolio, albeit at a slightly slower growth rate. But again, essential value proposition in high-value markets where customers really deeply rely on us to innovate and support their manufacturing processes. Altogether, it's about $2.5 billion of revenue, 5,500 people all over the world, split 40% revenue in Asia, 30% in the Americas, 30% in Europe. The hallmarks of the business are stable margins, so EBITDA margins north of 20% and very strong, stable cash flows. So less than 2% of sales in CapEx. So our returns on invested capital, our tangible assets are industry best overall. I think I've done enough introduction. So maybe I'll turn it over to Tom for questions.

No, that was great. I appreciate it. I guess first off and kind of go into some recent news, I guess last week, you positively surprised investors with updated guidance and that raised both 2Q and the full year guidance ranges for adjusted EBITDA. I think in that release, you cited strength in the Electronics business and improved overall profitability. Maybe would you characterize that the strength in the wafer-level packaging in circuitry business that you called out as maybe an indication of an inflection point in their demand trends or maybe something more transitory.

Sure. Yes. So last week, we increased our Q2 guidance from approximately $125 million of adjusted EBITDA to approximately $135 million of adjusted EBITDA, and we lifted up our full year guidance by $15 million. So from $515 million to $530 million to a new range of $530 million to $545 million. There were 2 causes for that, that we cited in our press release. The first is an acceleration in certain of our electronics end markets, and the second is profitability. So I'll start with the second, which is to say that the strength in margins year-over-year and sequentially remains. The work we did during a period of significant inflation to recapture value has held. And so our pricing actions have held and raw material prices have moderated. And so across all elements, we're seeing better margins year-over-year and stable margin sequentially which is great. That's gross profit margins. The second -- the primary driver is really the electronics market. And we called the bottom to the electronics market in the second quarter of last year and saw things starting to get better in the back half. We saw strength in the first quarter. And we really saw an acceleration in 2 markets in the 2 months of the quarter to date, the wafer level packaging market and our circuitry business. So wafer-level packaging is -- think about that as front-end semiconductor. And we're seeing fab utilization rate increases, materials increases, and that's really being driven by AI, right? So demand for semiconductor is very, very strong, and we've got a great set of products and solutions for that market, and we're seeing that continue to ramp. The second area is our circuit board business. So these are materials used in the manufacturing of printed circuit boards and that business has been strong as well in the second quarter. That's also being driven by AI applications and certain mobile devices, that's less smartphones frankly. Smartphone market is better year-over-year and growing, but we're not seeing that as a root cause for this growth. It's really some of these next-generation integrated circuits supporting AI applications and data center applications that has driven this lift and it's lifting that overall electronics ecosystem. As we stand here today, we see that this is not transitory to answer your question directly, we're coming off the worst electronics market in generation, and we're seeing the strength that we anticipated to some extent lifting the overall market. We've lost you here. Maybe you can write in a question or a copy of a question into the chat. Great. Here we go. So Tom has asked, can you discuss the impact from the new U.S. fabs. So that's obviously part of the story, right? The CHIPS Act and the desire, not just in the United States but broadly in the West to onshore semiconductor production. It is stimulating, it is driving what will be a reasonable incremental volumes in the semiconductor market. And that's helpful for us, right? We're volume, not value driven. So the price at which semiconductors are sold isn't a driver of our revenue. It's the number of semiconductors that are sold, the MSI or the volume of semiconductors sold that drives our business. And so when we see more capacity coming online, that's incrementally helpful. And when it's in the West, we've got a level of incumbency and home-field advantage that works to our benefit. From where we sit today, we see a pretty solid trajectory, incremental volume driven by new fabs in the U.S., but they're not really coming online right yet. So what we're seeing in the [ P&L ] today is not a product of chipset investment. But as we look forward in a year or so, we start to see the ramp of some of these new fabs and that is clearly going to be a tailwind to our business broadly. Let's see what else we've got. Tom, are you with us? Great, we still can't hear you.

Sorry about that, everyone. I was having some homegrown technology issues here. No, I appreciate that. Maybe just kind of still on the onshoring of the chip factories and maybe you touched this and I apologize if you did. But have you kind of laid out the opportunities? And then are there any risk with the wave of investments being made as far as capacity accelerates?

Yes. The opportunity is incremental capacity that's domestic and local, and some of this is coming at really leading edges. And with it is an advanced packaging opportunity, and we've become a preferred vendor at this -- at these new nodes and for these nonstandard designs, right? So historically, innovation in semiconductor markets was getting to smaller and smaller transistor sizes to smaller and smaller nodes. Now innovation is new packages and new designs and assembly techniques. Those are very nonstandard, whereas it used to be an exercise in scale, now it's an exercise in design and packaging, and we're a partner to not just the semiconductor fabricators but to the OSAT who are doing those designs and innovating to solve the emerging pain points that have developed. Some of the large semiconductor players, front-end semiconductor players or foundries are moving back into advanced packaging applications. And the reason for that is that there's so much value now being derived from advanced packaging and because of our capability, again, across the breadth from laying copper or, call it, deposition at the wafer level down to printed circuit board fabrication and assembly, we've got a good seat at the table and a set of solutions that are really enabling some of the innovation in advanced packaging. And so this incremental volume, it's not generic volume. It's leading edge volume and our value proposition is differentiated there. There is a risk always when you see incremental capacity, right? And there is a level of cyclicality in the semiconductor market that we have to be aware of. But that cyclicality, historically, has skewed towards price or value of the market, not volume in the market. And it's clear with emerging applications or AI and automation that we're in the really early innings of what's going to be a long and durable period of growth in semiconductor volume. I can't speak to value per se, but in volume, and that's the driver for our -- for revenue for us.

Okay. No, I appreciate that. I just wanted to go back and ask one follow-up question on your updated guidance answer. And I apologize if you mentioned this, but I don't think you did. Is there any key end markets or macro factors that you're currently tracking as harbingers of maybe a broader-based acceleration in customer demand that we should also keep an eye on?

Yes. So I think we try to be very specific. In our release, there are 2 drivers, right? It's margins, which is across the overall business; and then it's a couple of pockets of electronics demand, right, primarily in wafer-level packaging and circuitry. Now the front end of the line is a leading indicator for Electronics, right, incremental fab utilization, semiconductor volumes, those chips go somewhere, those chips don't float, right? That's something we like to say. And so that should indicate an acceleration in the rest of the electronics portfolio broadly, but we haven't seen that across all of our Electronics business yet. It's really been more concentrated. I would note that in our guide there isn't a significant ramp in the back half versus the first half, right? So in a typical year, you get a 5% to 10% uplift in the second half versus the first half because Q3 is when we see new mobile phone platforms launching. We've got a lot of value in that and that ramp supports us. Our new guide doesn't have such a steep ramp from 1H to 2H. And that's frankly just a little bit of conservatism as we sit here today. Some of what we're seeing in the second quarter could be linked to the broader smartphone market, we don't believe it is really directly attributable to that. Smartphone market is soft versus where it's been through the trend or through the cycle, better than it was last year. That's upside as we see it. So this isn't smartphone resurgence or replacement cycle or anything like that. This is lapping a period of slow inventory and incremental demand driven by AI and its applications.

Okay. That's good. Maybe just kind of looking backwards a little bit. I think in 2023, you did 2 M&A-type acquisitions with ViaForm and Kuprion. Maybe just kind of talk about some of the strategic rationale and the expected financial benefits that you're either seeing or expect to see that kind of shape those transactions for you.

sure thing. So those are 2 very different, quite idiosyncratic transactions. We're very pleased with both of them as we sit here today. The ViaForm transaction, the history there is about 20 years ago, a predecessor company sold distribution rights to a material that's used in copper deposition onto silicon, so basically, circuit formation in the semiconductor market to a predecessor company to Entegris. And for many years, we were back and forth, trying to untangle that relationship because it wasn't ideal. Entegris was getting a 35% distribution margin. We continue to own the innovation and manufacturing of the product. The customer couldn't see exactly through the supply chain as well as they would have liked. And an opportunity presented itself where we could pay Entegris to terminate that distribution agreement. And we did so, we paid a full price at the time, but it was off of trough earnings, right? It was in the second quarter of 2023, which is really the trough for the semiconductor market. That transaction had an attractive financial return because, it's a very sticky business, and we're seeing a recovery in the electronics market. And obviously, this product is ramping really nicely. We just talked about wafer-level packaging being one of the reasons for our increased guidance, and this is a wafer-level packaging product. Then the added intangible benefit, I would say, of giving us a better seat at the table with the semiconductor fabricators. And we just got through talking about how innovation that's happening in the back end, and we've got great capability for advanced packaging and the front end of line cares more about advanced packaging. And so now we can sit with semiconductor fabricators and talk about our value proposition across the supply chain in a way we couldn't before. And that leads to mind share and commercial opportunities and innovation opportunities we may not have had otherwise. So it was very attractive from an industry access perspective but also from a financial perspective. We paid about 12x trough earnings. And sitting here today, it's probably single-digit multiple, and there was a lot of less risk because we're already making the product and doing the innovation associated with that product. So that was a great one for us, and we're -- we think it's win-win, frankly. It was also a win for our counterparty. Kuprion is a bit of a different story. Kuprion was a materials technology that was developed by some really outstanding scientists and stood up as a stand-alone business with incredible capability, really differentiated capability for emerging needs in leading-edge electronics. So what our emerging needs in leading edge electronics? As the features get smaller or as the computing density becomes more concentrated, the lines on the circuit board or the holes in the circuit board get more and more narrow and so plating them becomes harder. And this is a material that can solve that problem for the IC substrate market, the very, very leading edge. Again, we're talking about advanced packaging. Thermal management becomes a bigger problem because all of these small lines together generate a lot of heat and there's a lot more power density going through these chips. And so just dispersing that heat is more and more important and more and more difficult in the products that we -- or the product capability we've acquired with Kuprion has excellent thermal properties, and we can get far more technical than that, but I'll save that unless you have a follow-up. The long and short of it is this is a transaction where we paid a small amount upfront to own this technology, and we had a lot of opportunity to work with the material, to build confidence that it worked and then we structured the acquisition with earn-out payments based on achieving certain qualification milestones internally and externally and then ultimately the revenue that the business generates. As we sit here today, the first bottlenecks that we saw were commercialization -- was commercialization, how do we create demand. And we've actually stopped trying to sell the product because we've had so much pull from the market because the material does solve such burning pain points from our customers. We don't want to continue to make promises in the market because we've got to sort out our internal supply chain and what we call the customer supply chain, which is applications know-how. So the demand is absolutely there and came faster than we thought, and now we're working on supply chain. And that will be the answer when folks ask us about Kuprion for the next 6 to 9 months. It's scaling up our manufacturing and helping our customers establish what their manufacturing processes would look like. But it's -- the product has exceeded our expectations in terms of its technical capability and in terms of customer receptivity.

Okay. No, I appreciate that color. That's great. Maybe shifting gears a little bit. You had mentioned a little bit in the last answer on supply chain. Maybe certainly, the global supply chain for your industry and the semiconductor industry has been seeing lots of disruptions and challenges over the last couple of years. I was just wondering maybe your thoughts on the current supply chain environment. And maybe what could be the -- maybe what kind of challenges you see out there over the kind of medium term, 9 to next 12 months?

Yes. So we're -- I'm not going to say this, but we're through the worst of supply chain disruption post COVID. And there was a very difficult couple of years where raw material availability was challenged, prices were really high, logistics cost was really high. And we were fighting to get material to support our customers, and we made it through the worst of that. There still are some disruptions in supply chain, given energy prices in Europe, for example, some of our suppliers just don't have economics to continue to supply. And so our R&D teams have been working very hard to reformulate in some cases or qualify new suppliers for business continuity purposes. And as one of the largest players in our markets, we've been able to support that and that's been differentiated for us. Logistics costs have stabilized but haven't really come down that much, I would say. So overall, logistics about a point of sales higher than it was before the crisis, and we don't see that coming in too much. But by and large, I would say, our internal supply chain issues have been mostly resolved then our customers' internal supply chain issues or customer supply chain issues are better. Obviously, there was a lot of issues with demand planning, let's call it, over ordering, under-ordering, excess inventory in the channel which [indiscernible] did impact our P&L. The next thing, I would say, from a supply chain perspective is China Plus One. So our customers, our supply chains have a decent-size presence on the ground in China and both Chinese and non-Chinese manufacturers are looking for an extra country, another country to build up. And that's happening in Vietnam and Thailand and Indonesia but also in Mexico, for example. And that's a good trend for us because we've got boots on the ground, applications labs and ability to help our customers set up their manufacturing capabilities in these new jurisdictions and that's bringing opportunities our way.

Okay. No, that was great. Maybe kind of an industry question. Obviously, in the last 2 weeks, DuPont Electronics announced their spinoff. Just wondering if you could discuss your initial thoughts regarding the impact of this planned spin-off on the industry and the overall competitive nature that you're seeing out there?

Yes. So DuPont Electronics business is a great, large electronic materials business. The spinoff doesn't change anything from a competitive perspective because they're not taking anything apart that had any, call it, commercial synergy from what we can see, right? So it's just standing them up as a stand-alone entity. Perhaps when they're through with this, they'll have a more focused entity and that will have some impact. But it's not a combination that has any strategic synergy or a separation that has any strategic dissynergy from our perspective. They've got a great collection of businesses, with great technology and people. We've been competing with them in certain markets for many years. And this doesn't really change anything from our perspective. Our business is a market leader in the markets in which we participate. And those are just a selection of niche, very high-value, attractive markets in the electronics space. And we've seen consolidation in electronics materials over the past several years, but none of it has impacted us from a strategic perspective. And none of it has disadvantaged us as we see our customer value proposition in go to market. And the DuPont separation falls into that same category.

Okay. That's fine. I know we touched on a little bit on the introduction your exposure into the automotive, whether it's ICE, hybrid or EVs. Maybe just delve into that a little bit in kind of some of our remaining time here as how you see your solution portfolio evolving over the next several years, whether it's for EVs or ICE or the hybrids and maybe represent a greater share of the overall market.

Sure. so our automotive exposure is both in our Industrial business and in our Electronics business. Our Industrial business -- rather our segments are based on what the products do, not where the products go, right? So our Industrial business provides surface treatment. So think about that as the [indiscernible] on your car looks like metal, but it's a thin film of metal around the piece of plastic. That's our chemical solution that's plating that metal on to plastic or the brake calipers on your car are corrosion resistant. They can sit in the water and not corrode. That's a coating of zinc or zinc nickel that we've plated onto that brake caliper. And so about 50% of our Industrial Solutions business is automotive. And to some extent, that's agnostic of the type of car. There are some nuts, balls and fasteners that go into the engine that won't be needed in an electric vehicle, but it turns out there are many multiples more fasteners in an EV versus an ICE vehicle, interestingly enough. So we see a bit of an uplift in the IS business, in the Industrial Solutions business when you move from a combustion engine to an electric vehicle. It's in our Electronics business where we see more of an uplift. And so we said we're at about 1.5x to 2x the value on an electric vehicle versus a comparable internal combustion vehicle. And that's really because of the electronics, particularly power electronics but generally electronics in an electric vehicle versus a combustion engine car. And that has held, and our capability in power electronics has really been a really nice growth driver and margin driver in our Assembly Solutions business and semiconductor assembly business where we're selling materials that go into power semis and power inverters for the past several years. And the penetration of electric vehicles in the automotive fleet is a tailwind for us as we see it. That is whether that's pure electric or hybrid vehicles, and the opportunity is not just from proliferation of electric vehicles but it's a proliferation of our technology into electric vehicles. So we've done very well with some of, let's call it, the more, nimble automotive supply chains for electric vehicles. And our concentration and value is much greater than those than in some of the legacy OEMs that are in the process of converting their capability for electric vehicles. And so this year, for example was a weaker year for EV, but we're winning a lot of business outside of some of our legacy, let's call it, core OEM customers as they see the value proposition as they're preparing for future model years. And so our power electronics business is seeing some of an impact from a softer electric vehicle market this year, but is winning future business at a very rapid clip and the trajectory for our value in electric vehicles is very strong and increasingly OEM agnostic and that's where we want to be.

Okay. That was great. We got a few more minutes left. Maybe just shifting gears a little bit, maybe touch on the balance sheet and the liquidity and your thoughts on uses of cash and you remind us also your range of your leverage ratio goals.

Yes. So we've always said that our leverage ceiling is about 3.5x. And last year, we ticked slightly above that for the ViaForm transaction. So we [ went to about ] 3.6x, 3.7x. But that was a unique time where it was a highly attractive transaction, and we knew we were at the trough from an earnings perspective. And it's a business that delevers 0.5 to 0.75 of a turn naturally given the cash flow characteristics. Our ceiling of 3.5x is not based on a risk assessment of the business, it is based on the cost of capital where if we're above 3.5x, we think the equity value gets punished and our cost of debt goes up and at 3.5x or below, we've got a more attractive through-the-cycle cost of capital. Today, as we sit here, leverage is getting closer to 3, which is typically around where we've run. And there's a path based on the new guidance and the cash flow characteristics -- cash flow generation this year. We'll be under 3 by the end of the year barring further capital allocation. So we'll be in a position to deploy capital as we get towards the back half. And our framework is unchanged, right? So we've got a leverage ceiling, we want to invest behind our businesses. So the first order is to buy back stock. And anything that we would do would be compared to a stock buyback, where we look at the free cash flow yield on our shares and we look at the cash-on-cash return after everything from M&A, and we want to get a premium for deploying capital outside of our 4 walls, businesses that make our company better and that are better inside of our business. So it's really going to be something we deeply understand that has -- that enhances our value proposition to our customers and it comes with synergies. That's what we'd look for from an M&A perspective. And if there's nothing to do, there's nothing to do and we're happy to build cash and wait for an attractive entry point, either in a -- more attractive entry point from a share buyback perspective or from an M&A perspective. So ample liquidity, balance sheet a very comfortable place, getting even better, and we'll be evaluating capital deployment opportunities as the year moves on.

That was great. I appreciate that. Maybe just lastly, as we're kind of running down here on time, maybe your thoughts on talent acquisition, labor outlook as certainly the IP-driven products that you guys develop, certainly, it's typically been a tight labor for us. Maybe your thoughts on the labor outlook for you guys over the next 12 to 18 months?

Yes. This is a people-based business. Fundamentally, we're a professional services firm supporting our customers that happens to bill for materials. And so all this company is, is what our people have done and what our people will do in the future. So we are very, very focused on attracting great talent, developing that talent and retaining it. It's a competitive environment, particularly in parts of Asia at the leading edge electronics and then on the other side in the West, there's a demographic issue within the industrial workforce. And so what we believe is that if we're not the employer of choice, we won't have enough people. And so over the past 5 years, as Element Solutions, we've invested a great deal into becoming the employer of choice and becoming a place where people can build long-term careers and have fulfilling not just jobs but lives and investing in the communities around our people and that's worked. And the data bears that out from internal surveys we do every other year. The labor outlook, it's -- across the board, it's been a tough labor market. And we've been managing both tracking attrition and are fortunate not to have seen a lot of that because our competitive advantage comes from our people and also developing talent to deal with succession. And for those that are familiar with the company have seen we've managed some senior-level succession over the past couple of years quite successfully. Our businesses haven't missed a beat. And with that, we've created a bench of really good up and coming talent as we think about this business for generations.

Great. I think we've run out of time. I apologize for the technology issues early on, but it's been very interesting talking to you, and thank you for participating in our conference.

Thanks for having us. Thanks for the questions.