Element Solutions Inc (ESI) Earnings Call Transcript & Summary

Good afternoon, everyone. I'm Aleksey Yefremov, Chemicals Analyst at KeyBanc. And with me on stage is Ben Gliklich from ESI, Element Solutions, President and CEO, second time, I believe, at our conference, thank you for coming. I think very interesting area, very interesting company for semiconductor, materials, interconnect, with a lot of interesting changes. Thanks a lot, Ben. So maybe I'll turn it over to you to introduce the company and maybe explain how this is relevant to someone who's been looking at the tech their whole life.

Yes, absolutely. Thank you -- thanks for the introduction. Thanks for having me. It's great to be here. Element Solutions is a provider of chemical technology. So we are providing chemical solutions, process solutions that enable the performance of emerging technologies. The way I like to think about it is all of these improvements you're seeing in user interfaces and softwares in performance, whether that's of electronics or power electronics, they all have some manifestation in the physical world. And Element Solutions is a key enabler of those breakthroughs. We provide processed chemistries that are used to turn a piece of plastic into a printed circuit board, turn a piece of silicon into a semiconductor and put them together to form electronics hardware. The business is about $2.5 billion of revenue. About 65% of the business is in the electronic space. The remaining 35% is industrial, with the presence all over the world close to customers.

All right. Great. And you've had -- you have the privilege of being one of the few companies that raised guidance this year. So maybe you can brag a little bit and tell us how this year went and what's the outlook for the second half?

We're pleased but never satisfied. Look, we're participating in rapidly changing growth markets. And we're coming off of a difficult year for the electronics hardware industry broadly defined, coming off of a period where there was a lot of inflation in our supply chains, and we're actively raising prices. And frankly, the second quarter was a very strong quarter for the business, but it was a product not just on what happened in the prior 90 days but over several years of execution, strategic execution to position the business to benefit disproportionately from some of these emerging electronics trends and commercial execution to really reclaim value in our supply chains, the price increases to offset inflation that we saw. What was most exciting about what we saw in the second quarter was a really strong ramp in activity despite a rather subdued broader environment, which is to say the smartphone market has been soft. It was at a very deep trough in 2023, and it's only coming back modestly thus far this year. The industrial markets have been soft and haven't shown any signs of improving. Yet, we took our numbers up to what would be a record adjusted EBITDA for the company. And that's a product of AI, automation and some of these emerging electronics hardware trends that are now beginning to show up in the P&L. They're not just the future. They're the present.

So maybe we can talk about those key trends, right? What is actually enabling you to start growing faster, both in terms of broader market trends, but also your products, how you fit in there?

So taking a step back, for the history of the semiconductor industry, innovation was getting to smaller node sizes and that has started to break down. And so breakthroughs in computing power are coming from integrated chip designs. So multiple die on a chip or on a chiplet that's then packaged in an interesting way. Where we focus historically is on printed circuit board mineralization and instrument materials. We're the only company in the world that can speak to all the places the electron goes from the copper on the silicon through the die attached to the package attached to the circuit board. And there's just been a huge amount of innovation in and around those interfaces. And we've got a great seat at the table for that. And these electronic hardware breakthroughs are demanding more sophisticated technical solutions and, as a leading innovator, we're providing them. And so we've seen an inflection from server board demand, data storage demand, certain new mobile devices that have been introduced, power electronics in the electric vehicle market. All of those trends are propelling the business to record levels.

So should we think about the way your business is winning, is it just more material being used that is the same material or it is new technologies that are required to get to?

It's incremental development on -- for the most part, it's incremental development of existing solutions. So taking what we have today, modifying it modestly to meet a new demand. So part of it is innovation at our level, part of it is innovation at the customer level. Yes, more sophisticated hardware requires more content. And represents -- poses more challenging technical issues requirements to the content -- to the material suppliers. So we're innovating and we're seeing more value for the for the improved solutions.

And by the way, who are your customers? Are you -- are they OSAT companies, fabs or both?

So we're selling to semiconductor fabricators, to EMS providers, to printed circuit board fabricators, to OSATs. But maybe more importantly, we've got a seat at the table with these OSATs that's emerging in a new way because of the new technical challenges and the materials compatibility issues associated with more dense, more power density, for example, thicker circuit boards, ruggedness, durability of package designs. And so our customers aren't the only folks who're speaking within the supply chain. We're driving specification through the supply chain by engaging with OEMs.

Okay. So you have a seat at the table at the design stage, right? You're not just selling kilograms of product?

Our seat at the table is in advance of the design stage where we're doing technology road maps, so we understand where the customers are going and innovating to solve their needs. So it's very much customer-led innovation, where -- and it's low-risk product development because we know if we can solve a problem, there'll be a sale. It's not really basic research. And the seat at the table goes beyond just the design and the innovation side of things. It's also at the customer site. So our customers rely on our people to troubleshoot their manufacturing issues. This is less so on the semiconductor fabrication side, but more in the printed circuit board market and other industrial markets, where we have technical service people on site at the customer making sure that their chemistries are in balance and delivering the quality that they expect to meet.

All right. So if we zoom out, what is the growth rate that you're shooting for? And what is it this year?

Yes. So we revised or, I would say, provided greater clarity on a product -- application-by-application basis around the growth rates for our electronics business earlier this year. We've seen a real inflection in the market and what we had previously been communicating is on sale. So our electronics business is going to -- we expect our electronics business to grow in the high single digits through the cycle. Our industrial business is more of a GDP plus grower. We had an Investor Day in early 2022, where we posited that the through-the-cycle growth rate for this business should be 4% to 5% on the top line. That's probably a bit stale today, where EBITDA would be growing the high single digits, I think that's a reasonable proxy in the near term, it should be better because we're reclaiming value from the supply chain. We're seeing an inflection in some of these markets that through the cycle growth rate is not reflective of where we are in the cycle today, right? We're coming off a trough. So EBITDA was up 21% organically in the second quarter. Our guidance is for 15% constant currency, EBITDA growth at the midpoint of the range this year. And we've got a high level of conviction that this year won't be -- it will be the first in several consecutive years of record earnings.

So good solid, roughly slow double-digit EBITDA growth for few years, it sounds like.

Look, there's always volatility around the trend. The trend is up, and there are going to be some peaks and troughs along that way. So I can't speak with certainty in 2025 or 2026, but the general trend is certainly up off of a deep trough. And we feel great that we're positioned for record earnings while those markets are still closer to trough than trend.

And to be clear, you did not have a big cyclical rebound this year, right? So it's not like you have a much harder comp than '25, so...

Yes, that's right. I mean when you think about what drives the business, underlying growth is units. There's going to be content per unit. There's going to be market share. There's going to be margin from mix, but fundamentally we're driven by units. And units aren't great this year, right? As of today, market research is suggesting low single-digit smartphone unit growth this year, automotive market isn't particularly strong on a year-over-year basis. But we're talking about 15% EBITDA growth. So a unit tailwind would be very powerful. A refresh cycle in the smartphone market would be very powerful to the earnings trajectory of the business.

So in electronic materials, if I recall correctly, you have kind of 3 primary businesses, circuitry, packaging and semi-materials, am I right?

Circuitry Solutions, which provides printed circuit board fabricators with the process chemistry that turns a piece of plastic into a printed circuit board. Assembly Solutions, not quite packaging, but Assembly Solutions, which are materials used to put chips on the boards in most cases, and then semi, which has 2 pieces: a front-end piece, which is wafer-level packaging, which is wafer plating and semi-assembly, which is die attach. So putting the die into the package.

So within -- and those are the 3 groups of businesses that are most benefiting from an advanced packaging trend, right? If I understand it correctly. So maybe you could talk about that what advanced packaging means for the company on those 3 businesses.

Yes. I was talking earlier about innovation now moving from node size to package design. And so we're providing material that's enabling that. Our wafer-level packaging business isn't just putting copper onto the silicon. It's putting the silicon or the chip on to a wafer, for example, right? And so as you get into chiplet design, we benefit from that. The printed circuit board that is sort of moving up from legacy circuit board technology to becoming almost a hybrid chip, the IC substrate market is what I'm talking about, is a market that we participate in and are enabling. And then the materials used, right, to put multiple die onto a chip at very small feature sizes and then these bigger chips on to boards to withstand very high-powered densities, right, are all materials that we provide. And so we've got a very broad portfolio for packaging applications. Packaging is a pretty generic term. We think about application specific. And all of our businesses are benefiting from this trend towards innovation and packaging design.

And again, we should think about that benefit as sort of content per device, let's say, per cellphone? Is that the best way to think about it or...

It's value as opposed to content, right? So in some instances, you're selling less material, just at a much higher price point because it's an enabling material. It's really solving an emerging customer problem.

So there's more need for innovation in the industry than in the past? Is it fair to say that's what's happening?

Yes. Innovation is being pulled up, so it used to be just again on the silicon level and now it's being pulled up from the circuit board and assembly materials markets. And so the value proposition we can bring to the supply chain is greater than it's been in the past.

And I guess that's one of the reasons I asked who your customers are and whether fabs are some of them because some of those big names are investing in advanced packaging, right, whatever that means. Does that mean that you get invited to talk to them more often than in the past? What does those investments mean for you?

Yes, that's exactly right. There was a quote from an article the other day where the CEO of one of these very large semiconductor fabricators was asked, "Why are you moving into packaging?" The answer was, "Historically, packaging was 5% of the bill of materials. Now it's 30% to 40% of the bill of materials." And that's value that they want to capture. And so we are -- we really have something at the seat at the table. We can speak to the breadth of materials required in these new designs better than anyone else. And so that is driving much greater interaction and engagement across the supply chain.

So if we kind of try to dig in and dig out a little bit, if we think about different types of advanced packaging, right, 2.5D, 3D, fan out, should we care about some of these more than others in terms of opportunities for you or sort of it's equally beneficial?

It's very hard to quantify any specific technology or any specific fabricator and align share for us. The business is very diversified and highly fragmented. But insofar, as you're seeing innovation and package design, you're seeing more units that's going to be lifting our share. And one of the things we like to think about is that, in general, electronics manufacturing capacity is somewhat generic, right? So if you go back to 2021, there weren't enough chips. So the automotive guys were left behind. They couldn't get enough chips to meet their needs. And then more recently, you're hearing that there are certain smartphone providers who may be capacity constrained because of the pull on the leading-edge fabs from AI. So when you have growth absorbing some of that capacity, necessarily we begin to see capacity additions. You begin to see new fabs being built, that's volume for us. So in general, any innovation or rather uplift in packaging units is going to be a leading indicator for earnings and mix, right? It's mix-positive.

Correct. So this high-end compute, right, the GPU and all the AI ecosystem, what does it mean for your business? Is it a big part? Some companies for whom it's still 2%, 3% of revenue, but still helpful. Like what is it for you?

So it comes back to that comment about absorbing electronics manufacture capacity. So it is beginning to absorb electronics manufacturing capacity, particularly at the leading edge. And so you're going to see incremental investment in fabs. We're already seeing that the investment profiles are really high. Utilization is ramping. That's very good for our business. It's not just good for our semiconductor business. It's good for our circuit board business because these big chips are on server boards that are very sophisticated for new circuit boards is high value for us. And it's good for our memory disk business where we're selling it to a hard disk drive market because there's more data being created and hard disk drives are still the cheapest per bit mechanism for storing data. So it lifts up the electronics business broadly defined. AI or HPC, however you want to define it, is not a huge percentage of our overall business, right? So it's high single-digit maybe on a revenue perspective, but it's growing very normally.

So besides advanced packaging, which is understandably investors care about for your company, what other products or areas are you excited about in terms of growth?

So we've got an emerging capability in power electronics that's very exciting for the company. So these are materials used in manufacturing of power semis and then in the package attach. So putting the power semi onto the power inverter. And we've got an outstanding product, highly differentiated using nanoparticulate silver that's sintered, not clobbered. So the applications process is different. It is both more reliable than the legacy attach technologies, meaning it -- when you're putting all of the current through this power semi and through this package, it's not going to remelt and break. It also has less thermal loss. So that's energy that's escaping the system in the form of heat as opposed to going to power the electric vehicle. So it speaks to the range on EVs. So this is a great technology that has a leading position with leading electric vehicle OEMs and a big opportunity from penetrating new OEMs and the EV market increasing. But it has broader applications, right, because power density is a problem not just in an electric vehicles. It's a problem in the data centers. It's a problem in renewable energy where you need to charge the grid. So that's a great technology in our semi-assembly business that has a lot of runway to grow. We invested in a new technology. We acquired a new technology last year called ActiveCopper, a business called Kuprion, which is a nanoparticular copper. So similar to what we do with silver, this is for copper, and it's got incredible attributes that are in high demand to solve -- to really enable the performance of certain next-generation chip designs and that's in the early innings with a very big addressable market. There's a lot of exciting nascent opportunities, I would say, in the portfolio.

And I know Kuprion has been sort of on the mind of investors. So where are you exactly in that adoptions phase for that product?

So the customer pool has dramatically exceeded our expectations. So we actually had to cap customer engagement because there was too much demand we didn't want to overpromise. So we're working on several dozen applications projects with a handful of customers. And we're really focused now on supply chain, right? We need to make more than we thought, faster than we thought. And supply chain standing this up is a heavy lift. And so that's probably a journey for another year. We do expect to be selling this product in some quantities in 2024, and we expect it to have an EBITDA contribution in 2025, which is sooner than we would have originally thought. But this isn't the driver of 2025 earnings growth. This is a driver of an inflected trajectory for the electronics business for several years to come.

So it's a brand new baby? It's...

It's not walking and talking, but it's crawling at least.

Right. I mean it does sound very promising. So those are already specced in applications for Kuprion.

So the way it is structured is -- they haven't been specced in yet. So the applications we're working on that several dozen are -- will become specifications. So there are 4 next-generation products or improvements on existing products at the customer level. And when they become design wins, we'll start selling the product.

All right. So you have strong indications of interest, so to say...

Very strong.

Then you have to produce -- presume your customers would want to test it right on [indiscernible-- you're doing now already a qualification.

The customers are doing the tests and the applications work as we speak.

And you think you're already sold out before having sold the first?

I wouldn't say sold out, right, because we're still working through capacity planning, but we're worried about selling -- overselling because the capacity will take some time to come online.

All right. That sounds very interesting.

Not worried, but we're working on matching demand and supply.

So -- well, at least in Kuprion, it sounds like it is proprietary and probably high margin. But in general, let's say, when you start selling new advanced packaging application, are you seeing bids from your traditional competitors, new competitors? Like does it change your competitive position? Could it even maybe open it up to new competition or the opposite that's happening?

The way the supply chain works is not -- it's not like a bidding process. You're working closely with the supply chain to develop a solution for their needs. So there are other people working alongside. And what determines who wins, first is technology. Do you have a product that can do it? And if there are multiple products that can do it, then it's quality, right? Then its service, then it's price. And so we are bumping into new competitors, particularly in that semi-assembly space, which is an emerging -- which was a smaller business for us, but it's growing rapidly. In the circuit board business, in the assembly business, they're reasonably well-established supply chains. And as I was explaining, it's incremental development in those markets. So there aren't really new competitors we're facing. So the competitive dynamics are stable, but I'd say we're a bit differentiated further today because we can speak to the compatibility of the materials, how if you use this material, this material and this material, which, by the way, we all sell, the product will perform, which is fundamentally different than 3 different vendors, each trying to sell one of their products because they don't have the breadth of portfolio.

I see. And traditionally, I mean you've done bolt-ons, right? Kuprion was a bolt-on. So could you talk about sort of your strategy or history there, what [indiscernible] going forward?

So one of the hallmarks business is very strong cash flow, right? Our manufacturing processes are asset-light, 2% of sales and CapEx. So we generate substantial cash, and we deploy that cash prudently behind our business. The framework is quite simple. Leverage below 3.5x, investing behind our businesses and companies that make us better and that are better inside of our portfolio. So that means businesses we deeply understand where we have synergies and where our customers are better off working with us after the pact and prior to that acquisition. And so that looks like industry consolidation, technology investment or moving into an adjacency where having that product inside of our portfolio is beneficial. We've done that reasonably effectively over our first 5 years as Element Solutions and translates into compounding earnings at pretty compelling rates. We compare all of our acquisition activities to buybacks. And so we want to earn a premium when we put capital outside of our 4 walls relative to putting it inside of our 4 walls. So we look at free cash flow yield and compare that to the cash-on-cash return from our investments.

Great. And then I'll maybe go back a bit to the technical side. I know the semiconductor business per se is not -- is only one part of the business, but should we sort of care whether memory or logic is doing better? Do you -- like is there a difference for your business?

Yes. We have a greater penetration in the logic side of the business -- of the semiconductor industry than the memory side of the industry, really solid state. We have a very strong position in hard disk drives, as I mentioned. But we are making progress on both sides with subsequent to our ViaForm transaction, you didn't talk about that yet, where we took in-house the distribution for certain silicon wafer mineralization technologies. So that's a share opportunity on the memory side disproportionately than relative to the logic.

If it's interesting enough, would you like to talk about that? I assume you're talking about the taking in-house, the Entegris partnership?

Over 20 years ago, a predecessor company at Element, sold the distribution rights to a very high-value product to a predecessor company -- semiconductor product to a predecessor company of Entegris. And it wasn't an ideal arrangement. It was a fixed margin that was lower than what Entegris was earning on their standard on average. And the customers didn't get to see through to us who were doing the manufacturing in the R&D. And we have been trying to sort of detangle that arrangement for several years. And last year, there was an opportunity. So we paid Entegris about $200 million to take that distribution -- to cancel that distribution contract. It gave us a better seat at the table with the semiconductor fabricators. Customers were happier, they [indiscernible] line of sight through to manufacturing and innovation. And we've more than quadrupled the pipeline for that product since we brought it in-house. We bought it at the bottom. We closed that transaction in June of 2023. So from that acquisition, we're going to generate $20 million of incremental EBITDA this year, translates to about a 10x multiple for a really high-quality, high-margin and high-growth product. It's a great transaction with a lot of run.

Great. And we have just some time left. I just want to open up to the room if anyone had a question. Maybe I'll throw a last one at you. Pricing, like how -- I mean we just lived through COVID-related disruptions, how do you handle that? And in general, how do you think about your pricing in sort of a normal world?

Yes. So we don't take price every year. Through the most part, we don't take price every year. We sell value. And we're a partner to our customers. We take price when our costs go up. And so we went through a highly inflationary environment, we were able to pass through a lot of the price increases that we experienced. And as the price comes down -- as our costs have come down, we hold price. So we had 250 basis points of margin expansion year-over-year in the second quarter. Some of that was mix, some of that was raw material deflation. And so we should be in a good position to hold price as we have because we are selling value. The way we increase price when there isn't an inflationary environment is the mix through innovation, introducing products that are bringing more value to our supply chain, earns a higher margin than otherwise. And that was part of what happened in the second quarter as well.

Great. Well, thank you, Ben. Thank you for coming here.

Thanks.