Q2 2022 Element Solutions Inc Earnings Call
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Good morning, ladies and gentlemen, and welcome to the element solutions Q2, 2022 financial results conference call.
At this time all participants are in a listen only mode. Later, you will have the opportunity to ask questions. During the question and answer session. You may registered to ask a question at any time by pressing star one on your Touchtone phone.
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Please note that this call may be recorded and I will be standing by should you need any assistance.
I would now turn the call over to Rune Gokarn senior director of strategy and Finance. Please go ahead.
Good morning, and thank you for participating in our second quarter 2022 earnings Conference call. Joining me are our CEO , Ben Glick lichen CFO Carey Dorman.
In accordance with regulation FD or fair disclosure, we are webcasting. This conference call any redistribution retransmission or rebroadcast of this call in any form without the express written consent of element solutions is strictly prohibited.
On 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 a discussion of material risk factors that could cause actual results to differ from our expectations.
<unk> and predictions. These materials can be found in the company's website at Www Dot element solutions, Inc. Dot com in the investors 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 Ben <unk> CEO of element solutions.
Thank you, Brian and good morning, everybody. Thank you for joining.
Element solutions had another quarter of solid earnings growth in a complicated macro environment.
Supply chains remain challenged the lockdowns in major commercial hubs in China persisted longer than expected.
Auto markets have not yet recovered in currencies moved significantly against us Nonetheless.
Nonetheless, we delivered on our commitments in the quarter organic net.
Net sales grew in every vertical and we met our adjusted EBITDA guidance.
We believe this once again demonstrates the stability of our businesses and the ongoing execution of our strategy by our talented team.
Demand across the electronics segment generally remained healthy driven by continued EV and <unk> penetration.
We grew modestly across our industrial verticals. Despite continued weak production in the automotive market any overhang from geopolitical volatility in Europe .
The ongoing integration of our recent acquisitions is going well generating better than expected synergies and we've started to capitalize on new long term growth opportunities around sustainable chemistry.
Overall, our sales growth was driven more by pricing actions and raw material surcharges, then underlying unit growth in <unk>.
Certain of our markets demand was resilient, while in others, such as China and automotive it was weaker.
We grew constant currency adjusted EBITDA by 13% over a difficult Q2, 2021, comparable which was before supply chain disruptions and inflation took hold.
The biggest headwind to our financial results in the second quarter was the strengthening U S dollar, which weighed on sales by 7% in the quarter and presents additional headwinds into the second half of the year based on current FX rates.
While macroeconomic sentiment has worsened many of our end markets remain resilient, we expect the electronics business to grow sequentially and year over year in the second half from new smartphone platform launches and ongoing demand from mobile infrastructure and EV markets.
Softness in other consumer electronics sectors, such as white goods and personal computers has less of an impact on our portfolio and has been in line with our expectations coming into the year.
We also expect a modest recovery in the automotive market, where underlying structural demand still remains higher than the industry production levels.
As we've demonstrated multiple times over the last several years, we can and will continue to keep a long term strategic focus while also actively managing the business to navigate near term volatility and deliver on our targets.
On slide three you can see a summary of our second quarter financial results.
<unk> grew the top line, 6% organically similar to our first quarter performance.
This first half growth comes against a difficult comparison as the first half of 2021 benefited from a strong COVID-19 recovery.
On a constant currency basis, adjusted EBITDA grew 13% year on year.
Adjusted EBITDA margin declined 170 basis points with higher metal prices, driving 100 basis points of margin headwind on a year over year basis, though the dollar value of pass through metals in our assembly business declined sequentially as metal prices.
Excluding the impact of a $123 million of pass through metal sales in our assembly solutions business, our adjusted EBITDA margin would've been 25% in the quarter.
Our adjusted EPS in the quarter grew a healthy 9% on a reported basis. Despite a negative 7% impact from FX translation from the stronger U S dollar.
Terry will now take you through our second quarter business results in more detail Gary.
Thanks, Brent good morning.
On slide four we share additional detail on the drivers of organic net sales growth in our two segments organic.
Organic growth for electronics was 8% year over year in the second quarter.
Demand for high end electronics applications remained steady.
Our circuitry solutions vertical grew 14% organically driven by strong demand in pricing from the data storage market.
This strength helped to offset the impact of supply chain constraints and COVID-19 related shutdowns in China.
Semiconductor solutions grew 13% organically seeing continued end market demand for our wafer plating advanced packaging and advanced Assembly products.
But circuitry and semiconductor benefitted from higher surcharge revenue driven by increases in raw material costs.
Which account for roughly half of the 8% organic growth and the overall electronics segment.
In our assembly business, we thought sustained growth across most of our core product categories. Despite its greater exposure to automotive.
This business benefits from ongoing growth in electric vehicle production.
Through its power electronics products. However, it also has a greater exposure to both ICD automotive and China, which explains the relatively slower growth.
On a year over year basis, adjusted EBITDA margins in our electronics segment declined 60 basis points.
However, excluding the impact of pass through metals margins in the segment expanded 100 basis points approximately.
One note to make here is that in this quarter, we transitioned operation and responsibility of our films.
Which generates roughly $50 million of sales annually from our industrial and specialty segment to the circuitry business within our electronics segment.
The change reflects the increasing commercial activity and opportunities, we anticipate in printed and in mold electronics.
This market represents a significant opportunity for the company in the next three to five years.
The impact of this change is reflected in both current and prior periods and our earnings release and the other financial information provided today.
Organic net sales and industrial and specialty increased 2% year over year.
All three of our ians verticals posted growth in the quarter.
Industrial solutions grew 1% organically, which was driven primarily by pricing actions and surcharges associated with commodity inflation.
As we enter the second half of the year, we remain cautiously optimistic about improving auto production, especially in the fourth quarter.
Graphic solutions grew 2% organically year over year, however, profitability in this segment declined as pricing lagged cost inflation.
We have one business that we expect will drive a stronger back half and pricing actions should drive adjusted EBITDA growth in the second half and into next year.
Energy solutions also grew 2% organically continuing the rebound that began late last year as high oil prices dropped some rigs back online.
The recovery in this business has been slower than in prior periods of rising energy prices.
But we are beginning to see increasing levels of activity in this sector, which bodes well for 2023.
Industrial and specialty grew adjusted EBITDA, 13% on a constant currency basis, including the contribution of <unk> and synergies.
Margins declined roughly three percentage points.
The combination of increased logistics and freight costs negative mix from the weak auto market sale.
Sales growth from surcharges and raw material inflation, especially in our smaller inf's businesses all contributed to this margin decline.
At auto recovers and the overall supply chain disruption improves margin should increase in this segment.
Slide five address cash flow and the balance sheet.
We generated $66 million of free cash flow in the quarter, reflecting a strong sequential improvement. Despite continued investment in working capital of $37 million primarily into inventory.
The sequential buildup of inventory was largely in Europe , and southeast Asia, given ongoing supply chain disruptions in those regions.
Our other uses of cash in the quarter, including cash taxes, Capex investment and interest all came in slightly better than our expectations.
We have modestly decreased our full year estimates for these metrics.
Year to date, we've invested over $90 million of cash into working capital a majority of which was driven by sales growth and safety stock building.
We are revising our cash flow guidance to $270 million for the year to reflect our revised EBITDA guidance and uncertainty around the timing of working capital release.
We meaningfully accelerated our share repurchase activity in the quarter buying back approximately $43 million of stock or roughly $2 2 million shares.
Almost 1% of shares outstanding.
We remain opportunistic and expect to be active in the market. When we believe our stock is trading at a significant discount to intrinsic value.
Our remaining stock buyback authorization was $670 million as of June 30th.
Our net leverage ratio remained steady at three two times, despite returning over $60 million to investors in the quarter.
All of our term loan floating rate borrowings have been swapped to fixed so rising interest rates are not meaningfully impacting our cash interest expense.
These term loans are off the swap to euros and that cross currency swap was $86 million in the money at quarter end effectively reducing our leverage ratio to 3.0 times adjusted EBITDA.
No at the dollar has subsequently strengthened the value of that swap it increased along with it.
With that I will turn the call back to Ben.
Thank you Carrie.
Our second quarter results demonstrate the durability of many of our end markets and strong execution in other more challenging markets.
We're growing above the market on the topline and converting net sales growth efficiently into profits.
The translational headwind from the strengthening U S. Dollar has grown significantly in recent months.
Based on mid July FX rates, we now expect a greater than $35 million year over year headwind to 2022 adjusted EBITDA.
Due to FX translation, that's over $15 million higher than what we'd expected at the end of Q1.
Consequently, we are revising our adjusted EBITDA guidance range to $565 million to $575 million.
This new range implies modestly greater constant currency adjusted EBITDA growth over our prior growth guidance as we are not reducing guidance by the full impact of currency.
It's based on an expectation of sustained strength in electronics and a modest recovery in automotive production in the second half of the year.
Although these end market dynamics are still weaker than our expectation entering the year.
However, we have been.
Over delivering on synergies and managing other costs to reflect a shift in macros.
Should those end market conditions be worst than expected, we have further cost levers at our disposal.
We have historically demonstrated an ability to preserve profits and challenging macro environment and intend to do so once again in the second half.
We're also updating our adjusted EPS guidance to a range of $1 52 to $1 55, and our full year free cash flow guidance to approximately $270 million, largely reflecting the lower EBITDA and taken and taking into account higher working capital usage in the first half.
This guidance implies a substantial year over year growth in the second half in absolute dollars and more than 20% growth on a constant currency basis.
For the third quarter of 2022, we expect adjusted EBITDA to be approximately $140 million, which assumes improved margins from lower metal pass through impact and a sequentially higher level of revenue in constant currency.
These results represent a strong constant currency adjusted EBITDA growth of approximately 20% over the third quarter and 2021.
We've always said that secular growth is not linear there will be air pockets along the way.
And we're entering a period, where the macros may be less favorable in the short term, but we believe element solutions is well positioned to continue to deliver profit growth.
We've won more business year to date than we did in all of our full year 2019, or 2020, a reflection of the longer term momentum in our markets and our ability to convert those opportunities.
This gives us more conviction in our belief that the trends propelling our business are more entrenched today than they were entering this year electric vehicle units are growing quickly internet infrastructure data storage and next generation mobile markets are growing as well, we're playing a critical role solving complex technical challenges for the electronics hardware industry.
As circuit boards in semiconductors converge.
These secular growth drivers are just getting started and element solutions should continue to benefit disproportionately from them.
At the same time this has been an off year for the smartphone industry and the automotive component of our industrial business is operating well below 2017 levels of activity we.
We don't believe the shortfall in automotive production relative to demand is sustainable over the long term our recovery is inevitable, making these markets a coiled spring, which we think will ultimately drive substantial earnings growth when supply chain improve.
To wrap up I'd like to thank all of our stakeholders for their continued support of element solutions and in particular I Express my appreciation to our talented and dedicated people around the world responsible for another quarter of growth with that operator. Please open the line for questions.
Thank you at this time, if you would like to ask a question. Please press star one on your Touchtone phone you may remove yourself from the queue at any time by pressing star two.
That is star one to ask a question, we will pause for a moment to allow questions to queue.
Thank you. Our first question will come from Steve Byrne with Bank of America. Your line is now open.
Good morning, Steve.
Hi, This is a rock Hoffman on for Steve Byrne.
My questions. My first question is how did your volumes for auto manufacturers and <unk> compared to industry build rates and it's different is it due to share gains or increased content.
I appreciate the question Rob.
So auto build rates in the quarter were down 14% our volumes outperformed that Rx our auto business was up 1% on sales in the quarter of course, most of that was driven by price.
But we clearly outperformed the market.
It's hard to disaggregate between share gain versus content gain but from a commercial perspective. The team has been executing very very well and winning big pieces of business.
Got it. Thank you and just a quick follow up so how flexible are the PCB and semiconductor fabs that you supply are shifting between various end markets such as shifting away from products for handsets over to other markets and how would you shift to your pricing and volumes.
Yes.
PCB stabs had some level of.
Variability in terms of what end markets those boards supply.
PCB fats in general have been running.
Very close to full capacity and we're seeing capacity added in many markets.
And that's a similar dynamic to what we've seen in the semiconductor market.
Great. Thank you.
Thanks Rod.
Thank you. Our next question will come from Josh Spector with UBS. Your line is now open.
Yeah, Hey, guys. Thanks for taking my question.
Just curious if you could kind of parse out the organic performance in the quarter and your outlook kind of just trying to think about the buckets between volume structural pricing and surcharges and in your second half.
Still projecting volume growth as part of the mix.
Yeah, absolutely so in the second quarter as we said price was more of a driver than volume.
But we did see volume growth in certain of our end markets, particularly if you look in the circuitry business for example in data storage, we had a strong.
Order in the American market and the Korea market.
Ami conductor business grew volumes nicely the assembly business in power electronics grew nicely. The ians business. It was more of a price story than a volume story.
As we look out to the second half a couple of observations first on a year over year basis, we're comping against.
Easier comps and so we should grow organically year over year in the second half and then on a sequential basis typically the third quarter is our biggest quarter you see a ramp in the electronics business associated with new smartphone platform launches.
It's normally a 6% to 10% bump on a sequential basis given smartphone market weakness.
Only underwriting to a couple of percentage points of growth sequentially in that business and then in the fourth quarter, we're expecting an auto market recovery in line with market research and so we should see some volume growth in Q4, and the ians space driven by autos.
Thanks, that's helpful and just be curious I don't know if you're willing to quantify this but clearly Ottawa production remains a headwind for your mix and your sense acquired co venture evs or a bit of a tailwind how much would you say you're under earning at this point versus where you would be if production normalized some.
Level, similar to 2019 plus or minus.
Yes.
Tricky question to answer but.
We've been operating at call. It 80 million units auto production in 2017 2018, it was north of $90 million right. So there's a very significant unit deficit. That's built over the last several years over those years, we've been investing the sustainable chemistry with interim.
<unk> is driving share gains.
We have made this a focus market for us and so I think our share is better today than it was back then and so theres a substantial earnings opportunity associated with a more normalized automotive supply chain and I would add to that this is an off year for the smartphone market as well.
And.
We've got we believe deeply in the secular growth that's driving that market and also the electronics content that's driving that.
It's growing in the automotive market in the general industrial economy, so the longer term growth prospects for this business are unchanged.
The base will be growing off as we exit 2022 will be lower than it would normally so there's a lot of pent up earnings.
In the outlook for the company.
Thanks. So just one quick thing just with that is so if we look at auto production growing again at some point, that's a pretty quarter to a third or so of your business with those margins come back significantly above your normal incremental or should we think about that more similar.
They would come back above the normal incrementals in the IHS segment.
Okay. Thank you.
Yes.
Thank you. Our next question comes from Chris campus with Loop capital markets. Your line is now open.
Yes. Good morning, So I had a follow up on on the businesses outperformance relative to auto build just curious if you've seen any.
Any evidence that there's been.
Inventory building in the supply chain that you would get into that might've contributed that just just wondering about your confidence level that that hasn't been a contributor your outperformance addressing that market.
Yes, we've been looking for that Chris we're looking for evidence of that and we really haven't found it.
Anywhere in the automotive supply chain.
That's not something that we are.
Particularly concerned about.
Okay got it and then in your formal release you mentioned.
Record sales pipeline and our record new business wins I'm just curious if you could provide some more color you're talking about.
Some of these turnkey systems into the print circuit board ecosystem.
Just hoping to elaborate and interpret that as some harbinger for what.
The future business cadence might look like.
Yes, I appreciate that question Chris.
It's certainly a harbinger of from our perspective, it's something we look at in real.
Tail, we won more business in value in the first half than we did in all of 2019 or 2020.
At the same time the ramp of that business was slower than it is in normal years, which isn't surprising given the lockdowns, we saw in China and some of the other economics.
Conditions, we've been experiencing but one new piece of business. It is a new line a new project with a customer and so what that indicates to us is the.
Our momentum over the medium term in our end markets.
And the innovation that our customers are driving and that we're helping support.
So it builds our conviction in the longer term growth in our markets and our ability to benefit from it disproportionately.
Yes, Chris This is Gary I would just add it's spread across all of our verticals.
Verticals, so not just that the electronics business, but all of the verticals are seeing that that expansion and new ones.
It sounds good and then one one last one a follow up just on the semiconductor businesses.
Looking at that industry, there is a little bit of a bifurcation right now where you know memory units are a bit weaker there's overhang overcapacity some negative negative comments coming out of a big mess you guys, whereas.
Big logic foundry is still doing pretty well, particularly at the leading edge node just curious about your exposure to those.
Different chipmakers.
Your your plating chemistry into that into the fab be doing pretty good. So just wondering if there is.
Outside of exposure to one bucket of chipmakers versus the other thank you.
Sure and thanks for that question, Chris So a couple of reactions first.
Our business is driven by volume not price and volumes remained strong in the semiconductor market. The second is that our business is disproportionately in the logic side of the semiconductor market.
And so the noise in the memory market is not impacting us to the same extent as it is the overall market.
I appreciate that thanks.
Thank you once again, if you would like to ask a question. Please press star one on your Touchtone phone. We also ask that you. Please limit yourself to one question and one follow up in the interest of time. Our next question will come from carry on to Brian <unk> with Mizuho. Your line is now open.
Hey, good morning.
Good morning, Kieran I was just wondering.
Touching again on the pricing side, when we think about the prices that you've pushed throughout the last call. It 12 months or so and what youre going to be pushing in the second half how much of that pricing.
Or you could be able to keep let's say when costs subside and how we should think about that I guess since we as we go into 'twenty three and in some of these headwinds.
Tell me a little bit.
Yeah. Good question, Karin, So we break pricing into three buckets.
The metal pass through than theirs commodity surcharges, and then Theres a negotiated price and.
The first two of those buckets are really driven by the price of metal and where those commodities are and so those do go away when when those prices decline.
<unk> begun to in some instances the other negotiated prices historically, we've been able to keep.
We haven't seen a period, where we've had to go back for price. This frequently in such a short window.
But in the past, we've been able to retain that price the other driver.
Of margin opportunity is mix.
And we're growing faster in higher margin businesses with the exception of our auto exposure, where auto is higher margin than the blended average of the ice segment and so mix should continue to be a tailwind.
In terms of organic growth in the cyclical recovery in order that we expect.
<unk>.
Great.
Just a quick follow up on China, the Lockdowns and QQ, obviously impacted some of the demand that you saw in the quarter, whether that was in the assembly part of the business or other parts of the business, but when we think about <unk> and maybe even just the second half in general.
Are you seeing any pent up demand and kind of demand pick up from what you did in <unk> kind of pushed out towards the back half of the year and maybe how we should think about that.
Driving your results. Thank you yes.
The electronics business didn't have the same didn't see the same impact from the Lockdowns is the automotive business for example in other parts of.
Our Chinese exposure so the electronics business that we don't expect to have a substantial ramp.
As we lap the locked down sequentially.
The auto market was slower to pick back up after those lockdowns and.
The consensus is for a stronger fourth quarter in auto some of which coming from China. So so we do have that in our plan.
Great. Thank you so much.
Okay.
Thank you. Our next question will come from John Watson with C. J S Securities. Your line is now open.
Hi, Good morning, Thanks for taking my questions. My first one is just maybe high level for 'twenty. Three I was wondering if you could give your view on how.
How easy it would be a hard it would be to grow in the UK.
Actual recession. It sounds like you have a lot of irons in the fire with customer business with the auto markets.
Smartphones, having a I guess a stronger on off here.
Help me understand.
How sensitive you guys are to a to a consumer or a wider recession at this point.
Yes so.
It's a good question.
Look our business has proven an ability to grow in mixed markets I think we're demonstrating that this year.
One of the big assumptions, we'd have to make is around what happens to the auto market, where we've built up 30 million unit deficit between supply and demand and if production continues at these levels. If it ramps up its supply chain to improve that'll be a big driver of.
Demand for our business.
The secular trends propelling this business.
Very durable during a period of significant economic weakness during COVID-19 right on the electronics side.
The need for.
<unk> infrastructure for data storage.
Has not slowed despite an economic.
Slowdown that we've seen in the period year to date and the smartphone cycle as we said earlier, it's a weak year. So there are reasons to believe this business could continue to grow.
In an economic slowdown and we've proven an ability to preserve profit when demand does.
Slacker.
Got it Okay, and then just a more short term question. How confident are you in your in your smartphone customers orders.
The rest of the year if demand does continue to fall I mean, obviously, we've seen it in China and like you said the white.
Types of products.
Is there any wiggle room in the guidance you provided.
Yes, so as noted earlier.
Our baseline expectation is for a software smartphone.
Ramp electronics ramp in the third quarter because of weakness in.
In the smartphone market and so that is taken into consideration in our guide the other thing that we.
We've demonstrated and again going back to the answer to your first question is we've got multiple ways to deliver on our guidance if the demand isn't there we have cost levers.
That we know how to throw and manage cost to ensure that.
The bottom line number is what we committed to.
Got it thank you guys.
Thank you. Our next question will come from Angel Castillo with Morgan Stanley . Your line is now open.
Good morning, and thanks for taking my question.
Maybe just to follow up on that last discussion around the recession I think.
As you mentioned you have a lot of cost levers in a number of your end markets are maybe closer to trough. So maybe could you just maybe frame for us if we do go into recession, and what's the kind of downside in terms of EBITDA.
That you would anticipate with the portfolio that you have today given that you've done a number of patients.
The path is not as a apple to Apple.
Yes so.
You need to make an assumption around topline performance and John's question, just a minute ago, we talked about the reasons why the top line could be resilient.
In a time of a recession, but what we've proven is an ability to preserve profit as we said before.
Look at Covid EBITDA was down the same percentage as the top line was which is the most recent example, if you go back to that.
2008, 2009 period these businesses didn't exist in their current configuration.
But the top line was down.
12 ish in EBITDA was down just a little bit more maybe 15 in the full year period.
The GMC so.
We have a highly variable operating cost model and if demand isn't there cost comes out but.
But we have reason to believe demand should be resilient.
Period of economic weakness because of the secular growth trends that are propelling the business and the dislocation between supply and demand in the auto market that we've lived through over the past couple of years Okay.
That's very helpful. Thank you.
As we look at some of the metals prices, whether it's palladium nickel, we've seen move move lower and I think you kind of highlighted in your prepared remarks that some of this is maybe part of the second half. So could you just quantify for US I guess, what's kind of the impact of some of these things coming out in terms of maybe the margin and how we should think about.
Just the protest.
So for the most part.
These are these are not drivers of profit dollars Theyre just drivers of percentage margin right. So we have a direct pass through so the price of metal goes up one dollar we sell one more dollar.
And so they sort of negate one another on the profit line, but it has an optical impact on percentage margin on a year over year basis, there shouldnt be an incremental headwind as metal prices have declined on a sequential basis, there should be a tailwind to margin percentage going into the third.
Good quarter.
But the magnitude of that tailwind will depend on where metal prices settle over.
Over the next several months.
Got it thank you.
Thank you. This concludes today's Q&A I'll now turn the program back over to Dan for any additional or closing remarks.
Thanks, very much for joining everybody. We are looking forward to seeing many of you in the near future have a great day.
Thank you ladies and gentlemen. This concludes today's event you may now disconnect.
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