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. [Operator Instructions] 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 Varun 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 Gliklich; and 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 expressed written consent of Element Solutions is strictly prohibited. During today’s call, we will make certain forward-looking statements that reflect our current views about the company’s future performance and financial results. These statements are based on assumptions and expectations of future events that are subject to risks and uncertainties. Please refer to our earnings release, supplemental slides and most recent SEC filings for a discussion of material risk factors that could cause actual results to differ from our expectations and predictions. These materials can be found on the company’s website at www.elementsolutionsinc.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 Gliklich, CEO of Element Solutions.

Thank you, Varun, 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 and currencies moved significantly against us. Nonetheless, we delivered on our commitments in the quarter. Organic 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 5G penetration. We grew modestly across our industrial verticals despite continued weak production in the automotive market and the 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 than underlying unit growth. In 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 present 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 for mobile…

Good morning. On Slide 4, we share additional detail on the drivers of organic net sales growth in our 2 segments. Organic growth for electronics was 8% year-over-year in the second quarter. Demand for high-end electronics applications remain steady. Our Circuitry Solutions vertical grew 14% organically, driven by strong demand and pricing from the data storage market. This strength helped offset the impact of supply chain constraints and COVID-related shutdowns in China. Semiconductor Solutions grew 13% organically, seeing continued end market demand for our wafer plating, advanced packaging and advanced assembly products. Both Circuitry and Semiconductor benefited from higher surcharge revenue, driven by increases in the raw material costs, which account for roughly half of the 8% organic growth in the overall electronics segment. In our assembly business, we saw 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 ICE 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 operational responsibility of our films business, 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 increase in commercial activity and opportunities we anticipate in printed and in-mold electronics. This market represents a significant opportunity for the company in the next 3 to 5 years. The impact of this change is reflected in both current and prior periods in our earnings release…

Our second quarter results demonstrate the durability of many of our end markets and strong execution in other more challenging markets. We’ll growing a [bug of the] market on the top line and converting that 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’ve 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 year. However, we’ve been over delivering on synergies and managing other costs to reflect a shift in macros. Should those end market conditions be worse than expected, we have further cost levers at our disposal. We’ve historically demonstrated an ability to preserve profits in challenging macro environments 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 taking into account higher working capital usage in the first half. This guidance implies 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,…

[Operator Instructions] Our first question will come from Steve Byrne with Bank of America.

This is Rock Hoffman on for Steve Byrne. My question is -- my first question is how did your volumes for auto manufacturers in 2Q compared to industry bill rates? And if different, is it due to share gains or increased content?

Yes, I appreciate the question, Rob. So auto bill rates in the quarter were down 14%, our volumes outperformed that. Our auto business was up 1% on sales in the quarter. Of course most of that was driven by price but we clearly outperformed them from market. 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 in shifting between this and market such as shifting it from products for handsets over to other markets? And how would you shift your pricing volumes?

Yes. So PCB fabs have some level of variability in terms of what end markets those were supply and PCB fabs 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 have seen in a semiconductor market.

Our next question comes from Josh Spector with UBS.

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 in your second half. Are you still projecting volume growth as part of the mix?

Yes, 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 quarter in the American market, in the Korean market. The semiconductor business grew volumes nicely. The assembly business in Power Electronics grew nicely. The I&S business 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 are comping against easier comps, and so we should grow organically year-over-year in the second half. Then on sequential basis typically the third quarter is our biggest quarter. You see a ramp in the electronics business associated with new smartphone platform launches. That’s normally a 6% to 10% bump on a sequential basis. Given smartphone market weakness, we’re really 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 in I&S space driven by autos.

That’s helpful. I’d just be curious, I don’t know if you’re willing to quantify this, but clearly, auto production remains a headwind for your mix. And you’ve since acquired Coventya, EVs are 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 to some level similar to 2019 plus or minus?

Yes. It’s a tricky question to answer. But simply, 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 build over the last several years. Over those years, we’ve been investing, the sustainable chemistry we’ve introduced 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 there’s a substantial earnings opportunity associated with normalized automotive supply chain. And I’d 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’s growing in the automotive market and the general industrial economy. So the longer-term growth prospects for this business are unchanged and 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.

Just one quick thing just with that is, so if we look at auto production growing again at some endpoint, that’s a pretty 1/4 to 1/3 or so of your business. Would those margins comeback significantly above your normal incremental? Or should we think about that more similar?

They would come back above the normal incrementals in the I&S segment.

Our next question comes from Chris Kapsch with Loop Capital Markets.

So had a follow-up on the businesses outperformance relative to auto builds. Just curious if you seen any evidence that if there’s been inventory building in the supply chain that you feed into that might have contributed to that. Just wondering about your confidence level that has been a contributor to 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 were particularly concerned about.

Okay. Got it. And then in your formal release, you mentioned a record sales pipeline and record new business wins. I’m just curious if you could bright 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 case might looks like?

Yes. I appreciate that question, Chris. It’s certainly a harbinger from our perspective. It’s something we look at in real detail. 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 economic conditions we’ve been experiencing. But one new piece of business is a new line, a new project with a customer. And so what that indicates to us is the momentum over the medium term in our end markets and the innovation that our customers are driving and that we’re helping support. And so it builds our conviction in the longer-term growth in our market and our ability to benefit from it disproportionately.

Yes, Chris, this is Carey. I would just add it’s spread across all of our verticals. So not just the electronics business, but all of the verticals are seeing that expansion in new wins.

It sounds good. And then one last one and a follow-up just on the semiconductor business. looking at that industry, there’s a little bit of a bifurcation right now where memory units are a bit weaker. There’s overhang, overcapacity, some negative comments coming out of a big make guys, whereas big logic foundry is still doing pretty well, particularly at the leading edge. Now just curious about your exposure to those different chip makers because you’re plating chemistry into that -- into the fab, it seems to be doing pretty good. So just wondering if there’s outsized exposure to one bucket of chip makers versus the other.

Sure. And thanks for that question, Chris. So a couple of reactions. First, our business is driven by volume, not price. And volumes remain 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.

[Operator Instructions] Our next question will come from Kieran De Brun with Mizuho.

I was just wondering, touching down on kind of the pricing side. When we think about the prices that you pushed throughout the last, call it, 12 months or so and what you’re going to be pushing in the second half, how much of that pricing are you going to be able to kind of keep, let’s say, when costs subside? And how we should think about that, I guess, as we go into ‘23 and some of these headwinds start subsiding a little bit?

Yes. Good question, Kieran. So we break pricing into 3 buckets. There’s the metal pass-through then there’s commodity surcharges and then there’s negotiated price. And the first 2 of those buckets are really driven by the price of metal and where those commodities are. And so those do go away when those prices decline as they’ve 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 I&S segment. And so mix should continue to be a tailwind in terms of organic growth and the cyclical recovery in auto that we expect.

Great. And then just a quick follow-up on China. The lockdowns in 2Q 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 3Q and maybe even just the second half in general, are you seeing any pent-up demand and kind of demand pickup from what you didn’t see in 2Q kind of pushed out towards the back half of the year? And maybe how we should think about that driving your results?

Yes. The Electronics business didn’t have the same -- didn’t see the same impact from the lockdowns of the automotive business, for example, and other parts of our Chinese exposure. So the electronics business, we don’t expect to have a substantial ramp as we lap the lock 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 we do have that in our plan.

Our next question will come from Jon Tanwanteng with CJS Securities.

My first one is just maybe high level for ‘23. I was wondering if you could give your view on how easy it would be or hard it would be to grow in the event of an actual recession? It sounds like you have a lot of irons in the fire with customer business with auto markets, smartphones having a, I guess, a stronger on-off year. Just help me understand how sensitive you guys are to a consumer or a wider recession at this point?

Yes. So it’s a good question. And 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 have to make is around what happens to the auto market, where we’ve built a 30 million unit deficit between supply and demand. And if production continues at these levels, if it ramps up, if supply chains improve, that will be a big driver of demand for our business. The secular trends propelling this business were very durable during a period of significant economic weakness are encoded, right on the electronic side. The need for 5G 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 slack in.

Got it. Okay. And then just a more short-term question. How confident are you in your smartphone customers’ orders for 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 softer smartphone ramp -- electronics ramp in the third quarter because of weakness in the smartphone market. So that is taken into consideration in our guide. The other thing that 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 costs to ensure that the bottom line number is what we committed to.

Our next question will come from Angel Castillo with Morgan Stanley.

So maybe just to follow up on that last discussion around recession. I think as you mentioned, you have a lot of cost levers and a number of your end markets are maybe closer to trough. So maybe could you just maybe an for us if we do go into a recession, 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 positions and maybe the past is not as apples-to-apples.

Yes. So you need to make an assumption around top line performance in 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, if you 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 the 2008, 2009 period, these businesses didn’t exist in their current configuration. But top line was down 12-ish and EBITDA was down just a little bit more, maybe 15% in the full year period of the GFC. So we have a highly variable operating cost model. And if demand isn’t there, cost comes out. But we have reason to believe demand should be resilient in a 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.

That’s very helpful. As we look at some of the metals prices, whether it’s palladium, nickel, we’ve seen move over, 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 to flow through?

So for the most part, these are not drivers of profit dollars. They’re just drivers of percentage margin, right? So we have a direct pass-through. So the price of metal goes up $1, we sell 1 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 shouldn’t 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 quarter. But the magnitude of that tailwind will depend on where metal prices settle over the next several months.

Thank you. This concludes today’s Q&A. I will now turn the program back over to Ben for any additional or closing remarks.

Thanks very much for joining, everybody. We are looking forward to see many of you in the near future. Have a great day.

Thank you ladies and gentleman. This concludes today’s event. You may now disconnect.