Element Solutions Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 30, 2024

There are 11 speakers on the call.

Operator

Thank you for standing by. My name is Christa, and I will be your conference operator today. At this time, I would like to welcome everyone to Element Solutions' 2nd Quarter 2024 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

Thank you. I will now turn the conference over to Varun Gokhan, Senior Director of Strategy and Finance. You may begin.

Speaker 1

Good morning, and thank you for participating in our Q2 2024 earnings conference call. Joining me today are our President and CEO, Ben Glicklitsch and CFO, Cary Dorman. In accordance with Regulation FD, we are webcasting this conference call. A replay will be made available in the Investors section of the company's website. 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.

Speaker 1

These statements are based on assumptions and expectations of future events, which 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 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.

Speaker 1

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 our CEO, Ben Glicklitsch.

Speaker 2

Thank you, Varun, and good morning, everyone. Thank you for joining. Element Solutions had an exceptional second quarter. Our efforts over the past several years to reclaim value in our supply chain and position ourselves as key enablers of emerging electronics technologies are paying off with strong earnings growth. Our capabilities to serve fast growing, high performance computing applications, data center customers and semiconductor fabricators drove volume growth in high value verticals in what remains a soft consumer electronics and industrial environment.

Speaker 2

Similar to the Q1, we saw robust incremental margins driven by mix impacts and pricing stability amidst deflation in certain commodities. Our adjusted EBITDA margins expanded 2 50 basis points and adjusted EBITDA grew by over 20% year over year on a constant currency basis with both segments growing by double digits. Electronics segment results were driven by more than 10% volume growth in our Circuitry Solutions business, primarily due to strong demand from HPC, AI, EV and certain mobile markets. Our revenue in circuitry solutions grew over 20% organically despite the mobile phone market remaining well below long term average units. We also saw continued strength in advanced and wafer level packaging applications in our semiconductor business to support increasing semi fab utilization.

Speaker 2

This strength was moderated by relatively soft demand for power electronics and electronics assembly materials with certain EV customers. Continuing the Q1 trend, the Industrial and Specialty segment saw a combination of softer automotive demand in Europe and the impact of lower revenue from metal price surcharges in the core industrial portfolio. Profitability in the segment still increased significantly from lower raw material costs and ongoing strength in our Energy Solutions business, which grew net sales by almost double digits at high incremental margins. Margin expansion in the first half was a key contributor to strong earnings growth. For many of our businesses, these margins were achieved in volumes well below where they had been the past few years.

Speaker 2

So our margin strength underscores success of our investments in higher value, higher margin applications and our ability to take permanent cost actions that contribute to profitability. Moving into the second half, we should lap the benefits of lower raw materials and some of our supply chain actions, but margins should remain stronger year over year. Through long term concentrated investment in new capabilities within our electronics portfolio, we've positioned ESI to capitalize on emerging sources of demand that propelled the business this quarter. That dynamic supports our confidence in the long term growth algorithm of our electronics franchise. Our investments in die and package attached solutions, our new research center in the fast growing India market and our scale up of high volume manufacturing capacity for nano copper technologies are just a few examples of Element Solutions investing to align itself as a critical development partner for both OEMs and fabricators.

Speaker 2

Computing performance improvement increasingly requires unique material sets that span the circuit board, the chip and the variety of attachment technologies which connect them. And we are the only solutions provider with decades of technical expertise across the breadth of those applications in the electronics manufacturing supply chain. We have a differentiated ability to solve emerging customer pain points in high growth areas. And our pipeline of commercial opportunities in wafer level packaging and circuitry solutions reinforces that advantage and has accelerated as we build on improved customer intimacy from our successful VIAFORM investment and customer excitement around our CUPREON active copper applications development. Over the next 12 to 18 months, we're focused on scaling our manufacturing capacity to meet the commercial opportunity that has become apparent in these areas.

Speaker 2

At the same time, our balance sheet is improving to the point where we can consider additional inorganic capital deployment aligned with our strategy. It's an exciting time. Cary will now take you through our Q2 business results in more detail. Cary?

Speaker 3

Thanks, Ben, and good morning to everyone. Continuing on Slide 3, which provides an overview of our 2nd quarter financial results. We delivered constant currency adjusted EBITDA growth of 21% off of 4% organic sales growth. Strong incremental margins reflect a substantial mix benefit from standout growth in our high margin circuitry businesses in Asia as well as in Energy Solutions. Net sales in Electronics grew 7% organically, led by growth in high value advanced circuit board metallization chemistry and memory disk growth for cloud storage market.

Speaker 3

Net sales in our Industrial and Specialty segment declined 1% organically. We saw solid growth in offshore and modest growth in North American printer demand in graphics. This growth, however, was more than offset by lower precious metal surcharges and softness in industrial surface treatment. The strengthening U. S.

Speaker 3

Dollar negatively impacted total company net sales and adjusted EBITDA by roughly 3% 5%, respectively, on a year over year basis this quarter. Both segments expanded adjusted EBITDA margins over 200 basis points. Constant currency adjusted EBITDA grew 26% in Electronics, driven by positive mix from circuitry and gross margin expansion in all verticals, primarily from input deflation and stable product pricing. In INS, constant currency adjusted EBITDA grew 12% with a similar vertical mix impact as well as meaningful gross margin expansion in Industrial driven by product mix and lower input costs. Excluding the impact of $99,000,000 of pass through metal sales in Assembly Solutions, our adjusted EBITDA margin would have been 26% in the Q2.

Speaker 3

Moving on to Slide 4, where we share additional detail on the drivers of organic net sales growth in our 2 segments. We continue to see improving sales dynamics in Electronics, driven by our targeted growth areas. This is a positive sign for our business, especially as the market recovery is expected to broaden in the second half. Industrially oriented customers remain a headwind to growth, particularly in Industrial Solutions and our Assembly business in Electronics. In Assembly, soft automotive demand in Europe continued from the Q1, but this was offset by improving consumer electronics in China.

Speaker 3

The vertical grew net sales organically by 2% and year over year volumes were up. Circuitry solution sales improved 22% organically. Growth was led by continued demand for memory disk chemistry and cloud storage markets and strong volume growth in our core circuitry applications for specific customers in Asian Mobile as well as China EV and AI related applications. Our outsized growth in circuitry demonstrates the emergence of demand for our high value applications outside of the traditional high end smartphone market that has driven performance over the past several years. The smartphone market has not recovered meaningfully year to date.

Speaker 3

3rd party estimates for global smartphone unit growth of 7% in the quarter suggest only low single digit growth from Western OEMs with significant upside coming from domestic Chinese handsets. Our customers are expecting an improved second half and while still early new AI enabled smartphone, tablet and PCs have the potential to drive meaningful refresh cycles over the next several years. That lever is not considered in our outlook for the rest of 2024. Semiconductor Solutions grew 2% organically. Significant increases in wafer level packaging sales in Asia to both semi fabs and OSATs were partially offset by softer semiconductor assembly sales into power electronics for EV customers.

Speaker 3

We anticipate power electronics will see sequential improvement in Q3. By looking at both customer forecasts and the progress we have made broadening our Power Electronics customer base. We saw improved utilization from major OSAS and expect a multi year continuation of demand growth in wafer level packaging, driven by advanced packaging applications that support memory, server and AI chip markets. Moving to Industrial and Specialty. In Industrial Solutions, the majority of the 3% sales decline was reductions in surcharges for commodity metals like palladium and nickel.

Speaker 3

While these metal price swings impact headline sales, the higher mix of value add, high margin, recurring chemistry revenue drove margins up. Demand across Europe and from automotive customers globally was sluggish. Asia was a relative bright spot with Chinese export demand increasing both year over year and sequentially. We expect the negative mix of impact of commodity surcharge pricing to ease in the second half and new customer wins to drive additional sales volume. Energy Solutions remains a bright spot in the INS portfolio with organic sales growth of 9% in the quarter driven by volume and modest pricing actions.

Speaker 3

We expect the energy business to continue to operate at similar levels of profitability for some time. Turning to Slide 5. We generated $52,000,000 of free cash flow in the 2nd quarter. Dollars 33,000,000 was invested into working capital, primarily into accounts receivable due to sequential revenue acceleration, particularly in Asia and into inventory, also from sequential increase in demand as well as from higher tin prices, which is our single largest raw material. CapEx in the quarter was $15,000,000 as we progressed on strategic capacity expansion projects and applications development initiatives in select growth geographies.

Speaker 3

Our full year expectations for cash interest, cash taxes and CapEx remain unchanged. Turning to the balance sheet. Our net leverage ratio at the end of the quarter was 3.2 times. Our capital structure includes no interest rate exposure for the remainder of the year and we have no debt maturities until 2028. We expect net leverage at below 3x by the end of the year barring further capital deployment.

Speaker 3

And now, I will turn the call back to Ben to discuss our outlook for the second half. Thank you, Gary.

Speaker 2

We've had a strong first half and expect that to continue as reflected in the increased guidance we introduced in June. While our markets are not uniformly improving, our conversations with customers and suppliers support a constructive view on more broad based electronics demand improvement beginning in the second half. We do not see the industrial markets recovering in the second half nor do we expect them to be weaker. Historically, the Q3 is seasonally the strongest given the timing of product launches and pre building activity in electronics. This is likely to be the case again.

Speaker 2

However, the exact cadence and magnitude of that uplift in the second half will depend on the pace and level of improvement in mobile phone markets. The midpoint of recently increased adjusted EBITDA guidance translates to a healthy 15% constant currency growth. We would anticipate achieving the higher end of our range should mobile markets improve beyond current expectations of low single digit unit growth for the year. Our focus remains on execution. Commercially, we have a high quality, high probability pipeline of large, leading edge electronics opportunities.

Speaker 2

Operationally, we're working to optimize our footprint by expanding manufacturing capacity for future growth areas such as nano copper and power electronics, driving productivity in our legacy industrial manufacturing assets and building research and applications development in high leverage geographies. We've seen an inflection in our business in terms of the sources of demand in electronics, the adoption of our technology by new customers and the quality of engagement we have with large OEMs and specifiers. Our outlook for 2024 exceeds where we began the year and our go forward expectations for market outperformance have improved as well. To wrap up, I'd like to thank all of our stakeholders for their continued support With that, operator, please open the line for questions. With that operator, please open the line for questions.

Operator

Thank you. We will now begin the question and answer session. Your first question comes from the line of John Roberts with Mizuho. Please go ahead.

Speaker 4

Thanks and congrats on the strong results here. The range in the second half seems to depend on smartphones, but you're having really strong results in spite of minimal recovery in smartphones. So just how important are smartphones? And can you remind us about the second half outlook seasonality compared to your normal seasonality before the pandemic?

Speaker 2

Thanks for the question, John. So historically, we'd point to smartphones as a strong indicator for our circuitry business. And what you saw in the Q2 is that there are these new sources of demand emerging outside of the smartphone market that are propelling the business, right? We're in an improving, but still not strong smartphone environment and the circuitry business is up 22% in the quarter. Smartphones remain a big and important source of demand for the overall electronics ecosystem and a strong recovery or stronger than expected recovery in the smartphone market is what we've sort of pinned the upper end of our guidance range on.

Speaker 2

But we still have a path to getting to the midpoint of guidance without that stronger than expected recovery. With regard to the second part of your question around typical seasonality, the 3rd quarter is historically our strongest quarter. The second half is usually somewhere around 5% to 10% stronger than the first half. We've got about a 5% uplift because the smartphone market is not expected to be particularly robust based on, call it, market estimates, research estimates today. And so that's why we're sort of in that 5% range and the 10% range is tied to a stronger smartphone market.

Speaker 2

Great. Thank you.

Operator

Your next question comes from the line of Josh Spector with UBS. Please go ahead. Yes.

Speaker 5

Hey, good morning, guys. So I wanted to ask on the relative view on the strength of 2Q and the uncertainty, I guess, in forecasting 3Q right now. I mean, has anything been pulled forward in your view? Or is it more uncertainty around production plans, call it, in September that's making 3Q tougher to call?

Speaker 2

So, we don't see 2Q as a pull forward, right? We keep talking about these new emerging sources of demand for the electronics business, which are frankly very exciting, as the business is moving away from being as driven by smartphones as it was over the past decade. Things like high performance compute, industrial automation, electronics and electric vehicles are all driving pretty substantial demand or drove substantial demand in the Q2. We don't see that going away. With regard to uncertainty, the large OEMs don't know how many smartphones they're going to sell in the back half of the year, and that's what's going to drive volume.

Speaker 2

And there's quite a dispersion, I would say, between what some research analysts are forecasting in terms of units and then some

Speaker 1

of the things you see

Speaker 2

in the press, which are more optimistic about smartphone units in the back half. And so that accounts for the range that we have, going into the second half and also some of the uncertainty around phasing because production cycle ramps sometimes start earlier in Q3 and sometimes fall into Q4. But with regard to the back half, we feel pretty good about the range and about getting to the higher end of that range should smartphone units be higher than low single digits from a growth standpoint in 2024.

Speaker 5

Thanks, Ben. I guess on the semi side, can you talk about the two parts of the business maybe a little bit more? What kind of growth are you seeing on front end and assembly? And frankly, the impact of, I think, the power management side of it was bigger than we anticipated and somewhat surprising to hear you talk about that improving. So just curious how you see that trajectory moving through the second half as well?

Speaker 5

Thanks.

Speaker 2

Yes. Thanks for that question, Josh. It's a good point to clarify. So our semi business has 2 components. There's wafer level packaging, which is on the front end and then semi assembly, which is back end.

Speaker 2

The wafer level packaging business had a very strong second quarter. We're outstripping MSI growth, high single digit growth from a revenue standpoint in that business. Tied to the VIAFORM transaction, share gains there, there's a lot of momentum in our wafer level packaging business. The semi assembly business was softer in the Q2 and that's tied to our power electronics portfolio where the electric vehicle market, particularly within certain customers, was pretty soft in the Q2. We see that semi assembly part of the business accelerating in the 3rd quarter, Very constructive from a long term perspective, we've been winning Power Electronics business outside of the core OEMs where we've been concentrated in the past.

Speaker 2

And so our confidence in the growth opportunity for our power electronics business grew. The pipeline there is very strong and we're converting it very effectively. And in general, the outlook for that semi assembly business is very, very strong over a multiple year period.

Speaker 5

All right. Thanks, Ben.

Operator

Your next question comes from the line of Chris Parkinson with Wolfe Research. Please go ahead.

Speaker 6

Great. Thank you so much. Ben, just an extension off of that question for the intermediate to long term. I mean, you've made some decent investments and you've been kind of growing some capacity in specific substrates within that semi business. Can you just offer some further insight in addition to what you just said in terms of like how the street should be kind of gauging that business, not just for the next 6 to 9 months, but ultimately for the next 2 to 3 years based on your vision overall?

Speaker 6

Thank you.

Speaker 2

Yes. Thanks for the question, Chris. So we've been out with a couple of electronics deep dives teaching the investor community about the capabilities in our semiconductor portfolio, in our broader electronics portfolio. And there are a few observations I'd make. 1st, the semiconductor portfolio we have is very differentiated in terms of what we can offer from a front end perspective, wafer level packaging perspective, which gets to advanced packaging and then semi assembly, which is advanced packaging and package attach.

Speaker 2

Those are areas of the electronics hardware market where there's a lot of innovation. And our solutions are enabling our customers and their customers' next generation products. And the traction we have from the breadth of solutions and complementarity of our portfolio with the supply chain is very, very strong and it's creating significant opportunities, which we see in our pipeline and are very excited about. The broader electronics portfolio hangs together very, very well. And this comment I've been making about emerging sources of demand in our electronics business is very compelling for us and gives us a lot of conviction in the long term growth opportunities for the business because our addressable market is expanding as these new sources of demand become large markets.

Speaker 2

These new sources of demand are AI, high performance compute, data storage, even electronics in electric vehicles. And we see significant runway here as demonstrated by the strength in the second quarter in what was a generally soft industrial and electronics market gives us good visibility to record results in the coming years.

Speaker 6

And just the quick follow-up, I would say just on free cash flow. I understand obviously the working capital investment, but CapEx is flat, numbers moving in the right direction. Perhaps for the second half, can you just give us a little bit color on the puts and takes for second half free cash flow conversion? And just remind us of how we should be thinking about this conversion at 2025 onwards just given the evolving mix

Speaker 2

of your businesses? Thank you.

Speaker 3

Sure, Chris. So for the rest of 2024 to hit that first point, as you noted, we're holding the free cash flow range of $280,000,000 to $300,000,000 And the real driver of that is the working capital investment that we're expecting for the full year based on where our growth is coming from. The electronics business is where we're seeing most of our growth. That is heavily Asia focused and the working capital intensity for the Asia business is slightly higher than the average for the company. So that's really the dynamic you're seeing for 2024.

Speaker 3

You actually look at the PSO and DII for the business, you're seeing sequential stability, if not some improvement. And then we expect to see working capital percent of sales improvement as we trend to the full to the end of the year. So you should see some release by the end of the year. It will still be an investment on a full year basis. When we think about 'twenty five and beyond, don't think much has changed on the overall dynamics of cash flow conversion.

Speaker 3

In growing years, it's slightly lower and in more average growth years, should be back to the range we've seen over the last

Speaker 2

Very helpful. Thank you. No lumpiness we'd expect from a capital perspective. And we've been able to hold taxes and interest flat. And so we'll get operating leverage on those lines.

Speaker 2

Understood. Thank you.

Operator

Your next question comes from the line of Bhavesh Lodaya from BMO Capital Markets. Please go ahead.

Speaker 7

Hi, good morning, Ben. We saw sort of divergence in organic growth in circuitry versus semis and assembly. Is that just timing or the impact of some the new business wins that you spoke about, maybe some examples on what they are?

Speaker 2

Sure thing. So we've spoken already about what we saw in the semi business where the wafer level packaging business has been very strong in the semi assembly business tied to electric vehicles, offset that growth on the top line. In the circuit board assembly business, you've got a broader set of exposures and you're more industrially driven. So the automotive market and generally weaker industrial backdrop are responsible for the performance divergence, I would say, between circuitry and circuit board assembly in the Q2. On the Circuitry solution side, we saw strong demand driven by these emerging applications in electronics.

Speaker 2

So you look at high performance compute, talked about AI, we talked about EV, certain mobile markets. So there was some strength in the local Chinese mobile market. There was strength in certain tablet applications in the Q2. Volumes in that business were up north of 10%, and mix was also a driver there as these new applications are high value applications. So the price point of our chemistry and our solutions are higher and that's driving the balance of the organic growth that we saw.

Speaker 2

As we look forward to the second half, I think that that divergence between circuit board assembly and circuitry should persist because we don't expect the industrial markets to get materially better. But we do see the semi business accelerating in the second half. And so you should expect a stronger semi set of results from the semi business in 2H.

Speaker 7

Understood. And then you have sounded more, I would say, open about potential M and A or inorganic investments. In the past, you've done all kinds of transactions like existing businesses like Coventia or VIAform or even something like CUPrion, which is more of a growth development timeline story. Can you tell us what your focus is going to be as you go into the second half of next year? Like what kind of businesses are you looking at?

Speaker 2

Sure. So I think, Vamesh, you rightly pointed out what I would characterize as flexibility and an opportunistic approach when it comes to M and A. And I would say that it's an opportunistic approach when it comes to all of our capital allocation. We look at the opportunities available to us and we deploy capital to the highest returning available channel. And we'll continue to pursue that strategy.

Speaker 2

We just have more capacity today and we'll have increasing amounts of capacity as we roll forward from a sizing perspective. Our M and A philosophy is pretty straightforward. We look for businesses. We want to invest behind our businesses, into businesses that are of equal or greater quality that we can make better that are better inside of our company and available at attractive valuations. And we've been able to surface those types of opportunities over the past several years.

Speaker 2

And I would expect over the next couple of years, we'll have an opportunity to continue to do so. Thank you.

Operator

Your next question comes from the line of Steve Byrne with Bank of America. Please go ahead. Steve, your line is open.

Speaker 4

Sorry about that. I was on mute. Sorry about that. Ben, on that 7% organic sales growth in Electronics, can you split out volume versus price on that? And more importantly, how would you compare your volume to like underlying demand growth or productivity production rates?

Speaker 4

I recall in the past, you expected a few 100 basis point of outperformance versus some of your key end markets. Is that still the case? Or do you think that that potentially is expanding?

Speaker 2

Yes. Thanks for the question, Steve. So not all volume is created equal in our electronics business as we run the gamut from mostly metal to very small leader sized containers of high value additives into the semiconductor fabricators. But I would say most of the growth in the Q2 was volume driven. There was also a positive mix impact.

Speaker 2

This wasn't a quarter where we were out actively taking price per se, but mix was a contributor to organic growth. And if you look at the backdrop in which we're operating, I do see outperformance in excess of what we would have pointed to, particularly when you look at our circuitry business. Again, the smartphone market was up in the mid single digits and our circuitry volumes were up in the double digits. Our front end capability in wafer level packaging, that was a high single digit to double digit volume grower and MSI wasn't up in that order by that order of magnitude. So we are certainly outperforming our key benchmarks as we had committed to probably in excess of that baseline.

Speaker 2

But 1 quarter is a tough sort of period to make a judgment call around that.

Speaker 4

Thank you for that. And I recall a couple of years back, I thought computing, maybe it's a combination of data storage and computing power was roughly 10% of your sales in electronics. Where is it now and where do you think this could go, particularly as computing moves more and more driven by AI computing power?

Speaker 2

Yes, it's a good question. Again, it's hard to make an assessment on a single quarter. I think we can dust that out better after a full year. But clearly, this quarter, these new sources of demand are contributing disproportionately to growth and therefore growing from a mix perspective, right? So our data storage business grew really well.

Speaker 2

Our content in large server boards grew very nicely. Content in electric vehicles grew nicely, but was offset by a softer broader automotive market. So it clearly is going to be a significant growth vector and will be a larger portion of mix. I'd say it's got several years of runway from disproportionate growth relative to the broader electronics market. But other markets like the smartphone market are still going to be big markets for us.

Speaker 2

And as they recover, they're going to contribute significantly to growth because we're closer to the trough in that smartphone market than we are to the long term trend. So the growth vectors here are from secular growth in the markets we just talked about and an ongoing recovery in the broader electronics ecosystem.

Speaker 4

Thank you.

Operator

Your next question comes from the line of John Canwate from CJS. Please go ahead.

Speaker 8

Hi, good morning. Thanks for the questions.

Speaker 1

Can you expand on the mix and concentration of customers in

Speaker 8

the Power Electronics business, legacy versus new launches and logos going forward and how you expect that to drive growth? And maybe after that, how does Couprion factor into that mix in the next year or 2?

Speaker 2

Thanks for the question, John. Yes, it's an important point. So our power electronics business was historically rather concentrated in a couple of OEMs and we've done a lot of work to expand our penetration of the electric vehicle market both into legacy Western OEMs that have longer product launch life cycles and into some of the emerging Chinese electric vehicle OEMs. And that's been successful thus far, both in terms of current period revenue, but also and more importantly, in terms of pipeline and opportunities. And so we're diversifying that portfolio actively.

Speaker 2

We've had some great success, some very big wins. And that concentration is going to decline as that as this technology gains traction in the broader global supply chains. I think we're a couple of years away from calling that a complete success, a complete victory, but we're certainly on track. And what that points to is an ability to outperform electric vehicle units going forward. So we're going to be growing that business not just as EV units grow, but as the penetration of the EV supply chain expands.

Speaker 2

With regard to CUPREON's impact on that, the nearer term CUPREON or active copper opportunities are not in power electronics. They're not in die attach applications. They're more in the circuitry side of the business, thermal management opportunities and metallization opportunities. Over time, Cuprion will likely be an alternative so that we can offer a broader set of capabilities into the electric vehicle market. But the more exciting and very substantial near to medium term opportunities for active copper are actually on the circuitry side and we've got great traction and made significant progress over the past 90 days from a technical and commercialization perspective with ActiveCopper.

Speaker 8

Got it. Thanks for the clarification. And then, just to drill a little bit deeper into smartphone, prospects for the second half. It seems like you're expecting strong demand, but I think Apple has said that they expect to supply constrained as well. I was wondering if you could square those two comments knowing that your concentration among the higher end smartphone suppliers is a little bit stronger?

Speaker 2

Yes, it's a good question. And that dispersion between some comments from high end smartphone OEMs with regard to what they're asking their supply chains to produce for in the back half versus market research for which is talking to or suggesting low single digit unit growth, that dispersion accounts for the range we have for the full year, the EBITDA range we have for the full year. It's not a huge surprise that there's some level of supply concern. We talk about how a lot of electronics capacity is generic. And so when you've got excess demand from an AI perspective, right, at the leading edge, that's going to absorb capacity from smartphones, for example.

Speaker 2

In the near term, it's a supply constraint perhaps, but in the long term, it's a very bullish and exciting trend because you're going to see more capacity come online, which is going to drive more volume and growth for us. And we participate disproportionately in that higher end electronics area. And so it points to real growth at high value for the next several years.

Speaker 8

Great. Thank you.

Operator

Your next question comes from the line of Duffy Fischer with Goldman Sachs. Please go ahead.

Speaker 9

Yes. Good morning, guys. If you would, the implied $276,000,000 of midpoint EBITDA in the back half, What's the best guess how that gets split by quarter? And then if we move towards the higher end of that range for the back half, is that more likely to be in

Speaker 2

Q3 or in Q4? Thanks for the question Duffy. It's difficult to forecast the September, October split, which accounts for less precision, I would say, in our Q3 guide. But the way that consensus has it is about right. Consensus is somewhere around $140,000,000 to $145,000,000 for Q3 with the balance falling into the back into Q4.

Speaker 2

I think that if mobile phone units are really ramping, you'll see that in both the Q3 and the 4th quarter. Okay.

Speaker 9

And then if you exclude the metal pass through in some of the contractual pricing business, sequentially, what do you think price cost does into the back half of the year?

Speaker 2

Yes. So I don't see us lapping or the cost deflation that we saw through the first half starts to the year over year impact of cost deflation starts to fall away in the back half. And so price cost should be closer to neutral in the back half than it was in the first half. I think we had about $3,000,000 to $4,000,000 of ex metal raw material savings in Q2 and that number will be lower in Q3 and Q4.

Speaker 9

Great. Thank you, guys.

Speaker 2

Thanks, Devin.

Operator

Your next question comes from the line of Mike Leithead with Barclays. Please go

Speaker 9

ahead. Great. Thanks. Good morning, guys. I wanted to ask on incremental margins in the quarter.

Speaker 9

It seems like in both Electronics and Industrial, you posted some pretty high numbers there even before adjusting for some of the metal pass through. So was that mix? Was that the cost deflation you just mentioned?

Speaker 1

Can you just kind of

Speaker 9

help unpack what drove that this quarter?

Speaker 2

Sure thing. It was mix and cost deflation as you rightly pointed out. So it was more mix than cost deflation. So as I just said, about $4,000,000 of cost deflation across the business on a year over year basis. And then we had very favorable mix, right?

Speaker 2

So in the industrial and specialty segment, both from a vertical perspective, right, the offshore business outperformed the other 2 and that's at a higher margin and also within the vertical. So we were selling less certain of certain commodity metals that we sell with a surcharge and hence lower margins in the Industrial Solutions business and that volume was replaced by proprietary higher margin chemistry. Within the Electronics business, it's a similar story where we saw both outperformance from higher margin verticals like circuitry and also mix within that circuitry business skewing towards these high value emerging vectors of growth like AI. And so it's mostly a mix story, but there was, of course, some cost deflation and we've been able to hold price as we said we would.

Speaker 9

Great. That's helpful. And then just a bigger picture question. There's a lot of headlines and stories around AI enabled smartphones and sort of what that can do to the phone refresh cycle. And I think you alluded to that in your prepared remarks.

Speaker 9

But if you think about the next gen of smartphones or other devices, would you expect your content or profitability per smartphone to improve? I guess I'm trying to get at any mix or margin tailwinds besides just the unit volume story for Element. Yes.

Speaker 2

I think you're seeing that in the Q2 where the new sources of demand are coming at higher value. And so you're going to get higher margins from emerging applications where we've got differentiated solutions, right?

Speaker 8

The more

Speaker 2

unique our value proposition to solve a customer pain point, the higher the margins. And you should get units as well if there is a refresh cycle as you're speculating there. So you should see both volume growth and mix improvement in that scenario. Great. Thanks.

Speaker 2

Thank you, Mike.

Operator

Your next question comes from the line of David Silver with C. L. King and Associates. Please go ahead.

Speaker 2

Yes. Hi. Thank you.

Speaker 10

My question here would be focused on, I guess, discretionary CapEx spend. But for the first half of the year, Ben, I guess, net income is up, but free cash flow is down and you cited sorry, CapEx is up and you cited some investment in working capital. I'm quoting from Slide 5, but you said the discretionary CapEx spend or the higher CapEx spend reflects progress on several strategic capacity expansion and applications development initiatives. Could you just highlight what you're directing discretionary capital into at this time? What are the highest priority initiatives that you're allocating discretionary capital to?

Speaker 2

I'm not sure discretionary is the term we use for it, but this is a business that doesn't require significant capital to support its margins and to grow. We're doubling capacity in one area where we were somehow capacity constrained around power electronics, for example. The double capacity there, it's a $15,000,000 investment ballpark, which has been running over the past 12 months or so. We're getting close to the conclusion there. We're building we talked about this in our script a little bit in our prepared remarks.

Speaker 2

We're building a research and development center in India, which is a very fast growth, we call it a high leverage geography across the electronic supply chain. Really, we're investing and these are not huge dollar projects, and there are only a few that we can manage at any given time. But we're investing in areas where our customers are going or in capabilities that our customers are pulling from us. Less really capacity because we have ample capacity by and large across our manufacturing footprint, more in capabilities to support customer innovation and build customer proximity.

Speaker 10

Okay, great. And then I'd like to just go to the first page of your press release and I'm going to quote you by saying you have there's growing confidence for several years of record earnings ahead. And while I generally agree with that, I mean, there's been a few surprises, I guess, in the overall end market development, transportation, consumer electronics has been soft, etcetera. But if you had to pick just a couple of factors or a couple of drivers that give you that growing confidence for several years of record earnings. What would you call out?

Speaker 10

Would it be the wave of new capacity or specific technologies the company specific level? What gives you that growing confidence? Thank you.

Speaker 2

Yes. So thanks for the question, David. And on an earlier question, we talked about both cyclical recovery and secular growth. And as we sit here today, it's a subdued industrial market at best. The overall electronics market is closer to trough than sort of the long term average.

Speaker 2

Yet ESI based on the Playlist guidance is on track for record EBITDA this year, right? And that's before taking into consideration $50 plus 1,000,000 FX headwind. So the strategic execution here between both value recapture and our supply chain and positioning the business to benefit from these pockets of new demand has really put the company in a place where we see we have high conviction for long term growth. And we always say that secular growth isn't linear and there are going to be air pockets along the way. But these emerging sources of demand are very powerful and growing very quickly.

Speaker 2

And so we're just starting to see the benefit of that. And recovery in the broader electronics market, which we're also starting to see the beginning of and a potential recovery in the industrial market, which we're not counting on in the back half. Those three things together give us the conviction to say that the runway from here and the outlook is very positive. And so we're not calling when the industrial market will get better. We're not calling the magnitude or specific timing of the electronics market getting back to trend.

Speaker 2

But we're seeing in the P and L today the strength of these emerging demand vectors. So between those three things, the outlook is great and it's an exciting time.

Speaker 10

Great. Thank you very much.

Speaker 2

Thanks, David.

Operator

And this concludes our question and session. And I will now turn the conference back over to Ben Glicklitsch for closing remarks.

Speaker 2

Thanks very much for joining this morning, and we look forward to seeing many of you in the coming days weeks. Have a good day.

Operator

And this concludes today's conference call. Thank you for your participation and you may now disconnect.

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Earnings Conference Call
Kearny Financial Q2 2024
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