Element Solutions - Q1 2024

Transcript

Operator (participant)

Good day, everyone. My name is Ellie, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Element Solutions 2024 first quarter financial results call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session.

If you'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you'd like to withdraw your question, please press star and number one button again. Thank you. I'd now like to hand over the call to Varun Gokarn, Senior Director of Strategy and Finance. You may now begin, please.

Varun Gokarn (Senior Director of Strategy and Finance)

Good morning, and thank you for participating in our first quarter 2024 earnings conference call. Joining me today are our President and CEO, Ben Gliklich, and CFO, Carey 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. 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 & Events.

Today's materials also include financial information that has not been prepared in accordance with the 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 our CEO, Ben Gliklich.

Ben Gliklich (President and CEO)

Thank you, Varun, and good morning, everyone. Thank you for joining. Element Solutions' strong results in the first quarter reflect solid execution in recovering electronics markets. It was a mixed overall macro environment in which our strength and increasing capabilities in fast-growing advanced packaging and data center markets offset a mediocre market for smartphones and softness in Western automotive and general industrial supply chains.

Our improving value propositions and investments in leading-edge semiconductor technologies and the impact of legacy pricing actions amidst deflation in certain commodities drove substantial profit growth. Constant currency adjusted EBITDA grew 17% year-on-year on the back of over 250 basis points of margin expansion. Our growth this quarter reflects the benefit of portfolio diversification and suggests the potential for further improvement as the electronics market recovery broadens.

Our focus on deep, growing profit pools should continue to generate market outperformance and strong incremental margins. The electronics business is recovering with a surge in Semiconductor Solutions, including advanced and wafer-level packaging applications. Our volumes in that vertical grew in the high teens year-over-year, outpacing the market and our Circuitry Solutions business. Our more industrially oriented circuit board assembly business declined slightly.

The Industrial & Specialty segment saw a combination of softer automotive demand in the U.S. and Europe and lower revenue from metal price surcharges as certain commodities have deflated. Profitability in the segment increased significantly on lower raw material costs, ongoing strength in our offshore business, and an improvement in our graphics business. Our markets are roughly off to the start we expected, and margins are driving our outperformance.

Gross margins returned solidly north of 40% this quarter, an internal benchmark for us, and should be stable at these levels, barring metal price impacts. While many of our supply chains are normalizing after a period of heightened volatility and shortages, logistics prices remained elevated relative to 2019 levels. Notably, our margins in the first quarter have been achieved at volumes well below where they had been the past few years.

While our costs of goods are mostly variable, margins have improved despite volume deleveraging. This further underscores the success of our investment in higher value, higher margin applications and our ability to offset cost increases. The benefit of cost actions taken last year contributed to bottom-line profitability as well. This has not come at the cost of growth capital.

We continue to invest in strategic capabilities, semiconductor assembly or advanced packaging technologies, a research center in fast-growing India, and high-volume manufacturing capacity for our new Kuprion products. Throughout what has been a prolonged downturn in our electronics end markets, we've maintained and in certain instances, grown sales and technical resources needed to support customers as the market evolves and new technologies take root.

Our commercial and innovation teams remain focused on delivering high-value solutions to solve customer pain points in high-growth applications. Our late-stage electronic sales pipeline in wafer-level packaging and circuitry solutions grew meaningfully in the first quarter.

This is in part due to the improved customer intimacy afforded by our highly successful ViaForm transaction and investment we've made in improving our circuitry technical capabilities. We paid our first product milestone earn-out payment for Kuprion this quarter, and active copper opportunities are progressing rapidly.

We're pleased with the outlook from our 2023 investments, but work remains on the operational steps necessary to maximize their long-term value. At the same time, our balance sheet is improving to the point where we can consider additional capital deployment aligned with our strategy. The year is off to a solid start, and the outlook is positive. Carey will now take you through our first quarter business results in more detail. Carey?

Carey Dorman (CFO)

Thanks, Ben. Good morning, everyone. Continuing on slide three, where Ben just talked to some of the highlights, you can see a summary of our first quarter financial results. Organic sales grew 1% year-over-year, and constant currency adjusted EBITDA grew 17%. These strong incremental margins reflect a substantial mix benefit from recovery in higher margin semiconductor and circuitry business in Asia, as well as lower raw material costs in Industrial Surface Treatmentt and favorable mix in the overall INS segment.

In Q1 2023, the high-end smartphone supply chain and the memory disk markets experienced significantly reduced demand, with inventory destocking that continued through much of that year. As we lap this period, we have seen memory disk recovery and growth in smartphone units supporting circuitry solutions.

Net sales in our industrial and specialty segment declined organically 3%, as high levels of offshore energy activity and improving North America printer demand and graphics were offset by declines in our industrial surface treatment business.

This quarter, total company net sales and Adjusted EBITDA were both negatively impacted by a strengthening U.S. dollar by roughly 2% and 4% respectively. Adjusted EBITDA margin improved almost 300 basis points year-over-year in constant currency terms. The margin trend accelerated this quarter, improving sequentially 120 basis points from Q4, 2023.

Excluding the impact of the $79 million of pass-through metal sales and Assembly Solutions, our Adjusted EBITDA margin would have been 26% in the first quarter. On Slide 4, we share additional detail on the drivers of organic net sales growth in our two segments. In electronics, categories that saw significant destocking last year grew in the first quarter of 2024, a positive sign for more broad-based recovery as the year progresses.

We saw consistent softness in our industrial-oriented businesses, particularly in the Americas and Europe, that impacted growth in both Industrial Solutions and our assemblies business in electronics. In assembly, soft industrial demand in Western markets drove a 2% decline in organic net sales. The circuit board assembly business has more exposure to industrial applications, with certain capabilities focused on high reliability alloys required for demanding automotive electronics use cases.

While year-over-year volumes in China and Asia more broadly were positive in the quarter, volumes declined in Americas and Europe. Circuitry solutions sales improved 8% organically, with growth primarily coming from a recovery in our memory disk business. Inventories of our customers' finished products declined in 2023, and this market has picked up again in 2024 on the back of resumed investment in data storage for cloud computing and enterprise servers.

Our disk drives still represent the most affordable mechanism for data storage per bit, and the near term growth outlook is favorable. The first quarter showed other signs of market stabilization, with overall smartphone units estimated to have grown at 8%. However, not all handset OEM supply chains experienced growth in the first quarter of 2024, with the bulk of the improvement occurring in China-based manufacturers. While we do skew towards the non-Chinese device makers, we have content across most smartphone models.

Our customer base is broad, and our growth generally should correlate to overall industry units rather than any particular manufacturer over time. Customers globally are expecting an improved second half. Semiconductor solutions led growth for the segment, with organic net sales up 11%. We saw significant increases in wafer-level packaging sales in Asia for both semi fabs and OSAT.

We expect a continuation of this demand growth related to advanced packaging that supports memory, server, and AI chip markets. Power electronics products also continued to grow in the first quarter as we successfully expand our ArgoMax tin/silver technology to a broader customer base of electric vehicle manufacturers. Moving to industrial and specialty, organic net sales declined 3% year-over-year.

Roughly half of the 6% decline in the industrial solutions vertical was driven by reductions in surcharges for commodity metals like palladium. While these price swings impact headline sales, buyer mix of value-add, high-margin, recurring chemistry revenue benefits margins. Demand from automotive customers was sluggish, in line with global auto production in the first quarter. European construction and industrial end markets remain soft, with customers continuing to operate at reduced volumes.

As we move through 2024, we expect a negative impact of commodity surcharge pricing to ease and new customer wins to benefit sales volume, particularly in the second half of the year. Graphics Solutions sales increased organically by 5%, reflecting improved demand, primarily with flexible packaging customers in North America.

Encouragingly, Adjusted EBITDA margins in this business also showed a meaningful expansion of almost 300 basis points year-on-year. Energy Solutions remains a bright spot in the INS portfolio, with sales growth of 14% organically in the quarter as production and drilling activity remains strong. We expect this growth for energy business to continue this year. Slide 5 addresses cash flow and the balance sheet. We generated $39 million of free cash flow in Q1.

The first quarter of the year has atypical uses of cash relative to annualized targets, including annual incentive payments and a semiannual bond payment. We invested $28 million into working capital, which primarily reflects a seasonal inventory build. CapEx in the quarter was $19 million, which is above the $50 million-$60 million annual run rate we expect for the year, and reflects the late timing of certain growth projects and integration initiatives that were originally planned for the end of 2023.

Now, turning to the balance sheet. Our net leverage ratio at the end of the quarter was 3.3 times, inside of our long-range target ceiling of 3.5, and once again demonstrating our ability to quickly delever with cash flow generation and earnings growth. Our capital structure remains fully fixed rate for the remainder of the year.

We have no debt maturities until 2028. Through cross-currency swaps, the effective interest rate on our term loan is fixed at 3.2% as of March 31st, and our liquidity position remains strong. With that, I will turn the call back to Ben.

Ben Gliklich (President and CEO)

Thank you, Carey. We've had a strong start to 2024 and are optimistic about the trajectory from here. Our investment in leading-edge and emerging technology is driving high incremental margin sets. And while our markets are not uniformly improving, our conversations with customers and suppliers support a constructive view on more broad-based electronic demand improvement in the second half.

There are reasons, however, for a level of conservatism this early in the year, given geopolitical risks, sluggishness in Western industrial markets, and modestly lower full-year expectations from certain supply chain participants. For the second quarter of 2024, we expect Adjusted EBITDA to be approximately $125 million, or approximately flat ex-currency on a sequential basis.

We're also updating our full year Adjusted EBITDA guidance range to $515 million-$530 million, which reflects 10%-14% constant currency growth, as the year-over-year FX headwind is now expected to be greater than $15 million. Were it not for the recent strengthening of the U.S. dollar, we would have increased the high end of the range as well.

Overall, we're pleased with our execution to start 2024. Commercially, we're building a high-quality, high-probability pipeline of large leading-edge electronics opportunities and margin-enhancing industrial projects. Operationally, we're increasing volume manufacturing capacity for future growth areas, such as nano copper and power electronics, streamlining our legacy manufacturing footprint, and building research and applications development in high-leverage geographies.

We continue to make systems improvements and better leverage our data to increase the proportion of time our employees can spend on value-added technical service and product development. Taken together, this positions us towards delivering on our commitments for the year in the current demand environment and generating above-market growth to exceed them as the environment improves from here.

To wrap up, I'd like to thank all of our stakeholders for their continued support of Element Solutions, and in particular, our talented and dedicated people around the world, working productively and collaboratively to support our customers and objectives. With that, operator, please open the line for questions.

Operator (participant)

Opening the floor for question and answer session. If you'd like to ask a question, please press star and number one on your telephone keypad. Our first question comes from Josh Spector from UBS. Your line is now open.

Josh Spector (Executive Director)

Yeah. Hi, guys. Good morning.

Ben Gliklich (President and CEO)

Good morning, Josh.

Josh Spector (Executive Director)

First, if you can comment... Hey, good morning. If you could comment on your, you know, expectations here of what you're seeing on demand versus earlier, 'cause you talk about things kind of in line, but your first quarter came in better. Obviously, there's been some moving parts. So where things stand today, you know, do you have a more positive view on second half, unchanged, worse? Kind of go through where things are set.

Ben Gliklich (President and CEO)

Sure. So as we get closer to the second half, we have more conviction that a recovery is coming, and we're hearing that more from customers in the electronic side of the business. On balance, I think the ramp in the back half is modestly slower than was expected entering the year, right? The semiconductor market, you hear industry participants who were talking about greater than 10% growth now talking about, about 10% growth.

But net-net, the electronics recovery is roughly what we would expect it to be, entering the year. On the industrial side of the business, there's pockets of strength and air pockets. As we said in our prepared remarks, our markets are roughly playing out as we thought they would this year, and our outlook is unchanged from a demand perspective.

Josh Spector (Executive Director)

Thanks, that's helpful. And I just wanted to kind of check on here where, you know, you recently talked about high single-digit % growth in electronics over the next 5 years. You delivered 4% growth in the first quarter. Obviously, you expect things to improve a bit. When do you think you'd get to that run rate? And I don't know if there's a way to unpack how the next year, year and a half, look from a cyclical improvement perspective versus, you know, how that framework impacts more of your secular growth view 2-3 years from now.

Ben Gliklich (President and CEO)

Sure. So in the first quarter, right, we had double-digit growth in semiconductor, high single-digit growth in circuitry, and the assembly business lagged because it's more industrially oriented, and the Western industrial economy was soft. By the end of this year, we should be, you know, on a year-on-year basis, getting up towards high single-digit growth, call it mid to high.

And of course, EBITDA growth, and we talked about getting to double-digit EBITDA growth in electronics. We will be at that level in 2024. 2025, if we see a continuation of the electronics recovery, which is a reasonable expectation based on industry outlook,

Should once again be double-digit EBITDA growth, and you'd expect that the electronics business should be in and around the same level of top line that we've been talking about. So, that's a medium-term outlook, I would say. I think it's reasonable to expect that we're about there for the next couple of years.

Josh Spector (Executive Director)

Okay. Thanks, Ben.

Ben Gliklich (President and CEO)

Thank you, Josh.

Operator (participant)

Our next question comes from John Roberts from Mizuho. Your line is now open.

John Roberts (Managing Director)

Thanks. I'll just ask one here, but congrats on the progress on Kuprion. When do you think we'll see first sales, and could you scope the potential additional payments for us?

Ben Gliklich (President and CEO)

Sure thing, John. Thanks for the question. So we paid our first milestone payment for Kuprion this quarter. The background there is Kuprion was a technology we acquired last year with an upfront payment and a large performance-based earn-out structure. The first payment was based on product performance, so that was an internal performance milestone, and we were able to get the product to perform at a certain level, which generated this payment. The subsequent payments will be based on customer success.

First, customer product qualification, and subsequently, customer-based revenue. We're working very closely with several customers, and I would expect us to have product qualification payments this year and revenue to begin in 2024 and really ramp in 2025.

The maximum we will pay for Kuprion, if we hit all of these targets, would be about $275 million. That would be linked to about $115 million of revenue, which would be a low single-digit multiple of EBITDA based on the margins we're expecting from this business.

We have six years to get to that ramp of revenue, but our internal expectation is we'll be able to do so well within that timeframe. The customer reaction and pull from the market for this capability is stronger than we could have expected, and our progress against qualification is faster than we expected.

John Roberts (Managing Director)

Thank you.

Operator (participant)

Our next question comes from Bhavesh Lodaya from BMO Capital Markets. Your line is now open.

Bhavesh Lodaya (US Chemicals Equity Research)

Hi, good morning, Ben. If I look at your FY guide, it seems your outlook for the year is roughly unchanged, slightly better. I would have expected second quarter to be up sequentially, just on some demand recovery, but also given some of the drivers you highlighted that impacted the first quarter EBITDA. You are building inventory as well. So maybe if you could comment on what you are seeing in your order books in the near term, trying to get a sense of the full year guide versus the second quarter guide.

Ben Gliklich (President and CEO)

Sure. Our expectation for the second quarter, as you heard, was for sequentially flat EBITDA constant currency, and there's about a $2 million-$3 million FX headwind, which gets you to approximately $125 million of EBITDA. There is a modest demand ramp that is offset by some OpEx ramps that we see in the second quarter, and that's how you get to that flat sequential EBITDA. It is a consistent demand environment.

You know, the industry expects the electronics market ramp to come in the second half. Typical seasonality supports an electronics ramp in the second half. I think when you look at half-on-half performance sequentially, it's a slightly greater than normal seasonal uptick in terms of the percentage of earnings in the back half versus the first half.

We feel like it's a reasonable place for the second quarter. April is off to a good start, but we're not going to extrapolate from that. That's how we think about the phasing, and it's generally in line with what we thought entering the year as well.

Bhavesh Lodaya (US Chemicals Equity Research)

Got it. And then the autos end market is clearly an important one for you. As it relates to your exposure, it appears consultant forecasts for Western autos are gradually rising. However, at the same time, there are some concerns around softening EV adoption rates. Can you share your view on what you are seeing for your business?

Ben Gliklich (President and CEO)

Sure. So yes, autos is an important end market for us. Our outlook for auto markets is roughly sideways from where they are today. It's not just units that's impacting our industrial business, it's type of units. So some of the higher end vehicles are struggling more than entry-level vehicles, and we have more content on the higher end vehicles.

The electric vehicle story is actually generally positive for us, despite a softer electric vehicle market. We've seen our really unique capabilities in power inversion getting much broader adoption in new OEM supply chains. So we've had some pretty compelling customer wins that will contribute modestly this year, but significantly over the next several years. By and large, we're excited about our capabilities in auto and our outlook for the businesses we have exposed to auto, albeit it's a weaker macro this year than ideal.

Bhavesh Lodaya (US Chemicals Equity Research)

Thank you.

Operator (participant)

Our next question comes from Christopher Parkinson from Wolfe Research. Your line is now open.

Harris Fein (SVP)

Great, thanks. This is Harris Fein for Chris. I guess from a high level, you know, top line was flat and pass-through metals were a neutral in the quarter, but margins were up a good amount year on year. So could you just maybe size the drivers of that, just between mix, lower raw materials, the offset of the surcharge roll-offs? And I know you guided to some variable cost rebuild this year. I think you might have already mentioned how much of that hit the PNL in the first quarter. Thanks.

Ben Gliklich (President and CEO)

Sure thing, Harris. There's a lot of moving parts here. The simple answer is that the higher end electronics businesses we have that are really performing well are higher margin, and the businesses that are seeing macro weakness are benefiting from lapping lower raw material prices, higher raw material prices, and favorable mix from those surcharges that have rolled off.

And so between the two of those things, right, we saw substantial margin uplift, and there was a modest impact, I would say, from the cost actions we took last year, offsetting some of that variable cost rebuild. So those are the two moving pieces. Raw material deflation year-over-year was a low single-digit $ million impact, just to help you quantify what those pieces are.

And, you know, what we said in our prepared remarks is margins are stably north of 40% on the gross profit line, and, you know, we see room for improvement in margin over time, driven by divergent growth rates and, you know, the higher value proposition we're bringing to support high-end electronics customers. So we're far from our margin ceiling, and should see progress from here.

Harris Fein (SVP)

Got it. That's helpful. And then just as a follow-up, in circuitry, you know, a lot of the debates with investors are around smartphone, but that doesn't seem to be the primary driver of results right now. So just, you know, with demand recovering, I know you called out memory disk and server. Just, you know, how are you thinking about normalized intermediate-term growth rates, what that looks like in that business?

Ben Gliklich (President and CEO)

Yeah. So within our circuitry business, there are really three moving pieces this quarter. Smartphone markets grew, Western industrial markets softened, and so our circuitry business in Europe and the Americas was soft. Those two didn't quite offset, right? The Asian business is bigger, and so the smartphone uplift more than offset the softness in the West, and then our memory disk business grew very nicely, returned to growth. That memory disk business is for hard disk drives.

As Carey said, they're still the lowest cost per bit storage alternative, and all of this activity in AI is driving incremental hard disk drive demand. So those are the three moving pieces. The smartphone market, while it grew, is still very dislocated from trend, and so we believe there's still incremental recovery there at high margin, and the memory disk market should continue to improve as well. So, you know, the circuitry business should be a mid- to high-single-digit grower from here for the foreseeable future.

Operator (participant)

Our next question comes from Steve Byrnefrom Bank of America. Your line is now open.

Robert Hoffman (Equity Research Analyst)

Hi, it's Rob Hoffman on for Steve Byrne. Just given the, OpEx ramp in, 2Q that you just mentioned, how do you think the near-term EBITDA margin, might play out for the rest of the year, kind of, compared to what we saw in 1Q? And, how much of a lever will mix benefits see for the rest of the year?

Ben Gliklich (President and CEO)

Thanks for the question. So EBITDA margins should be stable around where they are right now, in the second quarter, maybe modestly softer because of that OpEx ramp. But in the back half, they should continue to improve. Again, as we said, you know, we are several points away from past peak EBITDA margin ex metal.

I don't think we're gonna get back there this year, but we've got room to drive that margin higher, and multiple levers, right? We made comments about volume, being down, and so we're still facing, volume deleveraging, in the business. And so we've got multiple levers for margin expansion from here and, are confident we can drive that, you know, in the medium term.

Robert Hoffman (Equity Research Analyst)

That's helpful. And just in semiconductors specifically, with the strength in the business this quarter, I guess how much of that was kind of result of customer operating rates versus the mix gains that you guys saw?

Ben Gliklich (President and CEO)

Our semiconductor business ramped because of customer operating rates, because of customer wins. You know, that was organic volume growth, by and large, with a margin contribution from our ViaForm transaction last year.

Robert Hoffman (Equity Research Analyst)

Helpful. Thank you.

Operator (participant)

Our next question comes from Chris Kapsch from Loop Capital Markets. Your line is now open.

Christopher Kapsch (Equity Research Analyst)

Yeah, good morning. So my question, also on, focused on EBITDA margins and, more about the incremental margins, not about, less about absolute margin levels. If, you know, the strong EBITDA growth you had relative to much more modest organic top-line growth, the implication, as you referenced, like really robust incremental margins.

So the question is, as the balance of this year plays out, like if you have, you know, continued growth and recovery in electronics and, and potentially positive mix that comes with that, and then hopefully some, you know, seasonal improvement across the broader portfolio... Is there a reason to think other than the, you know, the build back in OpEx, is it that there'd be some reversion on incrementals?

Or is there a case that incrementals are just simply structurally higher than you previously thought because of, you know, just both the overall mix of your portfolio and maybe some of the pricing entitlements that you've implemented? Thank you.

Ben Gliklich (President and CEO)

Thanks for that question, Chris. You know, I think our view on incrementals are that, you know, conservatively 30%-40%, you know, through the cycle. Obviously, this quarter was a bit idiosyncratic, given a flattish organic performance and substantial organic EBITDA growth.

We could see quarters like that in the future, depending on mix and underlying demand, but I don't think we're gonna say that structurally, incremental margins, you know, are changed from here. There is some conservatism in that 30%-40% because some of our new technologies carry much, much higher margin than, you know, the core of the business. And as those ramp, they will improve. But, you know, I'm not sure we would draw a line in the sand and say that our view on incrementals have permanently changed after one quarter.

Christopher Kapsch (Equity Research Analyst)

Appreciate the color.

Operator (participant)

Our next question comes from David Silver, from CL King. Your line is now open.

David Silver (Managing Director)

Yeah, hi, good morning. I just have a couple of questions. I'll ask them both, together, I guess. But, as far as the ViaForm performance goes, I think this is the second consecutive quarter it was kinda called out for, you know, its strength. And, just wondering, is there any way to think about, you know, how much improvement you're thinking might be in 2024 over 2023? I know that the implication was when the deal was struck, to repurchase the distribution rights, that it was being purchased kind of at a below normal or below trend, level of, profitability.

And then just, along with that, is there anything, or how would you say the business is being run, with ESI, with your company in full control, as opposed to, you know, the previous arrangement, where another company, you know, was in charge of marketing and distribution? Thanks.

Ben Gliklich (President and CEO)

Thanks for that question. So, you know, we felt good about our timing for the ViaForm transaction. And we have benefited from the ramp in operating rates at customers over the past couple quarters. Most of the growth we've seen has been driven by that. But the opportunity pipeline associated with it has grown, and the applications window has grown, as there's...

You know, it is used in applications like hybrid bonding. So there's an opportunity for us with ViaForm to expand, or it's an expanding addressable market, and by being in full control from soup to nuts of this product, we believe we're generating more commercial opportunities than we would have otherwise seen. And so this year, the business will grow double digits in line, slightly better than ESI.

The long-term outlook is for significant outperformance relative to ESI because of this growth in pipeline, share opportunities, and growth in addressable market. It's a very compelling opportunity set for us. We're thrilled by that transaction.

David Silver (Managing Director)

Okay, great. And then just one on the R&D spend. So the first quarter, you know, the number's much higher year-over-year, but I, I do believe Carey mentioned last night that that includes the progress payment related to Kuprion there.

Ben Gliklich (President and CEO)

Mm-hmm.

David Silver (Managing Director)

But, you know, my sense is your business is becoming structurally, you know, more R&D intensive. So, you know, is there kind of a, a target percentage of revenues or, or, absolute total we should think about for, you know, adjusted or clean, you know, R&D spend, maybe for the balance of the year or, or going forward? Thank you.

Ben Gliklich (President and CEO)

Thanks, David. You're right to point out that the milestone payment for Kuprion was captured in R&D, this quarter, which explains the large increase year over year. Our business invests R&D dollars, not just captured on the R&D line in the P&L, but also in technical service and applications development, which is captured under selling and technical service in the P&L.

We do have, and we have increased investment in technology, particularly at the leading-edge electronics nodes, but the breadth of our portfolio doesn't really make it apples to apples to compare our R&D spend as captured on the R&D line in the P&L to other electronics materials companies. I think that our target is to continue to invest, aggressively where we have opportunities in support of our customers.

And so R&D will grow, you know, roughly in line with sales, which should be growing nicely, maybe a little bit faster, but our business hasn't structurally changed in terms of its R&D needs going forward.

Carey Dorman (CFO)

And David, I would just add that some of the ramp we've seen in CapEx over the last couple of years has been to support... a decent portion of that has been to support-

Ben Gliklich (President and CEO)

... lab expansion, both applications lab and our core R&D labs, as well as equipment to support that. So that's also R&D spend that we're investing, obviously, just showing up in the cash flow statement.

David Silver (Managing Director)

Okay. No, that's, I appreciate the perspective there. Thank you very much.

Ben Gliklich (President and CEO)

Thanks, David.

Operator (participant)

Question comes from John Tanwanteng from CJS Securities. Your line is now open.

Jonathan Tanwanteng (Managing Director)

Hi, good morning. Thank you for taking my questions, and nice quarter.

Ben Gliklich (President and CEO)

Please do.

Jonathan Tanwanteng (Managing Director)

I wanted to ask you about your semi business. AI has obviously been making, you know, headlines as well as, you know, the CHIPS Act and onshoring initiatives in other countries. Could you update us on how those things will flow through your semi business over the next 1-3 years, and how big it could become as a percentage of revenue? I know you gave some details on Viaform, but if you could talk about the whole business, that would be great, and the percent of profits as well.

Ben Gliklich (President and CEO)

Sure. Thanks for that question, John. So our semi business has accelerated this year. It has a lot of runway to continue to grow, and we expect it to outgrow, you know, the rest of our verticals and the rest of the electronics business, and so it will grow as a percentage of sales. You're right to point out the CHIPS Act.

The CHIPS Act is bringing significant investment into fab capacity in North America. We're seeing incremental fab capacity in Europe. And, you know, with ViaForm, which we just pointed out, and other investment we've been making, we feel like we're in a prime position to get, you know, more than our existing share, where we play in these new fabs, which will drive, you know, above-market growth here.

Also with regard to the CHIPS Act, we have an opportunity that we're pursuing to receive some funding from the CHIPS Act for R&D, which is very exciting and should, you know, stimulate incremental growth in the business and opportunities in the business. You know, the semiconductor business is 10%-ish of our overall revenue, but given its divergent growth rate, you know, it will increase as a percentage of the overall book of business.

You know, and could conceivably be, you know, 20% of the business in the medium term. And you know, we're investing aggressively behind that, but only in places where, you know, it fits our operating model, where the profit pools are deep and where we've got a right to win.

So we are being circumspect about where we invest, and where we choose to play. But, you know, we've got great capabilities and a lot of customer pull for them, which is compelling and exciting for us.

Jonathan Tanwanteng (Managing Director)

Great. Thank you. And then just in terms of the guidance and the underlying assumptions, what's the change in your expectations for China versus non-China handsets, and also ICE versus EV automotive? How does that mix impact you as the year progresses? Just help us understand your thoughts in those two areas.

Ben Gliklich (President and CEO)

So, our business in smartphones skews towards non-Chinese OEMs, right? So we've got more value and share on non-Chinese device makers than local Chinese device makers, but we still have plenty of value in local Chinese smartphones. And so in a quarter like this past quarter, where units were up maybe 8%, despite non-Chinese OEMs or Apple devices being down, we still grew our smartphone business.

And so that's, you know, our baseline for the balance of the year. It doesn't have any big assumption associated with the OEMs providing the smartphones, it's just a smartphone growth driver. And with regard to ICE and EVs, that's a difficult thing for us to parse out, because there are plenty of supply chains that we sell into that are EV or ICE powertrain agnostic. And so I can't answer that question specifically.

I would say that the general weakness relative to expectations in EV is something of a headwind, but it hasn't changed our outlook for the full year.

Jonathan Tanwanteng (Managing Director)

Got it. Thanks, Ben.

Ben Gliklich (President and CEO)

Thank you, John.

Operator (participant)

We don't have any raised hands as of the moment. I'd now like to hand back over to Ben for closing remarks.

Ben Gliklich (President and CEO)

Great. Thank you very much. Thanks to everybody for joining in, and we look forward to seeing many of you soon. Have a good day.

Operator (participant)

We would like to thank everyone for attending today's conference call. We hope that you have a wonderful day. Thank you. You may now disconnect at this session.