Element Solutions Inc Q2 FY2020 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Element Solutions Second Quarter 2020 Financial Results Conference Call. I will now turn the call over to Yash Nehete, Associate Director, Corporate Development and Investment Relations. Please go ahead.

Good morning, and thank you for participating in our second quarter 2020 earnings conference call. Joining me this morning are Executive Chairman, Sir Martin Franklin; CEO, Ben Gliklich; and CFO, Carey Dorman. In accordance with the Regulation FD or fair disclosure, we are webcasting this conference call. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of Element Solutions is strictly prohibited. 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 most recent SEC filings for a discussion of the most significant risk factors that could cause actual results to differ from our expectations and predictions. In the earnings release and supplemental slides issued and posted today, Element Solutions has provided financial information that has not been prepared in accordance with U.S. GAAP. For definitions and reconciliations of these non-GAAP measures to comparable GAAP financial measures refer to the release and slides which can be found on the company's website at www.elementsolutionsinc.com in the Investors section under News & Events. It is now my pleasure to introduce Ben Gliklich, CEO of Element Solutions.

Thank you, Yash, and good morning everyone. Like last quarter, I'll begin by thanking those on the front lines of the fight against the coronavirus. The healthcare workers, first responders, hospital staffers, and others going to work every day around the world helping the sick and protecting their communities have our deepest appreciation. We also thank our suppliers and customers who have overcome a great deal to remain open and keep our supply chains flowing to support their communities and our markets. The pace of adaptation in our supply chain has been remarkable. Nearly all of our facilities were opened throughout the second quarter, and our team adjusted to remain productive despite substantial disruption to our normal business cadence. I'm very proud of how our team has stepped up to the challenge of COVID without losing focus on their other longer-term activities. Navigating this pandemic has only added to the workload for our people, and while we've had to actively prioritize, we've not lost momentum on key projects in innovation, organizational transformation, or otherwise. We have a world-class organization that has demonstrated its prowess these past five months. Entering the second quarter, our visibility was limited. We can only speculate about the depth and duration of the impact of COVID on our markets in Europe and the Americas. The depth of the decline in demand in our industrial and automotive-oriented businesses in Q2 was significant. We expected that April would be the market trough, but May was worse. Net sales in May were down 23% year-over-year. This was primarily driven by our industrial and assembly businesses in the Americas and Europe, which have significant exposure to the automotive sector. Entering the quarter, it was expected that our customers in this sector would begin reopening in early May, and while some did, the pace of reopening was slower than the industry anticipated and suffered from stops and starts. Automotive production in the second quarter was down dramatically in the U.S. and Europe. Nonetheless, our financial results exceeded our expectations going into the quarter. We generated $85 million of adjusted EBITDA on net sales of $387 million. Despite net sales declining 15% organically, we preserved year-over-year adjusted EBITDA margin. Adjusted EPS in the quarter was $0.18. We began to see a recovery in these businesses in June and into July, while our high-end electronics business remained resilient throughout. Driven by wireless infrastructure investment and data center demand, momentum in our circuitry and semiconductor businesses from Q1 carried into Q2. This strength partially offset the decline in our more industrially oriented businesses. Our semiconductor business grew nearly 20% year-over-year in the second quarter. This is a smaller business for us, but a strong one, and with growth like this, it should not remain smaller for long. As our higher-margin businesses generally outperformed, mix improved in the second quarter, which, together with fixed manufacturing cost management, allowed us to hold our gross profit margin steady despite the sizable reduction in volumes. We were able to mitigate the impact of the decline in revenue on adjusted EBITDA margin through continued cost actions in both COGS and SG&A. Adjusted EBITDA margins improved modestly year-over-year. Once again, we have demonstrated our ability to preserve profit in spite of considerable topline pressure. This is one of the hallmarks of our business. OpEx declined $16 million year-over-year on a constant currency basis in Q2, through a combination of reduced employee compensation expense, lower travel expense, and other cost management actions, as well as the contribution from various government initiatives to address the impact on businesses from the pandemic. Importantly, we have not fundamentally restructured our talented workforce because we believe our markets will recover. We are not damaging the long-term growth potential of these businesses. The other hallmark of our business is strong and stable cash flows, and this was once again on display in the second quarter. We generated $61 million of free cash flow in Q2 and more than $109 million of free cash flow in the first half, which compares to $86 million in the first half of 2019 on an adjusted basis. So year-over-year our topline declined 8% in the first half, while free cash flow increased 29%. Carey will now take you through our results in a little more detail. Carey?

Thank you, Ben. Good morning everyone. On slide 4, we provide some additional color on the performance of our two segments. In Electronics, we saw an organic net sales decline of only 6% year-over-year. The assembly business was soft, primarily due to prolonged shutdowns throughout the automotive supply chain where our business is a key supplier. While Europe and America declined in conjunction with the broader auto weakness in these regions, Asia was mixed with China showing strength offset by softness in India. Both circuitry and semiconductor had strong second quarters with organic net sales above the same period in the prior year. Continued momentum in 5G infrastructure investment as well as increased demand for data center and cloud infrastructure provided a positive market tailwind. Adjusted EBITDA margins in this segment were roughly flat, as positive product mix and OpEx savings were offset by the effect of fixed costs. Organic net sales in Industrial & Specialty declined 26% versus last year. The Industrial Solutions vertical drove most of this decline, down approximately 35% organically in the quarter as COVID-related automotive shutdowns and general economic softness impacted all regions. The graphics business, which showed double-digit growth in Q1 as demand for consumer packaging surged, moderated to a small decline in the second quarter as CPG companies delayed the launch of new products and their volumes normalized. Significant oil price volatility drove declines in energy solutions as operators reduced inventory and postponed drilling activity in response to the uncertain macro environment. The outsized declines in the Industrial Solutions drove positive gross margin mix in the quarter, which, despite lower volumes, helped the segment expand gross margin approximately 40 basis points. Despite material OpEx savings in the segment in the quarter, adjusted EBITDA margins in I&S still declined as the overall dollar value of net sales decline was not fully offset. While our business has a significant variable cost component and we are able to flex in tough market environments, we have to balance short and long-term objectives when making spending decisions. We believe we struck the right balance in the second quarter in reducing cost without damaging the growth potential of these businesses for the long term. On a consolidated basis, operating expenses were down $16 million or 10% year-over-year in the quarter on a constant currency basis. Reductions in travel and discretionary expenses drove approximately 40% of the savings year-over-year. Compensation expense reductions, including temporary salary reductions, furloughs, long-term variable compensation, and government subsidies drove approximately 30% of the savings. We also continue to deliver ongoing savings through continuous improvement cost activity, which explains the rest of the variance. While travel cost reductions should continue to some degree in the third quarter, we have already rolled back some furloughs and salary cuts as you see demand activity starting to recover. Similarly, government subsidies are hard to predict, and we believe we have seen most of the expected benefits already. On slide 5, we cover cash flow and the balance sheet. We generated $61 million of free cash flow in Q2, which takes into account our $23 million semi-annual bond payment made in June, which is almost double Q2 2019 cash flow despite the far more challenging backdrop. Working capital release was a large source of cash in the quarter as we focused on collections and managing inventory to reflect the demand environment. We have not seen any material issues with debt, and our inventory build from the first quarter leaves DII as an opportunity into the second half. Nonetheless, we do expect to build some working capital back in the second half as we expect to grow the top line sequentially. Cash taxes in Q2 remained lower year-over-year in line with lower earnings. CapEx is always modest in this business, and while disciplined we have not sacrificed any significant spend this year. We remain focused on long-term growth. Free cash flow should remain strong in the second half, and we are revising up our full-year 2020 free cash flow expectations to more than $185 million. Net leverage at the end of Q2 remained unchanged from Q1 at 3.2 times adjusted EBITDA as our strong cash flow mitigated the effect of a decline in earnings. As noted last quarter, we drew on our corporate revolver in March out of an abundance of caution but then paid it down entirely in mid-April. Our liquidity position remains in excess of $500 million. We did not repurchase any shares in the quarter as we still have employees on reduced wages and furloughs. However, we remain committed to deploying strategic capital to compound earnings per share while remaining under our targeted net leverage ceiling of 3.5 times adjusted EBITDA throughout 2020. With that, I will turn it back to Ben. Ben?

Thank you, Carey. Given the ongoing impact and uncertainty of COVID-19, we intend to continue to give only quarterly rather than longer-term guidance until the macro environment becomes more clear. Our Q3 guidance is for adjusted EBITDA of at least $80 million. While our markets are improving, we remain cautious that macro conditions may impede the recovery in demand we are seeing over the short-term. July is shaping up to be about 5% better on the top-line than June but still about 10% down year-over-year. The sustainability of this current recovery depends on many variables that are unknowable today. So we do not think it's prudent to guide to an up and to the right recovery in demand. Our industrial and assembly businesses show strong sequential quarterly top-line growth as their markets begin to recover, but we still expect them to be down on a run rate basis more than 10% from 2019 levels at year-end. In our high-end electronics business, we believe inventory buildup in the first half accounts for some of the sales strength we have seen year-to-date. So we expect that strength could moderate sequentially in the back half of the year. Overall, the long-term macro trends in the electronics business are robust and encouraging. While we intend to continue managing costs prudently, several of the cost benefits we saw in the second quarter will not repeat in the second half. We rolled back some of our salary reductions in July and we do not expect the same level of impact from government subsidies in Q3. The combination of modest sequential net sales recovery, product mix, and discrete OpEx increases underpins our third quarter adjusted EBITDA guidance. Should the recovery be more robust, there is upside to our adjusted EBITDA guidance. On a full-year basis at June 30 rates, FX is a headwind to adjusted EBITDA of $8 million against 2019, of which we've crystallized $5 million in the first half, and about $2 million will impact Q3. On our Q1 call, we projected full-year 2020 free cash flow to be at least $175 million, which we are now increasing to $185 million. The implied front-loading in half-over-half cash flow generation is due to the working capital investment we expect to see with sequential net sales growth. The other drivers of cash flow, as Carey mentioned, should be relatively stable. We believe our ability to provide a full-year 2020 free cash flow outlook in the absence of full-year adjusted EBITDA guidance differentiates our business. We've demonstrated in our first 18 months of ESI that our businesses can generate strong cash flow in all markets. With regard to how we deploy that cash flow, I'd make a few comments. With adjusted EBITDA declining year-over-year, we intend to be prudent with our capital, given our targeted ceiling of 3.5 times net debt-to-adjusted EBITDA. Nonetheless, despite those parameters, we remain a growth-oriented company, and we continue to evaluate modest bolt-on acquisitions of businesses that are better as a part of ESI, bring us talent and new capabilities, represent good value, and can accelerate our growth rate. We view our own shares as an attractive acquisition alternative as well when trading below what we believe is their intrinsic value. We do not plan to buy shares until we finish rolling back salary actions company-wide, which we expect to do before year-end. We do, however, continue to consider modest tuck-in acquisitions that improve our portfolio. Before turning to questions, I want to reiterate a comment I made on the Q1 call that this crisis is making Element Solutions a better company for its customers and for its employees. It continues to bring our team together. The relationships we have built across the organization are lasting improvements. At the same time, we've shown our workforce, which is the very foundation of the company, that we are committed to them even in difficult times. We've shown our customers that we can supply them from many locations around the world in the midst of an unprecedented supply chain disruption. In addition, our confidence in the criticality of our solutions to high-growth supply chains has been reinforced. We've also seen the value of our diversification. Through this trying period, we've proven our industry leadership, which should further yield profitable growth in the inevitable market recovery. With that, operator, please open the line for questions.

And we'll take a question from Steve Byrne, Bank of America. Your line is open.

Yes, thank you. You have a very strong functional area in metallization, and I just wanted to ask you about what you're seeing in terms of trends in that technology, in either your autos or electronics end markets. Is there any changes in new products or new technologies in metallization?

Yes, it's a good question. Circuit board metallization is one of our key focus areas for our circuitry business. It's a market that evolves slowly, so we see innovation as an incremental process rather than radical changes, and we are at the forefront of this development. Circuit boards are becoming more complex as they accommodate increased functionality, particularly in smartphones and the demanding requirements of automotive circuitry. We are observing a rise in flex circuits, high-density interconnect circuits, and more direct metallization. This is a space where we stand out as a market leader, utilizing an alternative to traditional electrolytic plating that offers lower costs, strong margins, and is more environmentally friendly. While there is some incremental progress in this area, we do not anticipate radical changes, and it remains a growth market for us.

Well Ben, maybe a more broad question in R&D. The R&D expense line item seems to be quite variable from one quarter to the next. I don't know whether you had any particular challenges in the second quarter with R&D staffing. How did they manage the COVID risk? And maybe one more extension on that is anything that you see coming out of the R&D capabilities that gives you excitement about a new technology or new product launch?

Yes, absolutely. It's a good question, Steve. So the comparability of Q1 to Q2 is a little bit apples and oranges because we acquired a piece of technology in the first quarter for our offshore business, and it was categorized as SG&A, and that was about $6 million in Q1. So Q1 to Q2 was a decline because of the absence of that, but we really haven't cut R&D spending year-over-year. A little bit in compensation expense which is associated with some of the salary reductions we did, but we are continuing to invest in R&D at an equal pace to what it has been historically. As Carey mentioned and as I mentioned in our prepared remarks, we're investing in long-term growth for this business, and the savings that we've generated have not come at the expense of long-term growth. With regard to COVID and how our R&D function has been operating, indeed, it's hard to innovate from home. Our innovation team works at the bench in our facilities. We have done things to allow for them to continue to work in our facilities with social distancing in place. For instance, we've got an early shift and a late shift where some people come in, work a full day, but they come in early, and then the second shift comes in during lunchtime and stays late. So we have been nimble to allow for our innovation team to continue to be productive despite the disruption that we've seen. With regard to exciting innovation in the pipeline, as I said to your first question around metallization, this is a business that really relies on incremental development as opposed to breakthrough technology. There have been some compelling, I call them more breakthroughs around our silver sintering process that's used in power inverters for power electronics. We have some other things coming that are very exciting and will allow for us to maintain industry leadership from an innovation standpoint and contribute to the above-market growth that we aspire to.

We'll move next to Josh Spector of UBS. Your line is open.

Yes, hi, good morning. Thanks for taking my questions. So you guys continue to discuss growth in infrastructure, particularly around 5G developments. I was curious if you could characterize maybe how much of your sales or earnings benefited from growth in that market. What I'm thinking is as I look towards 2021 or relative to 2019, how much higher should base earnings be assuming that auto markets eventually recover to some level? Just trying to think how much additive that is to your base case assumptions.

Thank you for your question, Josh. Regarding our investments in wireless and internet infrastructure, we are clearly seeing benefits this year. This is evident in our high-end electronics within the circuitry and semiconductor sectors, which have continued to grow despite the broader macro challenges. Our semiconductor business has experienced a 20% growth, while the circuitry business had more modest growth in the second quarter, being more exposed to different factors. What is driving that growth is infrastructure investment in internet and wireless. We indicated in our guidance that we anticipate some of this growth will slow as we approach the second half of the year. Some of the outperformance can be attributed to inventory accumulation, which we haven't seen in July or August, presenting an upside as we head into Q3. The demand for this type of investment is not just a one-year trend; it is a multiyear trend where significant investments will continue in base stations and 5G phones worldwide. This should support ongoing strength in the high-end electronics market into next year and beyond. When considering a return to a baseline for next year, the critical factor is the industrial economy in automotive, where we've faced challenges this year as unit sales have declined significantly. While we have outperformed in those markets, unit sales have dropped. The circuitry and semiconductor businesses are expected to continue their strong growth into next year.

Okay. Thanks. And I guess, did I hear you correct in that you haven't seen inventories – inventory destocking been in effect yet to date this quarter? In those businesses I guess I thought that some of that would be – some of the headwinds that you talked about in terms of your guidance sequentially.

Yes. It's a good question, Josh. And so maybe I can frame the guidance a little bit in response to that, right? So I think the place to start around our guidance is that our culture is one of delivering on our commitments, right? In an uncertain environment like this one that leads us to set our targets conservatively. Our most impacted end markets are recovering. There's still a risk of setbacks in that recovery. Those are macro risks, not company-specific risks. That is what's driving us towards a more conservative guide of 80 – of at least $80 million of EBITDA. Part of that is also an abating in the strength we saw in the circuitry and semi businesses. I would say that July was stronger than our forecast coming into the quarter, and so we've built some additional cushion to the outlook. It was stronger both in the auto business recovering somewhat better than we had expected, and that abating in electronics hasn't come through in July. The first two days of August have seen a continuation of that trend. So from where we stand today, we've built some cushion relative to the guidance that we've given, and we feel pretty good about that.

And we'll take the question from Anthony Walker of Goldman Sachs. Your line is open.

Hey, good morning, guys. Thanks for the question.

Good morning.

Just to follow up on the question related to guidance. I can understand the willingness to capitalize on the improvement that you saw in July, but if we did see sustained volume improvement how should we think about the incremental margins that you could produce on the lower or fixed costs?

Yes. It's a good question, Anthony. A couple of variables to discuss in that regard. On the one hand, some of the OpEx savings that we recorded in the second quarter won't recur, right? So we've rolled back some of our salary reductions, and some of the subsidies that we received from a variety of governments around the world in which we operate, we're not counting on those coming through as well. So those are real. We talked about about 5% top-line growth into July. Some of that growth is coming from recovery in the more industrially oriented businesses, which are slightly lower margins, but we're still seeing continued resilience and performance from the higher-margin electronics businesses. Our thoughts around cost are that cost doesn't come unless there's revenue. So margins should maintain at these levels with that cost coming in, and with that revenue growth, it's not on the margin improvement.

Got it. And then maybe just drilling down into those comments around your profit expectations. As you mentioned, I assume those higher sales result in some operating leverage. Could you just maybe break out the magnitude of the lower subsidies, the furloughs that you expect to reduce? And how those compare to maybe additional structural cost opportunities that you identified and expect to take out in the second half? Thanks.

Yes. Sure, Anthony. So OpEx was down $16 million year-over-year. About a third of that is lower G&E, right? So we're traveling far less given the pandemic, and we would expect that to persist into the third quarter. The remaining $10 million is split between compensation actions and some of the government subsidies. The government subsidies are $4 million or $5 million in the rest of compensation actions. Not all of those compensation actions have been unwound, but a good portion of them have been. So order of magnitude, the OpEx growth sequentially should be more than $5 million less than $10 million. The permanent improvement that you spoke to there is a couple of million dollars of that in the second quarter, and we're working very, very hard to improve the cost structure of this business to get better quality outcomes at lower costs through the implementation of technology. We're making great strides in that regard, but there's no silver bullet. Continuous improvement is a journey that we will be on for several years. The opportunity associated with that is tens of millions of dollars, but it will come in small chunks over time.

Great. Thanks, guys.

Thank you.

Our next question is from Jon Tanwanteng of CJS Securities. Your line is open. Sir, your line is open.

Hello, can you hear me?

Hey, Jon, yes we can hear you.

Can you hear me now?

Yes.

Okay. Good morning, guys. Thank you for taking my question. My first one just – I heard your comments on the auto industrial business being strong through July and into August. I'm wondering, in your discussions with customers, have you heard them saying that they plan to be producing through what will be normally seasonal downtimes in Q3? We've heard that some of those auto OEMs are doing that, and industrial might be going through some restocking. Just wondering what kind of commentary you're hearing from your clients in that regard?

Yes. So it varies by region and by customer, Jon. It's a good question. In the U.S., we heard that the major OEMs, some of them were going to have their summer shutdown, some weren't. That was a good signal and we still believe that. In Europe, by and large, the summer shutdowns will occur. So August should be slower than July. That's our expectation, and it's too early to say anything different just four days into the month.

Got it. And so to be clear, the conservatism you're I guess referring in your outlook on the sales side is coming from electronics business where you think maybe there might be a destocking situation going forward?

I'd put it in two buckets, Jon. One is, as I said earlier, we attribute some of the strength in the first half in electronics to inventory builds, and as I said earlier, we haven't seen that play out in July or yet in August, though it's early. Some of it is just associated with the macro risk and the uncertainty of the global economy. As we said in our prepared remarks, we don't want to underwrite to an up into the right recovery in demand, given how fast-moving the pandemic, the virus has been. We're a company whose culture is delivering on its commitments, and so we want to give ourselves that opportunity in multiple different scenarios for the demand recovery.

Okay. And then I may have missed this earlier, but can you give us a little more color on the oilfield and the CPG market? I noticed in your press release or maybe in your slides they were a little bit weaker in the quarter. Just wondering what the update there, especially in oilfield I thought you would expect a fairly strong demand in the back half of the year just based on what your customers are indicating?

Yes. In the energy business, there are two key dynamics to mention. First, our customers have inventory of our fluids that they have been using and did not restock as much in the second quarter. This is a temporary situation, as customers, facing challenges in a tough market, are focusing on cash preservation. They will recover, but are currently trying to conserve cash. The second factor is the impact of foreign exchange, particularly in Brazil where we conduct a significant amount of business. The fluctuation of the Brazilian real has affected our energy business results. With the volatility in energy prices, we anticipate a decrease in drilling activity in the latter half of the year; however, production activity should remain stable. Customers will need to restock their inventories and return to a more typical ordering pattern, which we believe will lead to a stronger third quarter compared to the second. As for our graphics business, there was a notable surge in demand in the first quarter due to consumer behavior, but major consumer packaged goods companies are postponing new package design launches in light of the current economic conditions. These new designs usually result in increased orders for us, so the outlook for that business appears somewhat softer. This summarizes those two points, Jon.

Back later this year and it's just a timing thing, or is it maybe something that might be pushed until next year?

I think a recovery is more likely next year. I don't believe these package design launches take place quickly, and we do not expect them to happen this year.

We'll move next to Jim Sheehan from Truist Securities. Your line is open.

Good morning, Ben. Could you discuss the reasons why you maintained your headcount through this downturn? And were your competitors able to do the same?

We maintained our headcount through this downturn because our business is a people-based business. There is a huge amount of expertise and capability in our team, and we believe these markets will recover. We want to have the same capable people calling on customers and providing them service and innovating for us when they inevitably do recover. We've got a lot of conviction in that, and we believe we've got a great team and we want to preserve it, and we're able to do so. I can't speak to how competitors are reacting. I feel good about our balance sheet position and the health of our business. Some of our competitors don't have that same level of flexibility that we do. I'm confident that we will be in as good of a position if not better when things recover based on the actions that we've taken. The way the team has come together as I said on the prepared remarks, we have permanently improved the way we as a team operate and built a lot of goodwill with our workforce based on preserving jobs and other actions we've taken. This is a long-term game for us, and we've made some good bets in that regard.

Thank you. Regarding capital, your efficiency in returns is already significant compared to your peers. What is your outlook for return on capital in the future, and how do you plan to further distinguish yourself?

Yes. It's a great question, Jim, and that's something we think about and talk about a lot. The quality of this business, the amount of cash flow it generates from a rather modest set of fixed assets and capital invested in the business, should improve because the business is going to grow organically, and it doesn't require significant capital investments to grow or maintain its margins. The returns generated from the growth we can get relative to the investment we have to make is great, and so the incremental returns on capital should be improving. We've got a collection of great businesses on that basis, and we're running them better every year. As we talked about earlier in one of the questions, we're getting better quality outcomes at lower costs by using technology to run these businesses more efficiently. That's different from taking out cost when sales are down. Continuous improvement is a journey that will be on for several years, and we’re making great strides in that regard.

Terrific. And maybe you could talk about the U.S.-China trade relationship. How are you planning to mitigate the risk of further deterioration in U.S. trade conditions and the relationship with China?

Yeah. So that dynamic is out of our control, but how we position ourselves relative to it is something we think about a lot. First of all, we look local, right? So we've got local teams on the ground, local facilities, local manufacturing, local suppliers, local technical service people; we look local everywhere we're doing business. Another way that you mitigate that is through innovation and being on the bleeding edge, and offering capabilities that are differentiated such that should there be preference for local suppliers and our looking local isn't adequate. There isn't a good alternative to us. Continued investment in innovation is a focus area and helps mitigate that risk. The third thing is being in a position such that should supply chains move out of China to mitigate that risk for themselves, right? Our customers and OEMs being ready to absorb that demand and that work, and so we are a global supplier. We can provide the same level of quality and capability wherever our customers may move, we're there already. That is a margin tailwind for us, because margins are better outside of China in these businesses than inside. We spend a lot of time thinking and planning about that and are well positioned in that regard.

Thank you very much.

Thanks, Jim.

Our next question is from Sean Gilmartin of Barclays. Your line is open.

Hi, guys. On for Duffy this morning. Just a quick one from me, and I understand completely it's probably a combination of what's already been talked about. But you specifically called out kind of a tough year-on-year comp within the circuitry vertical. Could you maybe just remind us what was driving that strength in Q3 2019? And how we should think about maybe a lower sales or more difficult sales profitability there impacting the electronics segment in Q3?

Yes, absolutely. Thanks for that question, and it's a good point, right? Q3 of last year had very, very strong margins. That was driven by the fact that there was a pretty big buildup in high-end circuit boards for smartphones coming out of 2018 and into 2019. The smartphone market specifically, certain OEMs had very strong results in Q3 in the back half of 2019. There was a surge in demand for very high-end circuit boards for the mobile market in Q3 of 2019. That's a high-margin product for us and so it translated to a very strong quarter in Q3 of 2019, which makes the comp more challenging this year.

Got it. That's super helpful. Thanks guys.

Operator, do we have the next question?

We do. We have a follow-up from Josh Spector of UBS. Your line is open.

Hey, guys. Thanks for letting me follow up here. Just on industrial, your declines in the quarter were somewhat consistent, I think, with auto demand declines. Do you expect that to be the case in Q3 as well, or do you expect any lag in that recovery, or perhaps any lead on that recovery on some potential restocking activity?

Thanks for that question, Josh. Our goal is always to outperform our markets. The primary market in that industrial business is the auto market, and it's the best indicator. So I would look to that as a gut check when we do our forecasting and planning exercise.

Okay. Thanks. And then just one last one on – you acquired Kester at the end of last year. I was just curious if there is any significant deviation in performance of Kester relative to your heritage assembly business.

So bifurcated. The Kester business that was in the core traditional assembly market has performed similarly, I would say, to our core assembly business. There was a small piece of the Kester business we called out when we acquired it in the semiconductor market, and that business has grown exceptionally well at high margins. That's been a great story for us, and we're very pleased with its performance.

Okay. Thank you, guys.

Thank you, Josh.

And our final question is a follow-up from Steve Byrne of Bank of America. Your line is open.

Yes. Thank you for letting me get back in the queue here. I wanted to ask you if you expect any changes in the geographic distribution of your end markets, whether you are seeing any trends towards restoring initiatives for your customers?

So it's a good question, Steve. We have seen some parts of the supply chain begin to invest, particularly in electronics, outside of China in places like India and Southeast Asia. There's been automotive investment also in Southeast Asia. For us to put up a facility is not so complicated on a relative basis, it's a few million dollars. It's warehousing and blending tanks. For our customers, it takes tens, if not hundreds of millions of dollars, and so it takes a while. We're starting to see some of that, but it's not in full effect as yet, I would say.

Okay. Thank you.

This does conclude our question-and-answer session. I'd be happy to return the call to Ben Gliklich for any concluding remarks.

Thank you very much. Thanks to everybody for joining this morning. We look forward to speaking with you in the coming days and weeks, and please stay safe. Thank you.

This does conclude today's Element Solutions Incorporated Q2 2020 Earnings Conference Call. You may now disconnect your lines. And everyone have a good day.