Element Solutions Inc

1. BACKGROUND AND BASIS OF PRESENTATION

Background

Element Solutions was incorporated in Delaware in January 2014 and its shares of common stock, par value $0.01 per share, trade on the New York Stock Exchange under the ticker symbol “ESI.”

Element Solutions is a leading global specialty chemicals company whose businesses supply a broad range of solutions that enhance the performance of products people use every day. Developed in multi-step technological processes, these innovative solutions enable customers' manufacturing processes in several key industries, including consumer electronics, power electronics, semiconductor fabrication, communications and data storage infrastructure, automotive systems, industrial surface finishing, consumer packaging and offshore energy. Element Solutions businesses provide products that, in substantially all cases, are consumed by customers as part of their production process, providing the Company with reliable and recurring revenue streams as the products are replenished in order to continue production. Element Solutions delivers its products to customers through its sales and service workforce, regional distributors and manufacturing representatives.

Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with GAAP and include the accounts of Element Solutions and all of its controlled subsidiaries. The Company consolidates the income, expenses, assets, liabilities and cash flows of its subsidiaries from the date it acquires control or becomes the primary beneficiary. All intercompany accounts and transactions have been eliminated upon consolidation.

In preparing the unaudited Condensed Consolidated Financial Statements in conformity with GAAP, management uses estimates and assumptions that may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Management applies judgment based on its understanding and analysis of the relevant circumstances, including historical experience and future expectations. These judgments, by their nature, are subject to an inherent degree of uncertainty and, accordingly, actual results could differ significantly from these estimates and assumptions.

These unaudited Condensed Consolidated Financial Statements reflect all adjustments that are normal, recurring and necessary for a fair statement of the Company's financial position, results of operations and cash flows for interim periods, but are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2024. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Company's Consolidated Financial Statements and related notes included in its 2023 Annual Report.

Certain prior year amounts have been reclassified to conform to the current year’s presentation.

2. INVENTORIES

The major components of inventory, on a net basis, were as follows:

3. PROPERTY, PLANT AND EQUIPMENT, NET

The major components of property, plant and equipment, net were as follows:

For the three months ended June 30, 2024 and 2023, the Company recorded depreciation expense of $10.3 million and $10.1 million, respectively. For the six months ended June 30, 2024 and 2023, the Company recorded depreciation expense of $20.4 million and $19.6 million, respectively.

4. GOODWILL AND INTANGIBLE ASSETS, NET

Goodwill

The changes in the carrying amount of goodwill by segment were as follows:

(1) Includes accumulated impairment losses of $127 million.

Intangible Assets, Net

The major components of intangible assets, net were as follows:

For the three months ended June 30, 2024 and 2023, the Company recorded amortization expense on intangible assets of $29.8 million and $31.0 million, respectively. For the six months ended June 30, 2024 and 2023, the Company recorded amortization expense on intangible assets of $60.0 million and $60.6 million, respectively.

In the first quarter of 2024, one of the product qualification milestones agreed to as part of the Kuprion Acquisition was achieved. As a result, the Company made a payment of $3.9 million, which was recognized as research and development expense in the Condensed Consolidated Statement of Operations as the technology did not yet meet the accounting definition of an asset. The payment was included in "Acquisitions, net of cash acquired" in the Condensed Consolidated Statements of Cash Flows as a cash outflow from investing activities.

5. DEBT

The Company’s debt obligations consisted of the following:

(1) Term loans, net of unamortized discounts and debt issuance costs of $9.2 million and $9.8 million at June 30, 2024 and December 31, 2023, respectively. The effective interest rate was 3.2% and 3.3% at June 30, 2024 and December 31, 2023, respectively, including the effects of interest rate swaps and net investment hedges. See Note 6, Financial Instruments, to the unaudited Condensed Consolidated Financial Statements for further information regarding the Company's interest rate swaps and net investment hedges.

(2)Senior notes, net of unamortized debt issuance costs of $6.8 million and $7.7 million at June 30, 2024 and December 31, 2023, respectively. The effective interest rate was 4.1% at June 30, 2024 and December 31, 2023, respectively.

Credit Agreement

The Company is a party to the Credit Agreement, which provides for senior secured credit facilities in an initial aggregate principal amount of $1.53 billion, consisting of term loans B-2 of $1.15 billion, maturing in 2030, and a revolving credit facility of $375 million, maturing in 2027.

The Company's outstanding term loans bear interest at a per annum rate based on an adjusted one-month SOFR (as described in the Credit Agreement) plus a spread of 2.00%. The Company is required to pay a commitment fee on any undrawn portion of the revolving credit facility which is not material.

Guarantees, Covenants and Events of Default

The obligations of the borrowers (the Company and its subsidiary, MacDermid, Incorporated) under the Credit Agreement are guaranteed, jointly and severally, by certain of their domestic subsidiaries and secured by a first-priority security interest in substantially all of their assets and the assets of the guarantors, including mortgages on material real property, subject to certain exceptions.

The Credit Agreement contains customary representations and warranties and affirmative and negative covenants, including limitations on additional indebtedness, dividends, and other distributions, entry into new lines of business, use of loan proceeds, capital expenditures, restricted payments, restrictions on liens on the assets of the borrowers or any guarantor, transactions with affiliates, amendments to organizational documents, accounting changes, sale and leaseback transactions and dispositions. Subject to certain exceptions, to the extent the borrowers have total outstanding borrowings under the revolving credit facility greater than 30% of the commitment amount under the revolving credit facility, the Company's first lien net leverage ratio should not exceed 5.0 to 1.0, subject to a right to cure.

The borrowers are required to make mandatory prepayments of borrowings, subject to certain exceptions, as described in the Credit Agreement. In addition, the Credit Agreement contains customary events of default that include, among others, non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations and warranties, failure to make payment on, or defaults with respect to, certain other material indebtedness, bankruptcy and insolvency events, material judgments and change of control provisions. Upon the occurrence of an event of default, and after the expiration of any applicable grace period, payment of any outstanding loans under the Credit Agreement may be accelerated and the lenders could foreclose on their security interests in the assets of the borrowers and the guarantors.

At June 30, 2024, the Company was in compliance with the debt covenants contained in the Credit Agreement and had full availability of its unused borrowing capacity of $369 million, net of letters of credit, under the revolving credit facility.

Senior Notes

3.875% USD Notes due 2028

The indenture governing the 3.875% USD Notes due 2028 provides for, among other things, customary affirmative and negative covenants, events of default and other customary provisions. The notes accrue interest at a rate of 3.875% per annum, payable semi-annually in arrears, on March 1 and September 1 of each year, and will mature on September 1, 2028, unless earlier repurchased or redeemed. Pursuant to the indenture, the Company has the option to redeem the 3.875% USD Notes due 2028 prior to their maturity, subject to, in certain cases, the payment of an applicable make-whole premium, or to repurchase them by any means other than a redemption, including by tender offer, open market purchases or negotiated transactions. The 3.875% USD Notes due 2028 are fully and unconditionally guaranteed on a senior unsecured basis by generally all of the Company’s domestic subsidiaries that guarantee the obligations of the borrowers under the Credit Agreement.

Lines of Credit and Other Debt Facilities

The Company has access to various revolving lines of credit, short-term debt facilities and overdraft facilities worldwide which are used to fund short-term cash needs. There were no material amounts outstanding under such facilities at June 30, 2024 and December 31, 2023, respectively. The Company had letters of credit outstanding of $6.2 million at June 30, 2024 and December 31, 2023, respectively, of which $6.2 million at June 30, 2024 and December 31, 2023, respectively, reduced the borrowings available under the various facilities. At June 30, 2024 and December 31, 2023, the availability under these facilities totaled approximately $391 million and $392 million, respectively, net of outstanding letters of credit.

6. FINANCIAL INSTRUMENTS

Derivatives and Hedging

In the normal course of business, the Company is exposed to risks relating to changes in interest rates, foreign currency exchange rates and commodity prices. Derivative financial instruments, such as interest rate swaps, net investment hedges, foreign currency exchange forward contracts and commodities derivative contracts are used to manage the risks associated with changes in the conditions of those markets. The counterparties to the Company’s derivative agreements are primarily major international financial institutions. The Company regularly monitors its derivative positions and the credit ratings of its counterparties and does not anticipate nonperformance on their part.

All derivatives are recognized in the Consolidated Balance Sheets at fair value. Realized gains and losses on foreign currency forward contracts, commodity derivative contracts and the net periodic payments from interest rate swaps and cross-currency swaps are reflected as "Cash flows from operating activities" in the Condensed Consolidated Statement of Cash Flows.

Interest Rate and Cross-Currency Swaps

The Company uses interest rate swaps and cross-currency swaps to reduce its exposure to interest rate risk and foreign currency risk. The Company has designated its interest rate swaps as cash flow hedges and its cross-currency swaps as net investment hedges of the foreign currency exposure of a portion of its net investment in euro functional subsidiaries. These swaps effectively convert the Company's outstanding term loans, which are U.S. dollar denominated debt obligations, into fixed-rate euro-denominated debt through their respective expiration dates.

The total notional value of the interest rate swaps and cross-currency swaps was $1.14 billion and $1.15 billion at June 30, 2024 and December 31, 2023, respectively. As of June 30, 2024, approximately $388 million in notional value matures in January 2025 and the remaining balance in December 2028. The net result of these hedges is an interest rate of approximately 3.2% at June 30, 2024 on the term loans B-2, which could vary in the future due to changes in the euro and the U.S. dollar exchange rate.

Changes in the estimated fair value of interest rate swaps are recorded in "Accumulated other comprehensive loss" and reclassified to "Interest expense, net" in the Condensed Consolidated Statements of Operations as the underlying hedged item affects earnings. The fair value of the interest rate swaps was a net asset of $23.2 million and $11.9 million at June 30, 2024 and December 31, 2023, respectively.

Changes in the estimated fair value of cross-currency swaps are recorded in "Foreign currency translation" in "Accumulated other comprehensive loss." The fair value of the cross-currency swaps was a net asset of $38.6 million and $4.8 million at June 30, 2024 and December 31, 2023, respectively.

For the three and six months ended June 30, 2024, these interest rate swaps and cross-currency swaps were deemed highly effective. The Company expects to reclassify a $20.1 million benefit from "Accumulated other comprehensive loss" to "Interest expense, net" in the Condensed Consolidated Statements of Operations within the next twelve months.

Foreign Currency

The Company conducts a significant portion of its business in currencies other than the U.S. dollar and certain subsidiaries conduct business in currencies other than their functional currency, which is typically their local currency. As a result, the Company’s operating results are impacted by foreign currency exchange rate volatility.

At June 30, 2024, the Company held foreign currency forward contracts to purchase and sell various currencies to mitigate foreign currency exposure primarily with the U.S. dollar, euro and British pound. The Company has not designated any foreign currency exchange forward contracts as eligible for hedge accounting and, as a result, changes in the fair value of foreign currency forward contracts are recorded in the Condensed Consolidated Statements of Operations as "Other expense, net." The total notional value of foreign currency exchange forward contracts held at June 30, 2024 and December 31, 2023 was approximately $127 million and $93.9 million, respectively, with settlement dates generally withinone year. The fair value of the foreign currency forward contracts was a $0.4 million net current asset and a $0.7 million net current liability at June 30, 2024 and December 31, 2023, respectively.

Commodities

The Company enters into commodity derivative contracts for the purpose of mitigating its exposure to fluctuations in prices of certain metals used in the production of its finished goods. The Company held derivative contracts to purchase and sell various metals, primarily tin and silver, for a notional amount of $81.7 million and $63.8 million at June 30, 2024 and December 31, 2023, respectively. The fair value of the metals derivative contracts was a net current liability of $2.8 million and $1.2 million at June 30, 2024 and December 31, 2023, respectively. Substantially all contracts outstanding at June 30, 2024 have delivery dates withinone year. The Company has not designated these derivatives as hedging instruments and, accordingly, records changes in their fair values in the Condensed Consolidated Statements of Operations as "Other expense, net."

Fair Value Measurements

The following table presents the Company’s financial assets and liabilities measured at fair value on a recurring basis:

The fair values of Level 1 and Level 2 derivative assets and liabilities are determined using pricing models based upon observable market inputs, such as market spot and futures prices on over-the-counter derivative instruments, market interest rates and consideration of counterparty credit risk. Level 3 investments are valued using a probability weighted methodology based on possible outcomes of potential liquidity events. Significant assumptions include the enterprise valuation, the timing and type of liquidation events and the risk-free interest rate.

There were no significant transfers of financial instruments between the fair value hierarchy levels for the three and six months ended June 30, 2024.

The carrying value and estimated fair value of the Company’s long-term debt totaled $1.93 billion and $1.88 billion, respectively, at June 30, 2024. At December 31, 2023, the carrying value and estimated fair value totaled $1.93 billion and $1.89 billion, respectively. The carrying values noted above include unamortized discounts and debt issuance costs. The estimated fair value of long-term debt is measured using quoted market prices for similar instruments at the reporting date multiplied by the gross carrying amount of the related debt, which excludes unamortized discounts and debt issuance costs. Such instruments are valued using Level 2 inputs.

7. EARNINGS PER SHARE

A computation of weighted average shares of the Company's common stock outstanding and earnings per share for the three and six months ended June 30, 2024 and 2023 is as follows:

For the three and six months ended June 30, 2024 and 2023, the following securities were not included in the computation of diluted shares outstanding because either the effect would be anti-dilutive or the applicable performance targets were not yet met:

8. CONTINGENCIES, ENVIRONMENTAL AND LEGAL MATTERS

Environmental Matters

The Company is involved in various claims relating to environmental matters at current and former plants and waste management sites. At certain of these sites, the Company engages or participates in remedial and other environmental compliance activities. At other sites, the Company has been named as a potential responsible party pursuant to the federal Superfund Act and/or state Superfund laws comparable to the federal law for site remediation. After analyzing each individual site, considering the number of parties involved, the level of its potential liability or contribution relating to the other parties, the nature and magnitude of the hazardous waste involved, the method and extent of remediation, the potential insurance coverage, the estimated legal and consulting expense with respect to each site and the time period over which any costs would likely be incurred, the Company estimates the clean-up costs and related claims for each site. The estimates are based in part on discussions with other potential responsible parties, governmental agencies and engineering firms.

The Company accrues for environmental matters when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on current laws and existing technologies. The accruals are adjusted periodically as assessment and remediation efforts progress or as additional technical or legal information becomes available. The Company's environmental liabilities, which are included in the Condensed Consolidated Balance Sheets as "Accrued expenses and other current liabilities" and "Other liabilities," totaled $11.9 million and $11.3 million at June 30, 2024 and December 31, 2023, respectively, primarily driven by environmental remediation, clean-up costs and monitoring of sites that were either closed or disposed of in prior years. While uncertainty exists with respect to the amount and timing of its ultimate environmental liabilities, the Company does not currently anticipate any material losses in excess of the amount recorded. However, new information about the sites, such as results of investigations, could make it necessary for the Company to reassess its potential exposure related to these environmental matters.

As of the date hereof, the Company believes it is not practicable to provide an estimated range of reasonably possible environmental losses in excess of its recorded liabilities. As a result, the Company is unable to ascertain the ultimate aggregate amount of monetary liability or financial impact that may be associated with these matters.

Legal Matters

From time to time, the Company is involved in various legal proceedings, investigations and/or claims in the normal course of its business. Although it cannot predict with certainty the ultimate resolution of these matters, which involve judgments that are inherently subjective, the Company believes that their resolutions, to the extent not covered by insurance, will not, individually or in the aggregate, have a material adverse effect on its consolidated financial position, results of operations or cash flows.

9. INCOME TAXES

The Company's quarterly income tax provision is measured using an estimate of its consolidated annual effective tax rate, which includes the impact of foreign withholding tax accruals and uncertain tax positions, adjusted for discrete items, within the periods presented. The comparison of the Company's income tax provision between periods can be significantly impacted by the level and mix of earnings and losses by tax jurisdiction and discrete items.

For the three months ended June 30, 2024, the Company recognized a net income tax benefit of $17.5 million, as compared to income tax expense of $21.2 million in the same period for 2023. For the six months ended June 30, 2024, the Company recognized a net income tax benefit of $4.0 million, as compared to income tax expense of $38.1 million in the same period for 2023. Income tax benefit for the three and six months ended June 30, 2024 includes a continued U.S. benefit related to claiming foreign tax credits consistent with our election in the fourth quarter of 2023, a benefit from a U.S. tax deduction related to Foreign Derived Intangible Income ("FDII”), the negative impact of U.S. global intangible low-taxed income (“GILTI”), and the impact of changes to the level and mix of earnings.

The income tax benefit for the three and six months ended June 30, 2024 also includes a benefit associated with the release of valuation allowances of $35.9 million and $37.1 million, respectively. The benefit was associated with the release of valuation allowances previously recorded against certain U.K. tax attribute carryforwards, primarily consisting of net operating loss carryforwards and interest carryforwards. The valuation allowances are being released as the Company expects improved profitability in its UK business and a shift to a three-year cumulative income position. These expectations are based on actual and forecasted results.

10. RELATED PARTY TRANSACTIONS

The Company is party to an Advisory Services Agreement with Mariposa Capital, LLC, an affiliate of one of its founder directors, whereby Mariposa Capital, LLC is entitled to receive an annual fee and reimbursement for expenses. This agreement is automatically renewed for successiveone-year terms unless either party notifies the other in writing of its intention not to renew no later than 90 days prior to the expiration of the applicable term. Effective April 11, 2024, the advisory fee was decreased from an annualized amount of $3.0 million to $2.0 million. Amounts paid under this agreement are recorded in the Condensed Consolidated Statements of Operations as "Selling, technical, general and administrative" expense.

11. SEGMENT INFORMATION

The Company's operations are organized intotwo reportable segments: Electronics and Industrial & Specialty. These segments represent businesses for which separate financial information is utilized by the chief operating decision maker for purposes of allocating resources and evaluating performance.

The Company allocates resources and evaluates the performance of its operating segments based primarily on net sales and Adjusted EBITDA. Adjusted EBITDA for each segment is defined as EBITDA, as further adjusted for additional items included in earnings which the Company believes are not representative or indicative of each of its segments' ongoing business or are considered to be associated with the Company's capital structure. Adjusted EBITDA for each segment also includes an allocation of corporate costs, such as compensation expense and professional fees.