Q3 2019 Earnings Call

October 24, 2019

Ladies and gentlemen, thank you for standing by and welcome to Exultant third quarter 2019 earnings Conference call.

Participants will be and they listen only mode. A question and answer session will follow the presentation by management.

Today's call is being recorded and replays will be available through October thirtyth.

Those listening after today's call should please note that the information provided in the recording will not be updated and therefore, it may no longer be Kurt.

Well now turn the call over to Chris Mecray.

Please go ahead Sir.

Good morning. This is Chris Mecray, Vice President Investor Relations. Thank you for joining the call today to review, our third quarter 2019 financial results and for your interest in adult joining me today or Robert Brian CEO , and Sean Lavin CFO .

We released our financial results. This morning, and posted a slide presentation to the Investor Relations section of the website at <unk> Dot com, which will be referencing during this call. Both are prepared remarks and discussion today may contain forward looking statements, reflecting the company's herget future events and their potential effect on adult is operating and financial performance. These statements involve uncertainties and risks.

Actual results may differ materially from those forward looking statements. Please note that the company's under no obligation to provide updates. These forward looking statements. This presentation also contains various non-GAAP financial measures in the appendix. We've included reconciliations of these non-GAAP financial measures to most directly comparable GAAP financial measures for additional information regarding forward looking statements and non-GAAP financial.

Measures please refer to our filings with the FCC.

I'll now turn the call over to Robert.

Good morning, and thank you for joining us here.

He is also delivered a strong third quarter with adjusted EBIT adjusted EBITDA, adjusted EPS and free cash flow well ahead of expectations.

We overcame important macro economic political and currency headwinds as well as the distraction caused by a strategic review process, which underscores the resiliency of our business model, our multiple value levers and the commitment of our employees.

So net sales were impacted by volume headwinds across global markets works. All for participates exalted sales were still positive in the aggregate before FX and divestiture related impacts.

Operating profit and earnings per share both showcased solid execution and the benefit of continued margin recovery from pricing actions across most businesses and end markets.

And year over year operating cost reduction driven by our continual focus on exalt away.

Free cash flow also improved notably from the prior year quarter.

Results review of strategic alternatives initiated in late June is also progressing.

We do not have any incremental news to share with you today, but we will provide updates to the market circumstances warrant.

Turning to slide three let's review a few operating highlights for the quarter.

Consolidated organic and constant currency net sales were stable in Q3 in fact, increasing 0.4%.

This growth outcome included ongoing favorable price mix effects of 3.8% this quarter, which included some of the best improvements we have seen in any quarter as a public company.

Performance coatings net sales increased 8.7% before foreign currency and M&A related impacts.

Transportation coatings net sales were flat ex FX, reflecting lower light vehicle production volumes offset by volume growth in our commercial vehicle end market [noise].

Price mix in light vehicle continued to show positive gains with an increase of 2.8% as we made ongoing progress with multiple OEM customers to offset persistent and ongoing raw material inflation impacting the business since 2017.

This is now our fourth consecutive quarter with positive price mix, including an acceleration in the last two quarters.

We reported third quarter consolidated adjusted EBIT of 191 million.

17% increase from last year's third quarter, driven principally by strong price mix earnings drop through as well as from improved productivity.

And lower stock based compensation expense.

Volume headwinds FX impact and modest variable cost inflation, we're partial offsets to the quarterly profit growth.

Notably our adjusted EBIT margin of 17.3% was a full 300 basis points higher year over year and exult as margins broadly are approaching all time highs since we have been an independent company largely due to our success in recapturing loss pricing from 2017 2018.

The Gulf is consolidated fixed operating expense, excluding FX impacts was also 14% lower in the third quarter of 2018.

Our adjusted EBITDA margin of 22.5% has materially improved now approaching the all time high up 23.5% achieved in 2016, despite margins in light vehicle still lagging due to volume pressure pricing headwinds from 2017, and Uncaptured raw material inflation.

Date.

Adjusted earnings per share for the quarter was 52 cents per share, which compared with 40 cents per share in the prior year quarter with drivers consistent with those mentioned at the operating level.

Looking at our end markets briefly Axaltas refinished net sales increased 2.5% ex FX in the quarter.

We grew net sales ex FX solidly across North America in EMEA, While Latin America, and Asia Pacific were impacted by weaker macroeconomic conditions.

Our refinished team continues to effectively offset variable cost inflation with appropriate price management to sustain the broader margins of this business.

In volume terms, we continue to see moderate pressure globally, driven by a combination of distributor inventory management.

Continued structural volume reduction from the conversion to waterborne products.

Increasing body shop productivity and efficiency, which we drive with our customers every day and by an element of broader economic weakness.

Despite this the business has seen continued share gains in many regions exhibited in our increase in total net customer shop count.

In North America, we're seeing significant growth in our mainstream refinish markets as we've rolled out multiple products systems in recent years with great success.

Our industrial end market net sales declined about 1% in the quarter ex FX and before negative M&A related impacts from the China joint venture sale.

Drivers of this pullback include global volume weakness with volumes down mid single digits, largely offset by improved average price mix.

The contraction as with last quarter correlates with global industrial production indicators, which remain pressured in many key countries in nearly all regions.

Our overall execution remains solid, though and we continue to drive for share gain via new product introductions and innovation, which may also help explain our lower rate of decline relative to many underlying macro industrial indicators.

Light vehicle net sales decline, 0.8% ex FX for the third quarter.

Reflecting lower global automotive production rates, most notably in China, the year over year comparisons have ease since China's market contraction began over a year ago.

Lower net sales were also influenced by strike impacts in North America for the last half of September .

Hi, just production forecast for 2019 have been further reduced now 14 months in a row for the global picture and now calling for a 5.8% global production decline for 2019.

Versus the 3.7% lower assumption as of July end.

The updated global production guidance now includes a 5.8% reduction from EMEA, a 4.5% decline in North America, and a 6.5% decrease for Asia Pacific, including an 8.8% decrease in China.

Despite this fundamental backdrop, we continue to execute well on our business and we're working on multiple significant business opportunities for the 2020 to 2021 period.

Additionally line service revenues continue to grow offering some offset to production volume pressure.

Commercial vehicle net sales increased 2.9% ex FX in Q3, including ongoing strong overall vehicle production rates in the Americas in solid demand for non truck customers in most regions.

Price mix consistent with last quarter was slightly down in the period due largely to mix effects this quarter.

Regarding our balance sheet and cash flows third quarter free cash flow was strong and we're reconfirming, our full year free cash flow targets, a $430 million to $470 million.

We finished the quarter at 3.2 times net leverage a significant improvement versus the 3.5 times at June Thirtyth as we continue to target lower overall leverage over time with a 2.5 times longer term goal.

In terms of innovation investment highlights in refinish, we continue to launched several new we're finished products in North America, including nascent XL and the challenger mainstream brands to support new distributor channels also we will launch our new species Hecker sealer technology. This month that will provide a view will see friendly.

Sealer to use with our premium waterborne based codes.

In industrial we launched our new high thermal conductivity impregnating resin for energy solutions that lowers electric motor operating temperatures by 10% to 30%.

We also continued to globalize key well technologies.

Expanding the introduction of Dura upon into the Asia Pacific marketplace.

In transportation, we marked the third quarter of the Lumire clear codes global rollout.

These one k. and two k. products represent Axaltas newest product line of high performance clear codes for the OEM market.

And leverage our latest resin technology for improved appearance and enhance scratch resistance, while reducing cost and use.

In terms of operating highlights we completed the acquisition of UAE based capital paints in the quarter, which gives us a strong entre into the middle east in the powder business.

Overall, we're pleased to continued to produce well executed quarters year to date in 2019.

We've seen persistent volume pressure across global coatings markets, along with some acceleration in FX headwinds this past quarter, which we've incorporated into our revised guidance.

That said much of the impact has been mitigated by ongoing productivity efforts as well as by somewhat moderating variable cost inflation.

Raw material headwinds have been abating in recent months and in fact, we saw modest year over year tailwind in the month of September , which also bodes well for coming quarters, given the mark on current commodity prices.

We're very pleased that in the third quarter, we fully closed out the price cost gap that developed since 2017 at the total company level.

While in important achievement, we also acknowledge that light vehicle and certain industrial sub markets still have more to do in terms of gap closure and we continue to discuss this important need with our customers in these end markets.

In addition to focus on meeting pricing adjustments. We also continue to work hard to improve our cost structure and productivity.

Accordingly, we took another charge this quarter totaling $29 million, which will help us reach our Gulf away cost savings goals and we continue to make real time adjustments to our cost structure in transportation coatings to meet our broader financial objectives, despite near term cyclical pressures.

I'll now turn the call over to Sean to review our financial results.

Thanks, Robert and good morning.

Turning to slide for consolidated the constant currency net sales decreased 1.4% year over year, including a 2% decrease in performance coatings, and a flat results and transportation coatings.

Excluding net negative divestiture related impacts consolidated net sales increased 2.4% with performance coatings, posting a 0.7% increase.

The topline results consistent with last quarter reflected robust positive price mix contribution offset by volume pressure across all regions.

Nice mix was notably strong and performance coatings income, including a component of mix benefit in refinish, along with solid underlying price recapture.

Transportation coatings price mix was also positive, including ongoing recapture and light vehicle for the fourth sequential quarter offset slightly by weaker mix within commercial vehicle.

FX translation was a 2% year over year net sales headwinds for the period.

The impact of FX translation of the profit level remains largely aligns with the overall corporate margins key source of pressure included the euro the renminbi, Argentinian peso and pounds.

Two three adjusted EBIT of $191 million was a 17% increase from the prior year and margins improved 300 basis points to 17.3% driven by a combination of the price mix drop through benefit as well as lower overall operating costs from continued productivity savings and lower stock based compensation expense in the quarter.

Partial offsets to these drivers included volume headwinds across most end markets accelerating negative FX impact and modest raw material inflation for the quarter.

Turning to slide five performance coatings third quarter net sales decreased 2% year over year, excluding a 2.3% negative FX impacts and increased 0.7%, excluding FX, a net negative M&A related impacts.

Drivers of this 0.7 organic constant currency growth included a 5% increase in average price mix, partially offset by a 4.3% volume decrease.

Exult as refinish end market produced Q3 constant currency net sales growth of 2.5% year over year, including improved price mix contribution in the mid single digits.

Net sales growth ex FX was led by North America, and EMEA, while Latin American Asia Pacific were more subdued in the period consistent with the second quarter.

Volume decrease in the period globally, including distributor level inventory adjustments.

Industrial end market net sales ex FX decreased 8.4% year over year in the third quarter, but decreased only 0.9%, excluding the China JV sale impact.

This modest decline was driven by volume pressure in all regions, which aligns with global industrial production weakness offset by solid gains in average price mix from all regions.

Performance coatings third quarter, adjusted EBIT of 125 million increased 20% year over year with strong price mix contribution the realization of productivity benefits as well as lower year over year stock based compensation.

Partially offset by negative volume drop through FX impacts and modest variable cost inflation effects.

Adjusted EBIT margins of 17.3% increased 350 basis points year over year, reflecting price mix benefits and lower operating costs versus the prior year quarter.

Turning to slide six third quarter transportation coatings net sales were flat year over year before FX headwinds of 1.7%.

Segment volumes decreased 1.5% offset an equal amount by price mix benefit despite moderate negative product mix impacts from commercial vehicle.

Light vehicle third quarter net sales decreased 0.8%, excluding a 1.8% FX headwinds.

Volumes decreased low to mid single digits overall, driven by lower automotive production rates globally, but most notably in China as well as by the two week impact in September from strikes in North America, which have continued into October .

Average price mix remained positive up 2.8%, reflecting ongoing price recapture associated with persistent raw material inflation over the previous two years.

Commercial vehicle third quarter net sales increased 2.9% before FX headwinds of 1.2%.

Driven by solid overall vehicle demand globally, excluding China.

Forecast updates for truck production have begun to moderate in recent months given ongoing order rate weakness in North America, which continues to reduce backlog and lead times in the region.

Transportation coatings Q3, adjusted EBIT of $37 million increased 45% versus $26 million and the prior year quarter and associated margins of 9.7% increased over 300 basis points versus 6.6% in Q3 2018, as the benefits of improved price mix and lower operating.

Turning to slide seven third quarter free cash flow totaled 198 million versus $96 million in Q3 2018.

The notable increase was driven by stronger operating results and improved overall working capital outcomes.

We ended the quarter with cash and cash equivalents of 767 million and a net debt balance of $3 billion versus $3.3 billion at June Thirtyth end.

Good morning, guys I've got a couple of questions on the commercial and societies.

And in Europe , which seems touch a little bit of an issue there and what is that issue. Thank you.

Yes.

I'd say, we're afraid to commercial truck orders and your first question in that respect orders have been weak for Submarkets, though.

Production volumes are expected to begin to moderate and the relative near term in that market.

And just add on as far as 2020 looking at class four through eight now we're expecting approximately an 8% decline at least where the current forecasts are for 2020.

Okay.

Thank you and on the price mix.

So that was largely a mix issue, we did see strong volumes in CV and the third quarter up said Q3 2018, we did have a slight mix impact as far as lower average selling price on that wasn't that we were giving any sorta.

Thank you.

Your next question comes from the line of gunshots Punjabi with Baird. Please proceed with your question.

Hey, guys good morning I.

I guess first off on auto Refinish can you call out on volume weakness there had a reference point on the impact from the economy slow and get it can you just give us a little bit more color on that which we gens and where was the inventory optimization in that segment most pronounced too. Thanks.

Yes, Ghansham overall no in the refinished business. The overall business continues to perform to perform quite well as we highlighted we did see global volumes down roughly low single digits.

Due to some distributor inventory management that would be predominantly in in North America, and then as we've highlighted before the structural volume reduction from the solvent to waterborne conversion.

And given that msos by more.

That's helpful. Robert and then just for my second question on 2020 parameters. I mean, obviously there is lot of variability on volumes, but how should we think about the flow through effective pricing.

From what you've already accomplished and then also how should we think about gross and net productivity realizations in 2020.

Well I think overall, if we look at if we look at 2020, we'll be providing in our in our December our December outlook call more clarity on 2020, but I think is overall as we look at the year, we see a pretty strong set up for a better year in terms of core volumes across our businesses. We continue.

Due to expect to outperform the market next year in each one of our end markets.

A key driver that is really the expectation that global auto builds will will be stable and we've started to see some in some signs of that that the China market has already begun to stabilize.

And with ongoing innovation driven product introductions.

An ongoing share capture in core refinish market, we see 2020 of the year of positive volume development.

On the pricing side, we do expect to continue to achieve price positive price mix next year that would drop to the to the bottom line.

Thank you Robert.

Dave.

Your next question comes from the line of Christopher Parkinson with Credit Suisse. Please proceed with your question.

Good morning, as Harris sign on for Chris Thanks for taking my question.

When we think about industrial end markets can you just give us a walk through in terms of which verticals outperformed the segment average versus where you are facing some challenges and.

So if we look at the.

Industrial industrial overall, we we saw that sales decreased in the quarter about 1% ex FX and excluding our form the impact of our former China Potter joint venture, we did see volume pressure as you know from slower industrial markets, but we had strong price capture and really for us what's what's.

By the same by the same amount in that in that market part of that is.

OEM related in that some of those products, whether it's whether its E coat.

Or whether its metal coating systems go into the different go into the different tiers there.

In energy solutions, we did see volume down in that market, but price mix also also up in that market.

They're somewhat the demand was impacted by conditions in Europe , as well as in as well as in China.

And then in powder, we saw volume down in most regions, but again with our price increases price mix up compensating for that and we did see.

Somewhat of a slower conditions in Europe in particular in powder would we saw volume down low single digits, but price mix up by a commensurate amount and they're really what we're seeing is that a lot of a new business gains.

Volume challenges that are really are results of housing starts and repair and remodel being a little bit soft. So overall I think it will talk about that market. Our team is performing extremely well from a new customer acquisition and the new product introduction, which is allowing us to perform better than the overall market.

And and you also mentioned before that you closed so the price cost gap at the full company level.

Transportation segment, I guess, what's your expectation for olive oil production in Q4 in 20, and once you've targeted organic growth rate.

Good morning, and this is our country on for Pizza.

It's a business, where we expect overall net sales to grow over time, we work with our customers. Every every single day to help them be more efficient and to help them be be more productive obviously that requires a pretty significant technology investment in technology support on our side.

In terms of in terms of market growth with them as those we are extremely well positioned with MSR shows.

I expect that that sales channel for us to continue to to continue to grow and we'll continue to support that channel as well is continuing to support independent and small body shops as well so longer term I think we expect.

Net sales to continue to increase in the refinish market.

Thank you and secondly noted a modest tailwind in September from raw materials, and that's expected to help offset the lower light vehicle production. So I was just wondering if the basket of raw materials.

As flat or or ever so slightly down.

And then we continued to see price inflation in Isocyanates and pigments. So again that did give us some confidence that we might be potentially at an inflection point, however, uncertainty around the Chinese the Chinese tariffs are also.

Fit very relevant to with the outlook is going to be for next year.

Great. Thanks, good morning.

Maybe you can just.

Reiterate kind of some of the drivers that you see unfolding there.

And then I guess as far as OEM have you been.

Other markets historically.

So I think were fairly optimistic on on the China market overall as we as we go forward.

And just and if yes pricing there's going to answer the other question regards the transportation. So when you look specifically at light vehicle Rahm Robert did comment in his opening remarks were largely caught up at the total company level. We're still trailing when you look about price cost equation within light vehicle.

Okay.

Yes, so we're sticking with our original exalt away to $50 million year. If we were to see an uptick and inflationary pressure, we may expedite and some of those initiatives, but that's something we're working on thoroughly right now as we head into 2020, and we'll be providing more guidance. Once we go into December as far as the guidance update.

Great. Thanks.

Maybe in regard to customer inventories outside of the Refinished business can you can you talk about where you see those levels and if theres any anticipation of kind of a restocking maybe in 2020, if they are on the lighter side of things. Thank you.

And then from a from an industrial a perspective some of those sales or direct in some of the sales or through our through distribution, but in general.

Your next question comes from minus Josh Spector with yes. Please proceed with your question.

Okay, and I mean, I know you not to comment on anything with the speech strategic process itself, but if the results of that is do nothing.

How are you thinking about what the exalt itself strategy is over the next couple of years does anything kind of change in your mind or anything you consider doing differently.

Hey, guys nice quarter.

Like can you clarify a little bit you said what are the leverage needs.

Yes, Mike So we.

Okay, and then just a quick follow up in refinish and it's been a losses that that market seems to have grown what do you think needs to happen I know you're coming out with a lot of good new products and and such no. What do you. What are you looking for in terms of the market to show some growth going forward.

Countries around the world, where our market share of those individual countries might be lower than our global and our regional share. So I think we're pretty optimistic about the topline growth opportunities in that business.

Great. Thank you.

[laughter].

Hi, This is weak washer on for Steve I wanted to talk about the volume slowed on your revision refinish business was the slowdown did you see any kind of lower collision activity during the quarter was that mostly destocking in the other factors you said.

Yes, it was largely the other factors collision rates within the quarter, where in a major driver. It was really the continued conversion of solve into water as well as down some destocking at again robber comment, but we did see more of a macro impact and the European region.

Great. Thanks, and just one more on the variable cost inflation could you remind us how much of your variable costs, our raw materials versus say labor and distribution and how would you characterize kind of the labor in distribution cost year over year this quarter.

Labor and distribution relatively flat.

The causes level variable Cogs is about 60%.

As for perspective.

Great. Thank you.

Your next question comes from line of Bob Court with Goldman Sachs. Please proceed with your question.

Okay doesn't want new Walker all above.

In light of the macro headwinds.

Okay and performance light vehicle I thought was pretty impressive.

Talk about how impactful to strikes you reference ward during the quarter then how much share did you guys gain and how much of that contributes to put on performance. Thanks.

Yes.

Yes, so we're not going to get down to the granular level as far as quantifying the impacts on on the strikes I would give you some incremental as far as the impacts we saw in Q3 were expecting similar impacts in Q4, although the strikes are now essentially doubled in time and we are expected to make up some of that deferred.

It's in the back half of the quarter.

Right and then just like if you could comment on your ability to take share within the light vehicle for many leading Winston Salem, Thank outgrowth relative to what the Billboards in Florida to answer that.

Thank you know it continues to be Oh, we have we have good comp very good competitors in that.

We'll continue to leverage both our product technology as well as our service and support.

Good morning, it's okay, John how are you.

Hey, good morning smoking.

Follow onto like that.

<unk> cost question that was asked previously just like 60% of your Cogs variable cost and even if those were up 5% this quarter.

Price as well.

Price cost realization guys like it's definitely much better right. Because you have had these really nice gross margin expansion.

I think it's I.

Thank you I think Sofia, Sean mentioned, you know, although we did see.

Some flattening or some attenuating of raw material inflation in September overall for the quarter.

It was still it was still a headwind for us, but you are correct from an actual variable contribution margin perspective.

And so look I would add that you're somewhat overstating.

Perspective variable cost headwinds in the quarter. It was not to the magnitude that you suggest but certainly the magnitude of price Costa is meaningful and certainly overcomes the variable cost headwind.

So when you look at your gross margin expansion, you think half of it comes that productivity improvements and maybe half of its from whatever.

Raw material you know, there's this price realization car.

Yeah, I would say, it's probably heavier weighted towards price mix.

When you look at the quarter in particular.

So it was really a price mix story at the at the gross margin level.

We had performed we did perform relatively better in the in in the quarter.

I think in fairness, it's largely a function of the particular regional mix.

Do you think it has more to do is a regional mix and less to do with market share gains.

Hi, guys. This is colton bean on for John Mcnulty, Thanks for taking my question.

Just a follow up on light vehicle volumes I was wondering if you've seen any impact there from the switch over in emission standards for China five to China, six or do you expect to see any impact in Fourq you I know I know what had been a bit of a headwind in some businesses in first half a year.

Yeah.

Giving those players an edge over the China domestics, while they still catch up.

Okay. Thank you.

So that to the extent that someone is more heavily weighted to the international players as opposed to the domestics you are seeing a benefit.

Okay. So it would've been a slight benefit in the quarter then.

Relative to those other what we're talking about light vehicle end customers, but those light vehicle and customers.

That are non domestic.

We're seeing a benefit because they.

Okay, great. Thank you.

Hi, Good morning, everyone. You mentioned I think that higher priced in product mix contributed 3.8%. The sales I was wondering if is there anyway to quantify how much of this 3.8%, what's driven by price versus mix.

So when you look across end markets within performance, it's more towards a 50 50 split light vehicle certainly much heavier weighted towards price compared to Max.

And CV as I stated.

That was a negative mix story and not so much to do with actual price.

Okay, Great and then my second question was with margins, reaching all time highs I was wondering weird kind of do we go from here in terms of cost cutting and productivity gains.

Well just to clarify I think all time high margins were in the middle of 2016 at 23.5% EBITDA margins, we achieved 22.5% EBITDA margins in this indice quarter I think as we look forward on the transportation side there's.

Much more of the of the price gap.

Okay. Thanks, a lot.

Your final question comes from Paretosh Misra with Berenberg. Please proceed with your question.

Hi, Thanks, Thanks for taking my question.

Is there any color you could provide on margins in that business versus your industrial business. In other words is light vehicle I still higher margin sub segment versus industrial.

Yeah, we do not provide a information about the profitability of our of our end markets.

And we'll provide incremental guidance for 2020 once we get into December .

Okay.

Ladies and gentlemen, we have reached the end of the question and answer session. This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation.

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