Q3 2022 Axalta Coating Systems Ltd Earnings Call
Ladies and gentlemen, thank you for standing by welcome to Exalt is third quarter 2022.
Earnings Conference call, all participants will be in a listen only mode. A question and answer session will follow the presentation by management today's call is being recorded and a replay will be available through November 2nd those listening. After today's call should please note that the information provided in the recording will not be updated and therefore they know.
Longer be correct.
I will now turn the call over to Chris Evans. Please go ahead Sir.
Thank you and good morning. This is Chris Evans VP of Investor Relations.
We appreciate your continued interest in <unk> and welcome you to our third quarter 2022 financial results Conference call.
Joining me today is rakesh sachdev interim CEO , and president and Sean Lannon CFO .
Yesterday afternoon, we released our quarterly financial results and posted a slide presentation, along with commentary to the Investor Relations section of our website at <unk> Dot com.
Which we'll be referencing during this call.
Both our prepared remarks and discussion today may contain forward looking statements, reflecting the company's current view of future events and their potential effect on exalt is operating and financial performance.
These statements involve uncertainties and risks and actual results may differ materially from those forward looking statements.
Note that the company is under no obligation to provide updates to these forward looking statements.
Our remarks in this slide presentation also contains various non-GAAP financial measures in the appendix to the slide presentation. We've included reconciliations of these non-GAAP financial measures to the 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 SEC.
I will now turn the call over to Rakesh.
Thank you Chris.
I'd like to welcome everyone to our third quarter 2022 earnings call.
And we will start by discussing the key highlights on slide three.
I'm very proud of our team and what we were able to accomplish this quarter.
We delivered adjusted EBIT of $148 million and adjusted EPS of <unk> 39 cents.
Both within our third quarter guidance range, despite acute currency and inflationary headwinds.
Pockets of softening regional demand within our industrial business.
Constant currency net sales growth of 20% was extremely strong.
Driven by both volume and price almost an equal parts.
Volume increased 9% year over year as we benefited from market recovery in refinish and light vehicle and commercial vehicle.
Normalization of market demand in most of our businesses are being bolstered with new customer wins across our business portfolio.
We again delivered strong year over year price mix growth of 10% in Q3.
Which more than offset inflation from raw materials and logistics inflation costs in the period.
This represents an important inflection point toward a goal of recovering lost profitability. During this two year period of unprecedented inflation.
Before I review the quarter in more depth I wanted to take a moment to comment on our strategic prioritization.
Organization and my focus as interim CEO .
As summarized on slide four.
Let me begin by reiterating that it has been an honor to work alongside this accomplished leadership team.
After spending the last two months with the team I believe more than ever that there is a great future for this company and I share the team's strategic vision to unlock value for shareholders.
Exalt is strategic priorities remain unchanged and focus on strengthening our industry leading positions.
We are the number one or number two player in the majority of our end markets.
We are investing to support our differentiated capabilities and the needs of our customers, which is driving growth.
Exalt is above market growth accomplishments have been masked by challenging post COVID-19 dynamics, which has been inclusive of <unk>.
Strained auto production.
Hybrid work environments temporarily reducing body shop activity.
Unprecedented cost inflation Jill.
Geopolitical headwinds and China's zero carbon policy.
And headwinds from currency translation, given the strengthening of the U S dollar.
Nonetheless, we are expanding the reach of our technologies and deep customer relationships and to Adjacencies.
While also establishing platforms and new verticals to diversify our portfolio.
We continue to explore bolt on acquisitions, largely within our industrial coatings business, but we have had success deploying capital and weather remains compelling opportunities.
However, the pace of M&A, clearly has and will remain slow for the time being as we focus on our balance sheet.
Rest assured that we are building a quality book of business, which positions us to capitalize on post COVID-19 market normalization.
Now onto my primary focus as interim CEO , which is centered unsuccessful near term execution.
Of utmost importance today is price cost recovery.
We have made great strides with pricing in most key areas.
But select products customers and regions need continued focus.
Next our single largest cost category as raw materials, let me now spend over $2 billion a year.
Small productivity enhancements can deliver significant savings while we also look to take advantage of any market dynamics.
And lastly, operational and supply chain excellence is an area of emphasis and opportunity.
Two more efficient planning and execution, we believe we can release capacity improve operating costs and reduce working capital needs.
This requires a high degree of focused effort by many members of the organization across many sites.
But I anticipate that we can transition to a more efficient environment over time.
Altogether, we are focusing on controlling our own destiny to enhance profitability no matter the near term external environment.
Before moving back to discuss the quarterly results I wanted to touch on the boards search for a new CEO .
There are no updates to provide today on timing, but I can pass along that the board and myself are working expeditiously.
We are seeking a proven leader someone who has a relevant industrial experiences and the tools to unlock value for shareholders.
I'm pleased with the search committee is progress and increasingly optimistic that we will be able to onboard a real difference maker.
Moving back to the results on slide five.
Give you more color on our third quarter volume performance.
Globally volumes improved 9% year over year, driven by end market recovery trends and share gains across the portfolio.
This is a remarkable result, given the global macro environment and speaks to exalt is a unique positioning today in the markets we serve.
Volume growth was positive across all regions, but uneven driven by different macroeconomic end market and regional dynamics.
It is also notable that three or four of our businesses increased volumes in the quarter.
The Americas region was strong again this quarter with year over year improvements in contribution across all end markets.
China led all regions with more than 20% volume growth year over year as strong auto OEM production offset somewhat weaker China industrial demand environment.
In EMEA the demand environment is again challenging as weakening macroeconomic conditions are becoming more evident.
With the continued geopolitical headwinds from the Russia, Ukraine conflict.
For example, the brunt of the impact was felt in the industrial coatings, which is more economically sensitive than our other end markets and also lacks the sizeable market normalization benefits, we see today in refinish and morbidity coatings.
Altogether volume in EMEA increased 1% year over year.
Pockets of softness emerged and general industrial markets the volume dropped modestly.
Moving to slide six.
We are cautiously monitoring trends and at the moment. There are some early signs of softening in some of our industrial coatings exposure outside of EMEA.
However, we believe that the risk of further macro headwinds to exalt is mostly contained within select buckets of our industrial exposure.
Elsewhere, we see bright spots heading into 'twenty, two 'twenty, three and expect to grow in most end markets.
Market volumes have yet to recover to pre COVID-19 levels and most of the markets we serve.
At year end 'twenty two.
Volumes are estimated to be below 2019 level.
8% for the refinish markets, 11% for light vehicles, and 5% lower for commercial vehicles in particular with the heavy duty truck space.
Years of supply constraints have created deferred demand.
Evident in the aging auto fleets and also in low channel inventory levels.
We continue to operate below normal.
When taken together, we see significant upside opportunity for exalt upon market normalization.
But you also represents an offset to near term recessionary headwinds.
Lastly, it is worth noting that our volume growth outperformed market performance since 2019.
Exalt is a differentiator technologies and superior service remain a powerful driver for above market volume performance.
Given our pipeline of new customer wins, we expect to continue this trend going forward.
Nowhere is this more evident than in our industry, leading refinish end market, which we will cover on slide seven.
In refinish, our industry, leading aftermarket auto coatings business, we had a strong quarter with volumes up 4% and price mix, 12% better year over year.
The team continues to gain market share in the mainstream and economy segments.
Year to date, we added over 1200 net body shops globally and.
And 600, plus new stock points through distribution customers.
Our leadership position with large multi shop operators expanded during the quarter.
With the addition of several large U K based msos.
Our partners continue to recognize that we have a better way of doing business centered around what we believe to be the most productive paint system and technical teams in the industry.
Meanwhile, we are seeing favorable trends and return to work leading to increased ingestion rates and improved body shop activity in both North America and EMEA.
Industry volumes are recovering, but remain below 2019 levels in EMEA and North America.
Normalization continues to represent and then backfill demand tailwind and earnings driver over the medium term.
Moving to industrial on slide eight.
Industrial constant currency net sales increased 7% year over year, driven by 12% increase in average price mix, partially offset by 5% lower volume.
The business teams are doing an excellent job prioritizing pricing to offset variable cost inflation.
Even still the business is under earning today and so the team is actively pursuing more actions to recover our cumulative price cost deficit.
The industrial portfolio is our most economically sensitive and market and therefore, a lower year over year volume is a result of macroeconomic cooling in EMEA and a slow recovery in China.
Partially offsetting these challenges is robust demand for building products in North America.
Our current capacity is essentially sold out for the remainder of the year and we should continue to benefit from advantageous consumer trends going forward.
Also new product offerings like our R&D 100, winning appetite 2060, which is a sustainable single layer powder coating.
Expected to support above market growth.
Moving to morbidity coatings on slide nine.
In mobility coatings and industry leader in light vehicle and commercial vehicle exterior OEM coatings volume growth of 30% outpaced relevant industry production rates again.
We continue to drive share gains.
Trends for commercial vehicles are very favorable within North America.
In the second half of this year and is looking likely to exceed expectations.
September class eight orders were a market record and we expect a good end to the year for our business.
The teams are doing a fantastic job as evidenced by a leading industry position and.
And the external recognition from our customers.
Exalt over the sole recipient of the Daimler trucks supplier award for quality the prestigious honor and we've held the title of master of quality for 15 consecutive years as well.
I'm very proud of the team's accomplishments and their tremendous performance.
In light vehicles.
New business wins made over the past year, increasing our exposure in China and should support continued market outperformance in 2020, three and 'twenty 'twenty four.
The contracts are attractive for the business and are coming in that variable contribution margins.
Comparable to 2019 level.
As evidenced by the current profitability of light vehicle in Asia Pacific.
Yet at the segment level, we have much more to do to return to historic levels of profitability.
Below normal auto production is still a drag on earnings.
But price cost remains a core challenge for the segment and worsened marginally in the quarter.
We will cover this in more detail on the following slide.
It is our intent to fully offset the impact of raw materials energy and logistics inflation on our businesses.
This quarter represented an inflection point in our price cost trajectory as we more than offset year over year variable cost inflation for the first time since the current unprecedented inflationary environment began mid 2021.
Inflation has proven to be more persistent than we initially expected at the beginning of the year.
We now forecast a 2021 and 2022 combined impact of approximately $650 million.
Versus a $400 million initial projections earlier this year.
However, the raw material market has become more favorable in recent months.
We're now seeing greater availability of bulk commodities enabled by softening in adjacent markets and improved global arbitrage, given normalized global shipping and logistics.
Buckets are fresher do remain however, with EMEA energy inflation, becoming more significant.
Elsewhere inflation is mostly isolated to the specialties like additives and certain pigments.
Therefore, we believe that Q3 represents peak inflation and we see an opportunity for flat to modestly lower unit rates in the fourth quarter.
The anticipated raw material benefits will come through on slight lag as we've done over higher cost inventory on our balance sheet during Q4.
Pricing remains a focal point for the teams given incremental pressures like higher energy costs in EMEA and the need to offset the remaining $100 million price cost gap impacting our margins.
Now I'll turn the call over to Shaun to discuss our financial results beginning with slide 11, Sean.
Thanks for cash and good morning, everyone.
Net sales were $1 2 billion, an increase of 14% year over year for the third quarter, while constant currency net sales increased 20% driven by pricing actions demand strength across most of our businesses and benefits from our <unk> acquisition. We completed in mid September of 2021.
Constant currency net sales growth included a 14% increase in performance coatings, and an impressive 35% growth from mobility coatings, both light vehicle and commercial vehicle showed strong year over year performance.
Third quarter volume improved 9% year over year with positive contribution from three or four end markets offset by mid single digit percent decline in industrial volumes due to supply chain constraints as well as the macroeconomic and geopolitical headwinds within our European and China regions.
Backlog remains a challenge as we were again unable to fully meet demand in the quarter for both our industrial and refinished businesses.
Price mix increased 10% year over year or 14% better on a two year stacked basis.
Every end market contributed positive price mix and three of our four end markets showed an impressive low double digit growth.
The drop through of better pricing more than offset the 20% year over year increase in variable cost inflation, which is an important milestone in our efforts to reverse the price cost gap.
Sequentially price mix improved by 3% highlighting continued momentum in our prioritization of price cost recovery.
FX translation was a headwind of 6% on net sales for the third quarter, driven by a weaker euro Turkish lira, British pound and the Chinese renminbi.
Third quarter, adjusted EBIT was $148 million versus $146 million in the prior year quarter.
The year over year comparison included approximately $16 million of EBIT headwinds associated with the impacts from the Russia, Ukraine conflict, China, Lockdowns and FX translation.
Implying a more favorable earnings growth comparison, one excluding these effects.
In the quarter and throughout 2022, we have incurred higher selling and general administration expenses by design to support growth and from labor and general fixed cost inflation, which drove a step up in fixed operating expenses versus the prior year.
Turning to slide 12 performance coatings third quarter net sales increased 8% year over year, and 14% ex FX driven by a 12% increase in average price mix and a 2% increase from the <unk> acquisition.
Volumes remained largely flat as refinish growth was offset by industrial headwinds in EMEA and China.
Refinish reported a 13% net sales increase or 20% ex FX driven by low teens percent improvement in price mix, 4% growth in volumes and a 4% contribution from our new poll acquisition.
Demand for our products and services was strong and exceeded our ability to supply given can strengthen our supply chain.
Q3 marks the one year anniversary of our <unk> acquisition.
We are excited about the revenue synergies, we've seen so far along with the overall value creation in North America and Europe as this team and the product offerings have integrated as we had expected.
Industrial Q3, net sales increased 1% or 7% ex FX driven largely by a low teens percent improvement in average price mix, partially offset by modest volume declines in Europe and China.
Performance coatings reported Q3, adjusted EBIT of $122 million versus $123 million in the third quarter of 2021 as benefits from price mix and modest volume contribution were more than offset by headwinds from FX, Russia, Ukraine, China, Covid, 19, lockdowns and higher variable and fixed costs.
Nonetheless, refinish is on pace for another strong year of profitability in 2022.
Continuing the momentum seen in 2020, one as our team continues to execute extremely well.
Moving to slide 13.
Ability coatings constant currency net sales increased 35% in the third quarter as volumes increased by 30%, which outpaced bill rates across light vehicle and commercial vehicle.
Pricing momentum continued in both businesses, which in aggregate grew 5% versus the third quarter of 2021 inclusive of negative mix.
<unk> was a 5% headwind in the quarter coming mostly from the Euro Turkish lira and Chinese renminbi.
Light vehicle net sales increased 35% ex FX in the quarter.
Including a 32% volume increase which outpaced global auto production by roughly 400 basis points.
Commercial vehicle third quarter net sales increased 35% ex FX, driven by customer wins and recovery from constrained production rates from the prior year.
On a percentage basis volume grew in the mid twenty's year over year, while price mix at a low double digit percent improvement.
Mobility coatings reported Q3, adjusted EBIT of $4 million versus negative 3 million adjusted EBIT in the prior year quarter.
Volume and price mix growth were partially offset by raw material inflation and incremental fixed costs and FX.
While we are excited that the volumes continue outpace market trends growing EBIT margins and closing the price cost gap continued to be an area of focus and priority for the business.
Moving to our debt and liquidity slide on slide 14.
Exalt is third quarter balance sheet and liquidity profile remains solid.
We ended the quarter with slightly over $1 billion in total liquidity.
Our net leverage ratio ended the quarter at four one times, reflecting a slight decrease from four two times at June 30.
Net leverage remains elevated due to the phasing of free cash flow as well as incremental pressures on working capital balances associated with pricing and volume growth impacting accounts receivable as well as higher levels of inventory, which are elevated partly due to inflation.
On capital allocation, we made no additional purchases of shares in the quarter and so the year to date total remains unchanged at $200 million.
I would expect the pace of share buybacks to largely remain somewhat muted as we focus on net leverage and the balance sheet.
As interest rates step up the relative attractiveness of gross debt reduction has increased.
And if trends continue is likely to become a larger emphasis for future capital allocation in the near term.
Meanwhile, we are closely monitoring the debt markets for a window of opportunity to execute the refinancing of our $2 billion term loan, which matures in June of 2024.
On Slide 15, we will review, our fourth quarter guidance framework and commentary.
For Q4 net sales, we expect between approximately 6% and 8% year over year growth inclusive of an approximate 7% FX headwind.
This framework assumes nearly double digit price mix growth and reflects our continued prioritization of price cost recovery.
Volumes are expected to grow in the mid single digits largely centered within mobility.
Elsewhere pockets of softening demand, notably in Europe are expected to drive volume declines for industrial.
We expect to generate an adjusted EBIT of $120 million to $145 million in the fourth quarter, which correlates to approximately 200 million and adjusted EBITDA at the midpoint.
Sequentially, we expect a small drop in profitability at the mid point from the third quarter, primarily from softening within industrial. Additionally, we expect further foreign currency translation and higher operating expenses will add some marginal pressure from our third quarter results.
For adjusted EPS, We anticipate a range of 31 to 39 for the fourth quarter inclusive of headwinds on a per share basis from FX and Russia, Ukraine totaling approximately four pennies.
Within our fourth quarter forecast, we further assume raw material inflation will be a high teens percent headwind year over year, but flat to modestly lower sequentially.
Lastly, we expect fourth quarter free cash flow to be between 175, and $225 million, which includes higher than normal working capital balances.
As we move into 2023, we will be focused on returning working capital towards lower historical levels as a percentage of net sales, which we believe will represent a meaningful source of cash in 2023.
I will end with a few additional comments on the outlook into 2023.
The macroeconomic situation remains unclear and difficult to forecast. However, as Rakesh discussed earlier, we believe exalt is uniquely positioned to benefit from cowens as demand normalizes in core markets like refinish and light vehicle and commercial vehicle.
<unk> and global supply chains, with likely deflationary benefits and our variable cost of goods sold.
And lastly from a heightened focus on execution. Our teams are focused on actions to enhance operational and supply chain excellence.
We strongly believe in the earnings power of this company and the value creation opportunity that lies ahead.
With that we will be pleased to answer any questions. Operator, please open the lines for Q&A.
Thank you we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue. You May press star two if he would like to remove your question from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star.
One moment, please while we poll for questions.
Our first question comes from Mike Sison with Wells Fargo. Please proceed with your question.
Hey, guys, how you doing nice quarter I guess my first question in terms of mobility cuttings and I look back historically, you've done several quarters at 400 million in and you know just EBIT.
Tends to be in the 30 30 to 40 million range so well.
Why wasn't there more improvement I guess sequentially given your volumes were really good.
Hey, Mike Good morning, this is rakesh so.
Listen I'd start off by saying none of us are happy with the lack of profitability in the mobility business.
But having said that are.
You know we know there are a few things you have to do to get this back to where the profitability of Houston.
Yeah, just to give you an idea just to help you bridge what happened in Q3 versus Q2 of last year.
Yeah, we had about $90 million and higher.
Volume sales.
Well if you include price and mix, we had a little more than 100 bed bugs.
We got about $45 million to the bottom line.
Good guy from that.
Now, we lost about 35 million from inflation of variable costs and freight.
So we went down to about 10, we also reduced some costs in our plants.
And then we had opex increases so.
You know, we mitigated a lot of what we got from the new business and by the way the new business is quite profitable.
The business that we are winning in China has pretty good margins.
What we have to do going forward is clearly we have to get more price and I think the teams are fully committed.
You're going to see some of that in Q4.
We had wanted to try and get the benefit of the devaluation and the raw materials I think that's beginning to happen.
Yeah.
As Sean said $2 billion of ours by is in raw materials.
Half of that if you look at it is.
Additives, it's solvents.
Its monomers and that's already coming down so to the extent that we can take out even a few percent.
The raws, it's gonna have quite significantly now obviously, we have to hold onto the price not only hold on but we have to get extra pricing in the mobility business, which we've been.
But that's where we are at it's going to take some time I think there's a strong commitment and the company within the teams that we have to bring this back to you know like the numbers. You. Just said you know $30 million a quarter is.
It is what we used to do.
And you wouldn't even see some improvement in Q4 in this business.
Got it and as a quick follow up when you think about 'twenty three I know, it's a little bit early and.
Certainly uncertain times, but if you think about a lot of your and your end markets Refinished auto OEM and commercial it does seem like there's momentum there to grow next year, even if the economic environment continues to weaken. So if you think about growth in 'twenty three mm given your wins and volume trends recently.
Yeah, how do you think about the <unk>.
Potential for EBIT growth, particularly with raw materials coming down.
Yeah, So Mike there's still a lot of uncertainty about what's going to happen in 'twenty three right with the global recession discussion. That's happening you know theyre going to be cautious as we put our plans together and the overall auto production.
You know clearly as you know that there is pent up demand.
For automotive.
Our belts.
But and we are also winning as he said you know we have.
Conquest business, mostly in Asia that business is locked down and be able to see that benefit next year.
This should be a growth business for us on the top line next year.
And then as I said in terms of the EBITDA EBIT should grow much faster than our sales growth next year because of the things that I just mentioned.
Great. Thank you.
Youre welcome.
Our next question comes from Mike Harrison with Seaport Research Partners. Please proceed with your question.
Hi, good morning.
Morning, Mike was just we're just hoping that you could talk through a little bit more detail on <unk>.
<unk> 10, and that cumulative price cost gap.
What's the progress that you've made this quarter.
What you expected when you gave guidance or was there.
There were some surprises I guess either on the pricing side or on the cost side and I guess, maybe specifically to mobility did you expect to lose a little bit of ground, there or was that kind of a key surprise in the quarter.
Sean do you want to take that first and I guess, that's fine yeah, I mean, certainly the dynamic shifted in a sense that the price cost gap actually went down this quarter, which is clearly a dynamic where we're heading for but we saw a little bit more inflation and in particular on the mobility side, we saw a little bit more on the performance coatings side.
We're now in the positive industrial still lagging, but refinish is over performing but mobility essentially jumped up to $115 million gap and that was the big impact that rakesh just walked through on the challenged as far as the profitability on the volume growth on the mobility side.
Alright, and then was also hoping that you could talk a little bit more about how your fixed operating cost issue I think of exalt is a company that over the years is really focused on reducing our fixed operating costs.
I understand that there are inflationary dynamics at play here, but could you give a little bit more detail on what's driving these costs higher and kind of why we're seeing it.
Now.
And as we get into Q4.
So maybe I'll take a first shot and then Sean you can.
So really if you break down the opex expense about half of the increase was in the refinish business and a lot of that was because of sales commissions do you know the refinish guys are doing a phenomenal job of growing the business.
Some of the Opex.
Greece's, obviously inflation and the restaurants that we had.
By design as Sean said had you.
Added people to help us in the growth around the world now.
You know given.
What could happen next year you know this is an area that we'll be looking at very carefully because as you know.
You know, it's all kind of very nimble in the sense of if you have to take out operating expense in the face of.
A slowing environment you know, we can absolutely do that and do that very quickly.
Yeah, just to add on I mean top line organic sales are going to grow 15% in 2022 and take it back all the way to 2020, we did a lot on temporary savings and not backfill on attrition, but quite frankly, we needed to backfill some of those positions in order to grow and you're seeing that in <unk>.
Merit has uptick quite a bit labor historically has run around 3%. This year, it's much closer to 5%, so that's adding incremental pressure.
Alright, Thank you very much.
Yeah.
Our next question comes from Steve Byrne with Bank of America. Please proceed with your question.
Because you just said that that exalted can pick out operating expenses quickly and easily.
I'm your fresh look at our Salt So would you say that the mobility business has done that I'm asking about.
You know what fraction of all.
Cogs in mobility.
It was fixed versus variable and clearly you have challenges on on the variable side, but is that fixed cost structure of mobility.
Fairly significant and in stock and is there anything that you can see to do to to cut that too to drive an.
The improvement in in and earnings and mobility.
Yeah. So Steve you know the fixed cost in this business and let's take mobility, you've got obviously the fixed cost in the manufacturing plants. Some of our manufacturing plants are shared between the businesses.
And then there's also SG&A right. So if if you look at the.
Total fixed odds in the plants and the SG&A just a high level estimate youre talking about half a billion dollars of expense in the mobility business. So that's a big number.
And you know I'm not going to tell you what they're going to do because we're working through our plans, but obviously, that's an avenue for us to look at very carefully.
But it's it's been fairly significant number and we have the opportunity to address it and become more efficient.
Okay, and then on the refinish it does seem like.
There are several players in refinish, but all seem to be gaining market share just wanted to ask about the structure of of refinish is this something that you know is just ripe for more consolidation.
It's the big players are all gaining share or is there more to go on on this on this consolidation and where would you see the most opportunity for you as it by region or is it by you know segments between premium and you know economy.
Screen.
So clearly theres a consolidation that's been taking place in the U S. There's multiple shop operators have been consolidating and that has been helping exalt or in a big way because I think that what we offer to the msos and the kind of productivity that we can provide to them you know we've been signing up more and more.
All of them, so we've been gaining share here.
In Europe . The M. S. O concept is just beginning to take hold as you know we just won some significant MSL business in the U K.
That has not been inexistent in Asia, but in Asia. We are focused mostly on the premium segment, but if you look at overall globally. There's no question that we are benefiting from the consolidation and we're benefiting from share gains.
And not only that I think this is a business, where we are able to outstrip the cost increases that we've seen by higher prices. So it's it's it's a great business. We are also adding content in the refinish business to be brought into adjacencies that we are selling more than just paints and coatings and that's going to continue because once we have the pipe into.
Do the shop operators being able to supply additional content and that's going to continue in the years to come.
Thank you.
Welcome.
Our next.
Question comes from Josh Spector with UBS. Please proceed with your question.
Yeah, Hi, Thanks for taking my question I guess, just coming back to price cost and the cumulative gap closure.
He is also in the past you used to give some type of timeline on when you expect to kind of get over the hump. There do you have any estimate on our visibility to when you actually may be closing this gap and as you think about pricing and mobility. I mean, you talked about from lower raw as you talk about going after additional pricing.
What's the mindset in terms of how much price needs to be captured or you're capturing pricing kind of regardless of raw material decline to close that gap or are you thinking of being a blend of kind of both playing into that.
Yeah.
Yeah listen we know we've got about a $100 million gap, plus or minus and we're gonna get part of that through pricing.
And they're gonna get part of that through deflation no question about it and part of it has to come from operating efficiencies you know.
But one of them, but the one thing that I have found since.
That I've been here in the short time that I've been here is I think we have a lot and you haven't talked about this but do you have a lot more opportunities.
And just the way we run our manufacturing operation and the amount of cost we can take out and increase the capacity.
You know that's more to be discussed perhaps in the coming a call, but clearly if you have several levers I'm not sure. If you want to add any color to this.
I guess the other node as you know our prices typically pretty sticky were expecting the cycle to be no different yeah. If we see the pace of deflation as we think about next year.
Certainly be pushing price on the refinished side and that's a question mark on how much deflation, we see on how much incremental price, we get but do you think about that.
Dollar gap that represents 2% price.
So it certainly feels like we're on track to cover that as part of 2023, just given the pricing today.
So I guess, what if we're wrong on Ross deflation oil moves up inflation starts to pick up again.
Is there anything that's being done so if that cycle picks up changes direction that you can act differently or react differently to that environment.
Yeah.
Well I mean, if we go back into an inflationary environment you have to just be more aggressive on price and more aggressive on our cost.
But you know that's the commitment that we all have.
And we're starting to see them.
Yes.
Sean I was going to say one wildcard I think we feel pretty good about that'd be entering into the deflationary environment on the commodities.
One wildcard that we're all watching as the cost of energy in Europe .
Having said that in the last few days I've been pretty encouraged to see what's happened in <unk>.
Cost of natural gas and energy in Europe .
Market prices are down quite significantly.
Doesn't mean, it's going to continue to stay down but you know that's that's something that'll be going to continue to watch.
Okay. Thank you.
Our next question comes from Christopher Parkinson with Zero with please proceed with your question.
Great Yeah that helpful Slide seven and just kind of overlaying, you know, where we stand versus the in the marketplace versus 19 on refinish.
Could you just further kind of you know.
Broadly speak about your conviction in the specifically in the U S re finishes business.
<unk> ability to grow next year, just given what you're hearing from body shops, you know labor shortages kind of easy and collision rates up you know totals down you know it seems like a lot of things are moving the right direction low inventories you know just given the macro environment. What we're in it seems like a pretty big question. So could you just hit on kind of your outlook over let's say the next.
You know six to nine months and you know what you're currently seen in the marketplace. Thank you.
Sean you won't take let's talk now.
You're more color yeah, I mean, we're feeling really good on the trending kress, thus far through the year office occupancy rates and I wouldn't say, it's the hardest data point, but yeah. It certainly ticked up post the summer and we had 46% in September October month to date, it's up to 48%. So you know as folks are getting back in the office.
I'm expecting congestion to pick up which should hopefully correlate the body shop activity, but you know the U S market is still down 10 or 11%. So I do expect recovery next year. Even if you know there are some recession fears out there when you think about with the body shop level. You know it continues to be fairly high so I think as the labor shortages get.
<unk> Yeah. That's also.
<unk> tailwind for US and then just the Msos Y'all continues to do very well as far as picking up market share and I think we're really well positioned on that front in our refinish team is doing a fantastic job just as far as the productivity of our paint systems.
The technicians that we bring in the overall.
Service requirements, there I think that business is doing really well it sets us up really good for 2023.
I mean, just to add to what Sean said I think.
Neighboring issues in the body shops actually helps us because of our technology and I'm not saying you have a single application versus our competitors who have you know.
Multiple applications, so we definitely add productivity and in the <unk>.
Body shops.
And and that helps us.
Understood and just very quickly just on the mobility side of it when you take a step back and you know look out into 2023, there's clearly a lot of let's say longer term pent up demand you see you know the market seeing some growth in China at the same time there is some let's say teetering in the AR and the Western World you know.
Just going back to a previous analyst question, just how quickly can you actually react.
On the cost front, if and when you.
Starting hearing from your customers or incremental shutdowns or production rates being slightly lower than expected is that a case of you know weeks or is that a case of let's say you know a month or two.
Well you've had a precedent when the pandemic hit and you know I know I wasn't in the seat, but Sean you were and maybe.
You might want to say it would be dead and but I can tell you is that people would react as fast as.
As you know as anybody can and deep.
A very meticulous about it but when he does give us a recap a little bit of what we did yeah, Chris it it feels like where we're at close to a bottom I mean, we've been in that recession on the mobility side for two and a half years. So it's hard to foresee that we'd be below 80 182 million builds for 2023, but well.
Somewhere probably between weeks and months, if we see a clear sign that there is demand destruction and just as a reminder, we took $130 million al you know back in 2020, and we acted pretty quickly once.
We actually knew that the demand destruction was gonna be there I think we have the playbook and we showed that we can execute against it and I think you know another hypothetical scenario, we could do the same.
Helpful color as always thank you so much.
Yeah.
Our next question comes from Ghansham Panjabi with Baird. Please proceed with your question.
Good morning, everybody.
I just good.
Good morning, I, just wanted to go back to the mobility segment and.
So on the widening of the price cost gap and three Q, what was that bias to a specific region, you know Europe or.
Some sort of impact from mix, because China was up so significantly.
Just asking because you know inflation has been pretty visible in terms of what's been happening in your pricing initiatives have been a pretty substantial over the last few quarters, So what what specifically changed in <unk>.
I don't think it really.
Sorry go ahead, Sean Yeah. It was it was really across the board Asia was actually a bright spot for us just given all of the volume improvement that that region now.
It's it's the bright spot of the light vehicle business, just given all the incremental wins coming at an improved variable margins, but we saw the inflation really across the board.
It's a global issue on the mobility side that we need to get more price ghansham.
Got it and the 100 million price cost gap on a cumulative basis, what sort of buckets would you have us think about in terms of price recovery volume.
Some level of deflation and then separately, Sean maybe you can give us some indication.
In terms of what the high level variances would be for 2023, EBITDA, especially on FX.
Yeah, we're going to steer away from giving any guidance on 2023 at this point gotcha.
Mobility earlier in the year, when we thought up think about back to 2019 profitability. Yeah, we had a roughly a $140 million GAAP. Yeah. We've couched that it's 50 50 between volume and price cost price cost has gotten worse as we've progressed through the year. So it's probably more on the 75%.
On the price cost versus the volume, but certainly as we see stability on the inflationary aspects you know our pricing will start to catch up and I mean, it's notable in the third quarter, we would've expected a lot more drop through from a profitability perspective, but we did see that inflation and that's why our fourth quarter and Rakesh alluded to that's where we are fully.
Expecting to see a nice step up in profitability in the fourth quarter as we see stability and pricing starting to catch up and then also the volume impacts as far as the Incrementals on that.
Okay very good thank you.
Yeah.
Our next question comes from Kevin Mccarthy with vertical Research partners. Please proceed with your question.
Yes, good morning, with regard to your mobility segment, you've spoken in the past about certain customers with whom you have formulaic contractual relationships and so I guess my questions would be are you observing a meaningful difference in profitability between those customers.
Emerge and customers warrant on a formulaic relationship.
And as it relates to these formulas are do you feel as though you're capturing all of inflation or are the formulas, capturing a mostly just the raw material aspect of it I'd be curious to hear your thoughts on you.
You know basically how you think underlying price will flow through for those two buckets over the next few quarters.
Well you know what I would say is that clearly we have contracts with a number of OEM customers and.
You know we have taken the initiative of having discussion even before normally the contracts would open up a price discussion, but as you can imagine I think everybody is doing that.
And yes. So you know we have indices that are tied to inflation that drive pricing up or down now.
As you know that.
What actually happened in the supply chain is different than what happened with the broad indices. So essentially because there were significant supply chain constraints.
Many companies, including us paid more for raw material than what the indices would have suggested.
No.
As they go down we are going to benefit more because even not have to get.
At the same pricing back to the Oems as because we didnt get it on the way up.
And that's that should bode well for us as we look at in the face of a deflation but.
But yeah, I think we have different.
Tuitions I won't name customer names, but you know we have some customers that are going to.
They are getting pretty aggressive. It then you know you're going to see some of that benefit even in Q4.
Okay, and then as a follow up in your prepared remarks, I think you made a comment that you're sold out through the remainder of the year.
For certain industrial coatings, and I guess my question would be and which product lines are you sold out and given that circumstance. You do you think you'll need to invest in new capacity or where it might be the case that you know growth is cooling and we're fine on capacity.
No listen I think we have work to do.
Remove bottlenecks and increase capacity in our existing plants I don't see us having a need to add more capacity by way of equipment and facilities.
Yeah, and I mean, you've got a great new team that's working on this now I think.
As Sean said we've had.
Not being able to deliver all our demand too.
At the end of last quarter, but I think they're making good progress.
And Kevin just to add on I know you asked specifics yeah. We ended the quarter with roughly $50 million of backlogs all performance coatings.
10 to 15 of that is coming through industrial and it's specific to building products.
Building products is really where we're essentially sold out through the rest of the year and so sort of that backlog on remodel and new home belts continues to benefit that part of the business at least through the end of the year.
Great. Thank you both.
Our next question comes from David Begleiter with Deutsche Bank. Please proceed with your question.
I think in good morning, Rakesh is showing how much did the immobility coatings, how much did the.
Raw material price cost gap widened in Q3 versus Q2.
It was about 20 million Dave.
Very good and Sean Inc. In Q4, you mentioned improvement in mobility versus Q3, how much are you thinking about in that segment.
Yeah, well, we're not going to call out that specifically, but I mean, it's it's gonna be a nice uptick it's not going to be quite back to 2019 levels, but somewhere in between where we are today in 2019 levels as far as the quarterly contributions.
Very good thank you.
Our next question comes from John Mcnulty with BMO capital markets. Please proceed with your question.
Yeah. Good morning, Thanks for taking my question, maybe just another one on the light vehicle side I guess, you know admittedly what cash we were we were surprised on the on the lack of operating leverage and it sounds like some of it was was tied to the raw materials for sure, but I guess, maybe two two questions around it one is on the new business that you're bringing in since it was.
<unk> kind of one last year have you had an ability to actually raise the price on that business yet because inflation has been so extreme I guess, how should we be thinking about that and then also when you you're it sounds like you've been really kind of digging into the business pretty hard are there any is there any business or contracts, where you go you know what this just doesn't make sense, we shouldn't be doing this business like it is.
Is there anything that we should be thinking about where you might be walking away going forward from low margin no margin type business, how should we think about that.
Yeah, Let me answer your last question first so clearly we do have some customers may be honest.
The margins have been a lot of threshold and I think it's we have to prove to ourselves that we can get these margins up to where they need to be oh, yeah, we will trend.
William Horn crossing for sure I mean, I I understand its not like Maryland.
We're going to try and get every business at any margin, we're not going to do that anymore. So.
So having said that.
I think the teams are really working to do we're trying to address it.
You know this is this is an interesting space you know you only have two or three large players in this business and hopefully our OEM customers.
Give us the appropriate prices that I think all of us need and it's not just us.
And we even see that'd be cool.
But just to make sure you understand we are not trying to get volume at any cost.
I forgot your first part of the question can you repeat that again just around the new business that you won because I think you want it laugh out here and yet inflation has been so strong have you been able to reprice that.
You know I can't answer that question.
Pricing I know the margins, we got on the new business in the quarter and they were very good but it's not let's get back to you on that.
Got it fair enough and then just as a follow up so Sean it sounds like you're looking to unlock a decent amount of working capital as you look to 2023 and and and at least by our numbers. It looks like you you know there could easily be a couple hundred million of other tailwind if if things kind of play out like I guess, how should we think about the uses for that.
Going forward I know historically exalt is very comfortable with reasonable amounts of debt is that changing where cash on your under your watch and and also maybe can you give us thoughts on the potential for a dividend at some point for for exalt, if that might be in the cards or that might be a change in terms of how youre thinking about things.
Maybe I'll start and Rakesh you want to add on.
So working capital absolutely will be a benefit as we circle on the 2023, Yeah. We ended the quarter with working capital as a percentage of sales you know close to 14% and we expect to be closer to 12% by the end of the year and you go back 2019 2020, we've been running at about 8%. So.
We're seeing the inflationary pressures in inventory as well as you know we've just seen a buildup in raws given sort of the instability of supply chain. That's building safety stock levels. So that's going to be a core part of our focus and getting that out you know certainly starting in the fourth quarter and continuing into 2023, but David on capital allocation near term.
Yeah, we're gonna be building cash and looking to potentially paying down gross debt I covered in my remarks, we are very focused on refinancing the term loan.
First rates continue up it's going to be a little bit more attractive actually pay down some of that gross debt, but over time, it's gonna be share buybacks and M&A and getting back to sort of the old playbook. Once we get past this a high inflation time.
Got it thanks very much for the color.
Our next call I'll turn to Mike next question is from Mike <unk> from Barclays. Please proceed with your question.
Great. Thanks. Good morning, first question, maybe a little bit more higher level or cash you you've been in the seat now for a few months any initial impressions with the business or just discoveries that might be different from when you were you were only on the board and not in the interim CEO role.
Yeah.
Yeah I have several observations.
You know when I think about the business and I look at.
Our ability to get top line growth.
I think we are in a great place.
We are gaining share in several businesses.
I haven't talked about some of our new product launches a pipeline for new business in the industrial business is very healthy.
Feel good about the topline growth and the ability to get top line growth.
Obviously, the three or four things.
I see significant opportunity than we've had this discussion on this call.
Yeah, the price cost gap has to be closed and.
You know it comes in the form of pricing with customers.
Rich I talked previously about having commercial courage to go after the pricing.
The raw material has to be you know.
Have taken $650 million in raw material increases and we need given that the environment is changing we.
We need to get our fair share back.
And the other one that I think I've become acutely aware is just the opportunity.
Our operations and supply chain I think we have a significant opportunity.
Both in terms of.
Improving deliveries clearing backlogs lowering our cost the fixed cost in the plants.
And I think when you take all that in total.
I think the business can be at a different place a year from now.
Great. That's it for me thank you.
Sure.
Our next question comes from Alex Yeah, Yes, her mouth with Keybanc capital markets. Please proceed with your question.
Oh, Thanks, and good morning, everyone I, just wanted to come back to mobility.
You know quite Stark contrast between 5% and price.
And 20% of the cost inflation.
Perhaps there was some surprise in inflation, but I thought you typically have a couple of quarters worth of inventory. So there is some visibility.
Hum into that inflation I guess was that in mind are you disappointed was the pricing efforts that the team has been able the pricing that the team has been able to achieve.
And if so what what is changing in terms of improving the look the pricing execution.
Yeah, obviously, we are disappointed that we had this gap in the <unk>.
GAAP grew in the quarter.
Having said that I think the teams who are running this business.
Fully understand what we must do not having said that we do.
And I'm trying to close the entire gap by just pricing with customers because we know that things that we can do internally that we control that will also help offset that and.
And you're going to see some of that benefit in Q4 and I think.
You know as we March into 'twenty, two 'twenty, three I think you'd see a fairly big chunk of improvement there.
Same store cash in EMEA refinish volumes were pretty stable in the third quarter of this business are generally less cyclical, but still is subject to weaker consumer demand could this weekend in the fourth quarter of next year or do you.
Expect continued stability here.
Okay.
Thank God.
Got it Yeah go ahead, Sean No I was saying we are expecting a little slow down.
In the fourth quarter and refinish in EMEA.
Some of that is seasonality in December .
You're still pretty bullish about glad this businesses buying other than seasonality, we don't see any fundamentally.
Things changing then that should reduce this business.
Thanks, a lot.
Yeah.
Ladies and gentlemen, we have reached the end of our question and answer session and I would now.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
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