Axalta Coating Systems Ltd.

Greetings and welcome to the Exalta Coding Systems fourth quarter and full year 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Chris McRae, Vice President, Investor Relations.

Thank you and good morning. This is Chris McRae, VP of Investor Relations. We appreciate your continued interest in Exalta and welcome you to our fourth quarter and full year 2020 financial results conference call. Joining me today are Robert Bryant, CEO, and Sean Lannan, CFO. Last evening, we released our quarterly financial results and posted a slide presentation along with commentary to the investor relations section of our website at exalta.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 the potential effect on Exalta's operating financial performance. These statements involve uncertainties and risks, and actual results may differ materially from those forward-looking statements. Please note that the company is under no obligation to provide updates to 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 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'll now turn the call over to Robert. Good morning, and thank you for joining today's call. I hope you and your families remain safe and healthy. I'd like to begin by expressing my thanks and appreciation to all our Exalta team members globally. Our team has persevered through a very challenging year. and our global team's continued dedication, hard work, and relentless focus on our customers has produced very impressive results. We look forward to discussing them with you today. As many of you are aware, last night's earnings release was delayed from the original date of February 3rd. As quick background, we remain aware in January of a potential operational matter associated with production at certain North America transportation coatings customer sites. involving certain of our products over a discrete period during the fourth quarter of 2020. Unfortunately, with the uncertainty of the financial impacts and responsibilities, we had to delay our earnings date to continue our evaluation and assess the potential financial impacts. At this time, we're still reviewing the matter and do not believe that any potential liability is probable and therefore have not recorded any charge in the results we are presenting today. Similarly, Our Q1 guidance, which we will discuss today, does not take into account any potential liabilities. So keep that in mind as you assess that guidance. As we continue to assess the scope, root cause, and associated responsibilities among various parties, we believe total costs related to this matter could be material, and we believe total costs could be up to $250 million, based on what we know today. This does not assume any potential insurance recoveries, which we would pursue if we incur a substantial loss ultimately resulting from this matter or the likelihood of insurance coverage. It's important to point out that at this stage, we're not certain whether we will have any material losses and what, if any, responsibility we might have relative to the other relevant parties. There will be additional disclosure in the Form 10-K that we will be filing. However, given the ongoing review, we're not going to comment further today. With that brief background, overall, the fourth quarter for Exalta witnessed superb operating execution. We posted strong operating margins and converted free cash flow at a record level, driven by a combination of ongoing volume recovery and success in executing on cost actions throughout the period. Similar to the third quarter, adjusted EBIT showed impressive year-over-year growth, despite lower overall net sales result from our refinish business due to the impact of COVID. For net sales, we saw sequential growth of 4.6% versus the third quarter, indicating continued recovery across all of our end markets. Still, reported net sales decreased 2.2% year over year, or 4%, excluding FX tailwinds, with the consolidated business still largely impacted by lower refinish volumes. Fourth quarter net sales beat our guidance of a year-over-year decrease of 6.8%, with upside driven by strong underlying demand in industrial coatings and ongoing recovery seen in light vehicle within transportation coatings. As mentioned, quarterly operating profit was impressive, with adjusted EBIT of $205 million, up 18.4%, versus $174 million from the prior year quarter. Adjusted EBIT margins also impressed, with an increase from 15.8% to 19.1% year-over-year. Beyond that, we posted adjusted EBITDA of $253 million with a margin of 23.5%, also an outstanding near record level, and adjusted earnings per share of 58 cents, a 38.1% year-over-year increase. Free cash flow for the quarter was another record of $256 million, and exceeded the prior year's quarter of $248 million, driven principally by stronger EBITDA and excellent working capital performance, as well as lower cap index. Finally, we continue to reduce our net leverage ratio, which decreased from 3.7 times at September 30th to 3.3 times at December 31st, which reflects the significant decremental COVID impact of the first half of 2020 operating results on the full-year adjusted EBITDA calculations. A few notes on full year results. I'd like to highlight our strong fourth quarter cemented the second half recovery following the dramatic second quarter impact from COVID-19, as a strong overall volume rebound was complemented by aggressive and successful temporary and permanent cost actions and cash flow actions taken by our team and executed with great speed. While adjusted EPS for 2020 of $1.33, fell shy of the $1.80 in 2019, second half results easily exceeded prior year results in both quarters, despite ongoing lower net sales levels in both periods. Free cash flow was also strong and grew year over year in the second half. So strong, in fact, the full year free cash flow of $442 million was only moderately below the $475 million in 2019, despite the large volume headwinds and approximately $23 million of incremental cash interest related to the two debt financing actions we took in June and in November. As we closed out the year, we took an important step forward in positioning Exalta for accelerated growth. We hired two new business unit leaders for our transportation coatings and our industrial coatings businesses who are now driving execution and addressing new market opportunities for growth. We completed an organizational realignment to a global business unit focused model, which we believe will enable accelerated decision making and growth. We also had solid execution on the restructuring that we announced in July. Finally, we've recently hired a new head of strategy and business development to drive our enterprise strategy and our M&A activities as we actively pursue new opportunities for integrated growth. We're all very excited about these recent actions. Moving on to business conditions. Regarding the current demand environment, our businesses benefited broadly during the fourth quarter from continued recovery across most of the markets we served. The pace of that recovery exceeded our expectations. And a refinish remains the sole end market that continued to see material COVID demand impacts in the period. A refinish, total model driven for countries with available data, continued to improve through October before slipping somewhat mid-quarter, aligned with the relative severity of country-by-country pandemic restrictions. U.S. traffic during the fourth quarter remained around 10% to 15% lower year-over-year, dipping somewhat later in the quarter. while Europe has slipped from stronger levels back to weaker trends in the last four to six weeks of the fourth quarter as a result of restrictions that remained in effect in the early parts of January and February. Traffic in Asia Pacific is more variable, including strength in recent weeks in India and Australia, but there are some signs of slowing traffic in China, Japan, and some ASEAN countries due to the incremental pandemic effects. In the fourth quarter, U.S. data suggests insurance claims were down around 19% in the period, while Exalta's U.S. Body Shop customers saw better demand than this level. Overall global demand reflected the increased travel restrictions put in place as the quarter progressed. That said, we expect continued recovery for refinish throughout 2021 aligned with the pace of vaccinations and post-lockdown travel recovery. This could actually even surprise on the upside and pent-up travel demand. For Exalta's industrial coatings end market, demand trends were solid and even strong in many markets we served. In the fourth quarter, all our industrial sub-businesses grew net sales versus the prior year period, showing the resilience of this end market in the face of the pandemic and pushing new sales to new quarterly highs in many cases. Exalta's performance also exceeded broader industrial production metrics, with Q4 industrial production up a modest 0.3% globally, though clearly better than the decrease of 2.5% in the third quarter. We experienced particular strength in our energy solutions, coil, and powder coating businesses, driven by broader industrial production recovery. Additionally, U.S. homebuilding and remodeling continued to buoy our wood business, which showed excellent growth in the period. strength in auto production was a tailwind for the industrial eco demand. Forecast of global growth in 2021 point to continued expansion for this portfolio of businesses. In transportation coatings, an ongoing V-shaped recovery from lows in April and May continued to play out during the fourth quarter. Global auto production increased 2.5% in the quarter versus the prior year, propelled by strong global demand and efforts to restock low dealer inventories. This growth was led by Asia Pacific, with a 4.3 percent increase, including a 5.9 percent increase in China. EMEA posted a modest 0.2 percent increase. Latin America saw a 3.5 percent increase. And North America lagged somewhat, posting a 1.2 percent decrease due to the 12.8 percent lower volume in Canada in the period. Exalta's business matched pace with these global trends, led by Strength in the Americas and EMEA. Current industry forecasts call for a 13.4% increase in auto production for 2021, which we expect will support Exalta's businesses well through the year. With the commercial vehicle end market, overall global truck production increased 11.3% in the fourth quarter, led by a 20.3% increase jump in Asia Pacific, but also supported by an 11.3% increase in North America, which continues to be the largest part of our commercial vehicle business. This was offset somewhat by 15.4% lower production in EMEA and relatively flat rates in Latin America. The current forecast for class four to eight truck production for 2021 calls for a 3.1% dip in global production. However, these forecasts indicate we could expect to see impressive 18.7% market growth, excluding China, with North America at 17.3%. Current demand indicators remain healthy across most regions. In the U.S., recent order rates have been excellent, while heavy-duty truck inventories remain at longer-term normal levels, supporting continued production rates. With that, I'll now turn the call over to Sean for some additional comments. Thanks, Robert, and good morning. As mentioned, our fourth quarter was marked by continued recovery across nearly all end markets we serve, and we executed well in the period to exceed our targets for all of our key metrics. Net sales, down 2% year-over-year, were better than expected as recovery in automotive, commercial truck, and broad industrial markets progressed faster than expected. Performance Coating's fourth quarter net sales decreased 3.5% versus the prior year quarter, with refinish decreasing 10.4%, offset partly by industrial, increasing an impressive 8.6%. The refinish result was still stronger than the third quarter levels as expected. Transportation coatings net sales returned to growth in the period, increasing a modest 0.5% compared to the prior year quarter, driven by light vehicle growth of 2.4%, offset by commercial vehicle decreasing 6.7%. though notably better than the 22.5% drop seen in the third quarter as truck production rates increased through the period on the back of strong orders. Product price mix in the fourth quarter was essentially flat at negative 0.2% on a consolidated basis, with no major deviations between the end markets. We have previously noted an expectation that price mix would revert positively in refinish in alignment with volume improvement. Price remained a positive driver within refinish in the period, though. Consolidated adjusted EBIT for the quarter was a very strong $205 million, coming on the heels of the record-setting $210 million in the third quarter result, and representing an impressive 18.4% growth versus fourth quarter 2019. Performance coding segment level adjusted EBIT of $130 million increased 9.7% year-over-year, aided by tailwinds from cost actions, as well as some help from variable input costs. Adjusted EBIT margins increased an impressive 220 basis points to 18.4%. Transportation coding segment level adjusted EBIT of 48 million nearly doubled the 26 million result from the fourth quarter of 2019, also driven primarily by cost actions and moderate variable cost tailwinds. Adjusted EBIT margins increased an impressive 600 basis points to 12.9%, sustained by recovering volumes as well as the cost tailwinds previously noted. Adjusted EBITDA for the quarter was $253 million, a solid 8.6% increase from the prior year quarter, with associated margins of 23.5%, up 230 basis points from 21.2% in the prior year quarter. Fourth quarter adjusted earnings per share of $0.58, a 38.1% increase above the prior year's quarter's $0.42 per share, represented another excellent result for Exalta. Regarding cost structure actions, we were very happy with the strong execution that led to exceeding our targets for the quarter and year. We delivered over $50 million of total cost savings during the quarter while maintaining strong temporary savings to close the year with an impressive $215 million in total savings, as well as $155 million in incremental cash actions. Regarding our balance sheet and cash flows, we're very pleased that continued focus on working capital and cash actions through 2020 resulted in strong cash conversion through the second half of the year. Fourth quarter free cash flow of $256 million represented a quarterly record compared to $248 million in the fourth quarter of 2019. The strong fourth quarter free cash flow resulted in us ending the year with total liquidity still over $1.7 billion, even considering the approximate $200 million in debt pay down in the period associated with our November debt refinancing, as well as some incremental share repurchases of $25 million in December at an average price of $28.69. Our net leverage ratio was reduced to 3.3 times at year end compared to 3.7 times at September 30th and 4.0 times at June 30th. Our metrics, of course, still include COVID-19 impacts on adjusted EBITDA from the first half of 2020. Now I'd like to share certain of our expectations for the first quarter, noting that this guidance does not take into account any potential impacts from the operational matter that Robert covered in his opening remarks. Regarding our financial outlook, we expect net sales in the first quarter to increase versus prior year by 3 to 5 percent, including expected favorable currency impacts, with most of our end markets remaining in a positive demand trend. Refinish remains the key exception impacted by travel restrictions, which we expect to persist in various geographies near term. That said, we believe that the business will track reductions in COVID-related restrictions, and we anticipate a solid recovery over the course of 2021. In light vehicle, there's a moderate impact during the first quarter from the industry shortage of semiconductors, which has restricted customer production at various sites in the quarter. Much of this lost production is expected to be made up primarily in the second half of 2021. We expect to generate adjusted EBIT of approximately 155 to 165 million and adjusted diluted earnings per share of 40 cents to 45 cents per share in the first quarter, with the other Q1 metrics noted on our guidance slide. We are holding off providing full-year 2021 guidance due to the continued uncertainty associated with COVID-related impacts, especially for refinish. Still, our broader expectation is for the current global industrial expansion to continue this year. and we see a number of supportive elements in play, including global industrial production estimated at 6.3%, a continued strong U.S. housing market, light vehicle production growth estimated at 13.4%, strong growth of Class IV through VIII trucks outside of Asia, which is a small market for us today, and a general economic recovery globally that appears to support Exalta. Exalta remains intensely focused on enhancing productivity and reducing our cost structure. For 2021, we expect to see structural cost savings of at least $50 million, which is inclusive of the restructuring announced last July. We also expect some temporary cost savings to persist into 2021, but will be dependent on the pace of recovery in certain over-end markets. We are mindful of the potential impact of inflating raw materials and logistics costs, which have been a factor now in spot market terms for several months. The coatings industry generally has been effective over time in overcoming raw material cycles with appropriate adjustments to selling prices. And Exalta is currently focused on passing through inflationary costs with price where applicable. Regarding 2021 capital allocation, we continue to expect strong free cash flow this year and fully expect use of capital to include M&A as well as opportunistic share repurchases. With that, we'll be pleased to answer any questions. Operator, please open the lines for Q&A.

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you 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 keys. One moment, please, while we poll for questions. Our first question is from Gansham Panjabi with BARG. Please proceed with your question.