Axalta Coating Systems Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Exalta's first quarter 2021 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 May 4th Those listening after today's call should please note that the information provided in the recording will not be updated and therefore may no longer be current. I will now turn the call over to Chris McCrae. Please go ahead, sir. Chris McCrae Thank you, and good morning.

This is Chris McCrae, VP of Investor Relations and Treasury. We appreciate your continued interest in Exalta and welcome you to our first quarter 2021 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 will 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 effects on Exalta's operating and financial performance. These statements involve uncertainties and risks, and actual results may differ materially from these 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 us to review Exalta's first quarter earnings and our full year financial outlook for 2021. I hope each of you and your families remain safe and healthy. I'd also like to thank the Exalta team globally for their continued perseverance and dedication to the needs of our customers and our partners. Overall, the first quarter showed excellent operating and financial performance, falling on the heels of strong results throughout the second half of 2020. Continued broad recovery across our end markets enabled strong year-over-year top-line improvement ahead of our first quarter guidance provided on February 17th, while strong incremental margins leveraged our cost structure actions to date produced adjusted EBIT, EPS, and free cash flow that set new first quarter records. Net sales for the third quarter increased 8.1% year over year, or 4.9% excluding FX tailwinds. The consolidated business benefited from the comparison against early pandemic impacts during the first quarter of last year, but some headwinds held back additional volume growth for the current period. refinished volumes remained below normal levels due to pandemic restrictions still in place in some key countries we serve. The semiconductor chip shortage that has curtailed automotive production impacted light vehicle and commercial vehicle volumes in the period. Though less impactful to volumes, supply chain constraints due to severe weather, primarily in the U.S. during the quarter, strained material availability in North America while further fueling raw material input inflation. Without these headwinds, which fortunately appear to be transitory, the already strong growth reported in the first quarter would have been even better. It's worth mentioning that we believe much of this lost volume will be made up as demand remains very strong, but we expect these headwinds to persist during at least the early parts of the second quarter. Exalta's quarterly adjusted operating profit was impressive. Adjusted EBIT of $183 million increased 36 quarter with associated margins of 17.2%, up an impressive 370 basis points from 13.5% in the first quarter of 2020. These results exclude the impact of the previously disclosed operational matter at certain North America Mobility Coatings customer manufacturing sites, which resulted in a charge of $94 million in the period. I note that the actual cost associated with this matter could be materially less or greater than this charge once we complete all aspects of the evaluation process and resolve associated liabilities. Our initial estimate, as filed in our 10 identified a possible range of loss up to $250 million. Additional progress on the matter since our 10-K filing, and including the first quarter charge, indicates a decreased possible range that is not expected to exceed $160 million in the aggregate. Adjusted EBITDA for the first quarter was $237 million, with a 22.3% margin, reflecting a 290 basis point improvement from 19.4% in the prior year. adjusted EPS of 50 cents compared with 31 cents in the first quarter 2020, an increase of 61.3%. Free cash flow for the quarter was another terrific performance, with a generation of $11 million versus a use of $20 million in the prior year. First quarter free cash flow is typically a use due to timing of annual payments, so the result was aligned with the strength of our operating results in the quarter. Regarding capital allocation elements, we closed our first ever M&A deal in China in early April. A leading supplier of wire enamels to the Chinese electric motor market. The transaction boosts our energy solutions business, especially in Asia Pacific, while adding local manufacturing capacity at a fit-for-purpose cost structure. This is a great example of a strategic bulk-on deal that we will continue to pursue as we ramp up our M&A activity and leverage an active pipeline of potential targets. We also recently announced that Exalta's board increased our share repurchase authorization by $625 million, and we now have about $800 million in total availability to buy back stock through our repurchase program. we repurchased $64 million worth of shares during the first quarter. Regarding first quarter business conditions, we saw strong demand from all of our end markets through the period, with continued recovery evident across global industrial codings and notable underlying demand strength in both automotive and truck markets. For refinish, the pace of business overall in the first quarter was consistent with the end of the fourth quarter, with pandemic restrictions dampening total miles driven in affected countries. We saw signs of underlying strength in March, which has continued in early April. However, we expect improving demand during the balance of 2021 to be in line with the ramp up in COVID vaccinations and as more normal traffic conditions return. North America miles driven during the fourth quarter remained around 7% lower year over year, but the pace of activity gained momentum throughout the quarter, with March and early April accelerating very close to normal levels of traffic. Body shop activity for Exalta customers was around 12% below normal in the period. This, too, was stronger toward the end of the quarter. In EMEA, vehicle miles driven during the first quarter remained around 16% lower year over year, and body shop activity was around 15% below normal. though both were variable by country, aligned with applicable government restrictions in place during the first quarter. Miles driven improved sequentially through the quarter, but then slowed somewhat into April. We expect a continued increase through the spring as certain restrictions are expected to be reduced and lifted. Vehicle traffic in Asia Pacific has also been quite variable, but most countries remain above pre-COVID levels for the quarter. We continue to expect refinish demand recovery through the remainder of 2021, aligned with the pace of eased restrictions as well as vaccinations and post lockdown travel recovery globally. We believe that pent up travel demand, a preference for using one's own vehicle instead of taking public transportation or using ride sharing services and mobility normalization will be key drivers of Exalta's refinish business in 2021. which also suggests a brighter volume outlook as the year progresses. When driving patterns move back to normal, operating leverage for Exalta as a whole will be quite high given the profitability of our refinish business. In industrial codings, solid demand in the quarter remained firm across most market segments we searched. Similar to the fourth quarter, we saw strong growth in net sales year over year in all of our end businesses. First quarter global industrial production increased 4.6%, driven primarily by recovery in China versus the COVID-impacted quarter last year and a flatter profile for North America and EMEA. Exalta's net sales growth of 10.1% in the quarter clearly outperformed the global picture, including notable outperformance relative to Western industrial production results. Standout sources of strength in our industrial and businesses included energy solutions, powder coatings, and general industrial. At a market level, U.S. home building and remodeling continued to support growth for our wood business, and automotive markets remained healthy at a retail sales level globally. Additional tailwinds were seen across structural steel, agriculture and construction equipment, pipe, as well as distribution customers within Exalfa's general industrial business. Forecasts of global industrial growth in 2021 continue to support expected growth for our diversified industrial coatings portfolio. Many may have seen that we rebranded our former transportation coating segment as mobility coatings. While a small name change, the shift is far more impactful than it may appear. as it aligns with the broader lens with which our new segment leader, Hattie Iwata, is taking with the business. We see the dramatic and fundamental shifts taking place in the mobility sector as a unique change moment for the industry. And Exalta is proactively positioning our strategy and ambitions to meet these new opportunities. Hattie will be offering more detailed thoughts around this theme on May 5th at our Capital Markets Day. In mobility coatings, the global market recovery continued, though marred by supply chain shortages impacting production in the first quarter. Global auto production increased 14% in the quarter versus the prior year, propelled principally by the China rebound from production shutdowns during the first quarter of 2020. Asia Pacific led with a 32.6% increase, including a 78.2% increase in China. EMEA posted a 0.9% decrease, Latin America saw a 5.4% decrease, and North America was down moderately with a 2% decrease, including 14.9% lower production in Canada. Exalta's net sales somewhat trailed the global average, largely due to our smaller position in China automotive, while results more closely matched the market in other regions. Current industry forecasts call for an 11.9% increase in global auto production for 2021, which has been trimmed from the earlier 13% to 14% growth forecasts due to the industry semiconductor chip shortage. While the current forecast may continue to slip depending on how the chip shortage plays out, The silver lining here is that it's building in further growth to the medium-term forecast as lost production near-term is not actually lost permanently since dealer inventories must be restocked and consumer spending remains strong. For commercial vehicle and market, overall global truck production increased 44.6% in the first quarter led by a 76.1% jump in Asia Pacific, but also supported by a 4.1% increase in North America, where Exalta derives the largest share of our truck-related business. EMEA and Latin America both remain more subdued, with low to mid-single-digit declines in truck production in the period. The current forecast for Class IV to VIII truck production for 2021 remains intact, expecting a slight 2.1% increase in global production. Including China, however, the market is expected to rebound 22.6%, led by North America at 25.8%. Current near-term truck demand indicators remain healthy across most regions. In the U.S., order rates in March were near all-time highs, with Class VIII orders around 40,000, supporting continued solid production rates for coming months. Switching now to innovation. Exalta is driven first and foremost by innovation, which remains the foundation of our market strength and will enable our long-term growth. Last week, it was announced that Exalta won three 2021 Edison Awards, which are given for outstanding innovation in products or services. The three awards cover innovations across multiple aspects of our businesses, including coatings that enable LiDAR reflectivity for autonomous vehicles, an ultra-high performance waterborne sealer for the refinish market, and two coatings for the kitchen cabinet market that require only one coat compared to four coats previously, thereby reducing customer cost and time. These three awards follow the 2020 Edison Award that Exalta won for our Voltatex impregnating resin for electric motors, which greatly improve electric motor efficiency and reduce electric motor size and weight. i could not be prouder of our r d and technology organization and the entire team at exalta these awards highlight that exalta is at the top of the coatings industry and innovation and delivering exceptional value for our customers i'll now turn the call over to sean for some additional comments thanks robert and good morning As mentioned, our first quarter witnessed continued recovery across nearly all markets we serve, and we continue to execute cleanly to exceed our targets set for the quarter. Net sales, up 8.1% year-over-year, were slightly better than expected versus our 3% to 5% guidance from February, as recovery and refinish, as well as the broader industrial markets, continued at a solid rate. Performance Coating's first quarter net sales increased 9.2% versus the prior year quarter, with refinish increasing 8.5% and industrial increasing 10.1%. The refinish result included support from a stronger China performance year over year, but still lacked a full volume profile given ongoing lower miles driven in most regions and lower associated accident rates. Refinish did not realize a noticeable benefit from customer restocking in the period. though we anticipate improved volume over the course of the year, and this could include some restocking volume as the year progresses. Mobility Coatings net sales also demonstrated ongoing recovery in the first quarter, increasing 6.1% compared to the prior year quarter, including light vehicle growth of 7.2% and commercial vehicle growth of 2.2%. Volumes were boosted by recovery in China and light vehicle from the prior year comparison, but offset by the semiconductor chip shortage impacts in the current year quarter. Product price mix was a modest 0.3% positive contribution on a consolidated basis for the quarter, led by light vehicle, which saw mixed benefits in the period, and offset by modest declines from industrial and mixed from refinish. Price and refinish remained a positive driver in the first quarter. Commercial vehicle was relatively flat in the period. Consolidated adjusted EBIT for the quarter was a very strong $183 million, following our record-setting results during the second half of 2020 and marking another record for our first quarter, excluding the charges from the operating matter that Robert had noted. The stark 37.8% growth rate versus first quarter 2020 underscores the momentum of positive cost management that persisted into the new year. We achieved ongoing savings in operating costs for the quarter, including the continued pacing of structural cost savings from Exaltaway initiatives, as well as from somewhat better than expected carryover of our temporary savings from 2020. Adjusted EBITDA for the quarter was $237 million, a solid 24% increase from the prior year quarter with associated margins of 22.3%, up 290 basis points year over year. Fourth quarter adjusted diluted earnings per share of 50 cents per share, a 61.3% increase above the prior year quarters, 31 cents per share, represented another excellent result for Exalta. Performance coding segment level adjusted EBIT of $117 million increased 47.6% year-over-year, driven primarily by continued cost management benefits and associated strong incremental margins given the volume recovery. Adjusted EBIT margins increased an impressive 430 basis points to 16.6%. Mobility coding segment level adjusted EBIT of 39 million compared favorably against the 26 million result from the first quarter 2020, also driven primarily by cost actions and aided by the favorable volume comparison. Adjusted EBIT margins increased 330 basis points to 11%, a stellar level for the first quarter. Regarding our balance sheet and cash flows, we were pleased that first quarter free cash flow of $11 million represented a first quarter quarterly record compared to a use of $20 million in the first quarter of 2020, driven by strong EBITDA as well as continued solid working capital management. The strong first quarter free cash flow resulted in the result of ending the quarter with total liquidity still over $1.6 billion, even after incremental share reverses of $64 million in the period. Our net leverage ratio decreased to 3.2 times at March 31st compared to 3.3 times at December 31st. Our metrics, of course, still include COVID-19 impacts on adjusted EBITDA from the lows of the second quarter of 2020. Regarding our financial outlook for the full year 2021, our broader expectation remains that the current global industrial expansion will continue to support Exalta's growth, including tailwinds across most key markets that we serve. Exalta's global and emerging markets-focused business is aligned well with this backdrop of accelerating global growth as we emerge from the pandemic period. At the same time, we are focused on continued growth execution in our businesses, including innovation-led market share gains, leveraging Exalta's leading technologies, and service-based business models. For full-year net sales, we expect an increase of approximately 20% to 22% including the 3% positive from foreign currency translation and slightly less than a 1% benefit from the acquisition announced earlier this month. With that net sales forecast, we anticipate strong contribution from both segments, though weighted slightly stronger in mobility as a relative percentage of growth in both net sales and in sales volumes due to the more severe impact seen in the segment in the second quarter of 2020. For refinish, we believe the easing of mobility restrictions coupled with the ongoing vaccination progress will produce a solid recovery over the course of 2021 for the business as vehicle traffic resumes more normal pacing. Our current assumption is that refinishment sales volumes for 2021 will remain lower than 2019 for the full year by a high single-digit percentage due to the impact of the pandemic. For light vehicle, we do anticipate ongoing impacts from supply chain shortages to persist through most of the second quarter, but we believe a good portion of the production shortfalls will be made up during the second half of 2021. Industry forecasts currently call for approximately 1 million vehicles to be delayed from the second quarter to the second half of the year and partly into 2022 due to the shortages, while the first quarter saw 1.4 million vehicle production shortfall impacts. For exalted net sales volumes, we expect to moderately outperform the global market forecast of 11.9% for the full year. We expect to generate adjusted EBIT of $715 to $755 million, and adjusted diluted earnings per share of $1.95 to $2.10 for the full year, with other key income statement metrics noted on our guidance slide. For adjusted EBIT, we expect that the second quarter will represent approximately 23% of the full year adjusted EBIT, including ongoing impacts from headwinds that we noted from the first quarter. We also expect to see variable cost inflation more materially in the second quarter. For the full year, we anticipate high single-digit cost inflation for variable cost at the COGS level. Exalta is focused on passing through these cost increases primarily through selling prices to the channels we serve, while staying mindful on cost structure as needed during the early phases of the inflationary cycle. We continue to expect strong free cash flow this year of between $455 to $495 million, excluding any outflows related to the mobility operational matter, and expect uses of capital to include further M&A transactions as well as ongoing share with purchases. With that, I 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 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 your questions. Thank you. Our first questions come from the line of Gansham Punjabi with Baird. Please proceed with your questions.

Hey, guys. Good morning. Hope everybody's doing well. I guess following up on the last few comments, Sean, in terms of auto-refinish down high in single digits versus I think the 2019 baseline is what you said, how is that expected to evolve by region? What sort of outlook are you baking in in terms of how the mobility dynamic globally starts to improve as we cycle through the next few quarters? I know it's a very complex environment, but just curious as to what you have embedded for the rest of 2021.

Gosh, and this is Robert. I'll take that one. I'd say that in the first quarter, we saw sequential improvement month to month. And for April, we're expecting to see similar levels as we saw in March, driving a large increase, obviously, for the second quarter year over year. North America is expected to be higher than March. And for EMEA, we expect it to be slightly lower, given some of the recent COVID lockdown activities. And then for emerging markets, Asia and LATAM, it's a mixed bag there, but we expect them to be flat to slightly down. We expect to be significantly up for the full year versus the prior year, obviously, as we lap the COVID impact. And although we have some lingering COVID restrictions throughout the world, particularly in EMEA, we expect demand to be up given pent-up travel demand as well as vaccination rollouts. So sales volumes for the year are expected to be down roughly mid to high single digits from pre-COVID 2019 levels, but we expect them to be up significantly compared to 2020.

Got it. Perfect. Thank you. And then in terms of the cost inflation, you know, obviously everybody's upgrading. Rob McGill, Cost Inflation Guidance, I think you said high single digits versus last year. How should we think about price costs as we progress through the rest of the year? And maybe from a higher-level perspective, you can compare this current pricing cycle that you've been implementing along with your peers relative to the most previous cost inflation cycle, 17, 18.

We expect to fully cover raw material inflation during the course of the year, primarily via price pass-throughs. And if we think about that by business, in a refinish, we typically schedule price increases and have been able to pass on raw material increases fairly efficiently. I think our value proposition is not based on material costs, but rather the technology we offer and the associated efficiency gains at the body shop level. For industrial, end businesses should be able to increase price, but really full realization is determined by individual markets and competitive factors. Only a small portion of the total end market there is based on index pricing, so we're fairly confident of our ability to price through on the industrial side. In mobility, roughly 25% of our business is covered by indexing, with the remainder under contractual language that allows us to discuss pricing. So we've generally been able to successfully over time pass through sustained inflation, albeit with some lag to the realized increases. And the price increases outside of the index will also be achieved with new colors and on leveraging our services. And Gancham, maybe just to cover the uniqueness about second quarter and why you're seeing a little bit of a drop from a margin perspective with well material inflation really starting to hit us. Industrial, we're doing a nice job in getting realization there. We're putting incremental actions in from a refinish perspective, but similar to past cycles, the mobility side of the business will be a little bit lagging. But as Robert pointed out, we expect to be fully caught up by the end of the year in the aggregate. And certainly to the extent we have Any sort of leakage, we'll be looking at productivity improvements to make sure our margins hold. Perfect.

That's very helpful. Thanks so much. Thank you. Our next question has come from the line of Steve Byrne with Bank of America. Please proceed with your question.

Good morning. The guide on EBIT clearly shows a shift into the second half, and presumably that's a recovery in volumes from the chip shortage and the recovery of RAS and so forth. But I was curious, Robert, if you're seeing any signs yet of, some traction from some of the management changes you made and or the structural change ripping out that matrix structure? Anything that you're seeing that could be driving growth that you're now expecting to realize in the second half? Or is this really just simply a shift?

Well, I think you hit the nail on the head when you mentioned the management team. You know, we have added some very high-quality global P&L executives to our business leadership team, and they are already having a dramatic impact on the aggressiveness with which we're planning to grow the business, creative ideas, and new approaches. We've also added some very competent functional leadership as well. The overall matrix structure and ripping that out and having that now be global business units supported by strong functions has really allowed us to streamline the organization and our cost structure. So I'd say that, you know, if you had to kind of sum it up into how much of it would you say is due to the management impact versus how much of it is due to simply market drivers, I think a heavy element here is the management team. And I think we are now at a point where we have a world-class management team that is really making a difference both on the commercial side of the business as well as on the cost side of the business.

And just to follow up on a couple of those Innovation Awards comments that you made, Robert, the one coat on a kitchen cabinet versus four seems pretty compelling from the manufacturer's perspective, but could be a significant volume hit. Is that more than offset by the potential for you to gain market share in that industry and or realize a much higher price to offset lower volume? And is the same true on the refinish technology? How much of an impact does your latest technology have on a body shop's ability to push vehicles through that paint booth that is meaningful in terms of share gains, but maybe lower volume for you?

Well, I think the way to think about this is we are not selling gallons of coatings. We are selling solutions. And so we price the value that we create for our customers accordingly. So again, the way to think about it is we're pricing for a solution and the value that we create for a customer, not necessarily based on volume. Therefore, again, as we've highlighted, it's important for these businesses in coatings to really look at net sales. Volume, per se, can be somewhat of a tricky metric when judging how successful you're being from a commercial perspective. On the element of the Edison Awards that we won, as well as other awards that we've won for our technology. About two and a half years ago, we really refocused some of our R&D efforts, and we changed some of the emphasis that we had from incremental improvements to really spending a little bit more money on some aspects, applications, products, and even new business models, frankly. that could really be game changers. And so I think you'll continue to see some pretty exciting developments across all of our businesses from a product, from a service, from an application, as well as from a business model perspective that I think is going to keep us at the forefront of the coatings industry. Thank you.

Thank you. Our next question has come from the line of Jeff Kauskos with J.P. Morgan. Please proceed with your question. Thanks very much. What was the changing price in refinish exclusive of next in the quarter, and how would you compare it to normal historical patterns?

So, Jeff, we didn't actually quantify it. The only thing we signaled is that we actually got price in the quarter. It was modest, but it's similar to prior periods. Certainly, we have a mixed component that's somewhat camouflaging the pricing progress and the refinish side of performance.

In your operational issue, how much did you accrue in current liabilities for the payout of funds?

Yeah, so there's roughly $94 million that was accrued in the quarter, and that does not contemplate any sort of insurance recoveries, which we're still working on. Is that in current liabilities?

It is. Okay. Thank you very much. Thank you. Our next question has come from the line at PJ Juvecard, New City. Please proceed with your questions.

Yes, hi. Good morning. So you made an acquisition in China. I mean, I would imagine the China coatings market is highly fragmented. You know, what are the opportunities there, and is this like a beachhead that you're establishing to make more acquisitions?

PJ, we already have a fairly good-sized business in China in our energy solutions business. The acquisition of Anhui Shengran added somewhat less than $40 million in annualized sales, for which we paid less than $15 million in total purchase price. So it was an attractive transaction for us. Anhui provides Exalta with really a solid platform to further grow the energy solutions business in China, as well as in other Asia-Pacific markets. And it also allows Exalta to substantially increase our capacity, which is something that we really needed to do because the demand there for electric vehicles and other electric applications is really growing. It also adds products for large volume applications, which will complement our portfolio of specialties. And they also brought to the table a whole suite of other customer approvals. So we believe that this acquisition provides a powerful commercial as well as cost synergies with significant further growth opportunity. And in general, e-mobility and electronic coatings is a key area of focus for us, not only in China, but around the world. Great.

And then your charge that you took, potential of up to $160 million today, Can you just talk a little bit about that? You took $94 million in this quarter. So would that remaining would be in the second quarter? And can you just tell us what happened here and kind of what steps have you taken that it doesn't happen again? Thank you.

So, PJ, there's obviously commercial sensitivity, so we can't go too far in giving too much as far as details. But you'll recall as part of year-end in our Form 10-K, we disclosed a reasonable possible amount of up to $250 million. So what you saw in the quarter is we've been working collaboratively with our customers at our customer sites and working through the issue, understanding root cause, getting through testing. So what you saw in the first quarter is we made a good amount of progress, but a number of sites actually came off the table. There weren't any issues, and that's where you see the overall range decreasing from the 250 to 160. The $94 million, that's where we have line of sight into the actual root cause, so that's why we accrued in the first quarter. It's hard to say exactly when we'll reach conclusion on the residual and if there's actually an issue there that could result in a probable liability, and that's why we've actually disclosed in the 10-Q the possible amount of the incremental $65 million. But I can't tell you exactly when we would accrue that or if we would accrue it. And the other thing I did point out earlier, this is before any sort of insurance recoveries, which we're working with our insurance providers right now. And adding to what Sean said, the root cause has been identified, has been remediated, and additional controls have been put in place so that it does not happen again.

Great. Thank you.

Thank you. Our next questions come from the line of Laurence Bard with Exane. Please proceed with your questions.

Yes, good morning all. Robert, I've got a question on capital allocation and I guess, thank you very much for the disclosure on the acquisition, on the size of the acquisition. So it looks like you have spent more on buybacks than on M&A, I guess, so far. In the future, how do you intend to arbitrage between, I guess, buybacks with the upsized buyback envelope versus acquisitions? And can you talk about the M&A pipeline from here? Thank you.

Yeah, well, let me start, I guess, with the M&A pipeline. We've concluded our first substantive acquisition over the past two years, and we have a really full pipeline of bolt-on transactions. That being said, we would not have brought on someone of Jeremy Rowan's caliber unless we were planning on doing much larger acquisitions. and other types of ventures. So I think you can expect to see us be more active, but again, valuation discipline as we always have been. And I would think of share buybacks and M&A as two areas where we will deploy capital. If we continue to see our stock be undervalued, we will continue to buy back our stock at greater rates But we will now systematically buy back our stock to offset dilution, plus an additional few percentage points on top of that at a minimum. And as we have other opportunities due to market aberrations to buy our stock at depressed levels, we will continue to do so. So I think that's really where you would expect to see the majority of our excess capital and cash flow be deployed.

Thank you. And as a follow-up, you mentioned that there had been no restocking and refinish in Q1. I was wondering if you could talk about your assessment on inventory levels in industrial, in particular given that your volume started to recover very quickly in Q3, seemingly ahead of IP. So do you think that inventories have actually normalized already, or could that happen later this year?

No, I think pretty much across all of the industrial markets that we serve, inventory levels are really lean. Part of that is the way people have been running, but I think it has much more to do with some of the supply chain issues that are out in the marketplace. That segment of the market, much more so than light vehicle or refinish or commercial vehicle, or decorative coatings, frankly, industrial is really the area where raw material shortages have really had the biggest impact. So I think a lot of the industrial customers are running in a pretty lean fashion just due to the availability of materials more than anything else. So as those... customers restock as there's more availability of raw materials, I think we could see somewhat of an inventory build there at some point during the year when supply normalizes.

Thank you.

Thank you. Our next question has come from the line of John McNulty with BMO Capital Markets. Please proceed with your questions.

Yeah, thanks for taking my question. Just on the refinish potential for restocking, can you help us to understand what that actually might mean in terms of volumes for you? I mean, is it a 1% or 2% ad? Is it bigger than that? I guess how should we think about, as the refinish business restocks, what that could mean to the overall volumes? It's difficult to put a number on it. What I would say is that I would think of it as a rubber band, John. I mean, when we start to see people get back to work, kids go back to school, I'm talking globally, not just U.S. here, and we see traffic patterns and traffic congestions come back to normal, I think we're going to see a tremendous snapback in volume and in activity in that business. And I think the interesting thing is given the profitability of that business, of course, the operational leverage for a company like Exalta is huge. So I can't think of many companies that are more of a COVID rebound play than Exalta. Got it. No, fair enough. And then I guess maybe another related question on the refinish side. It seems like in part because of all the semiconductor issues and what have you for auto OEM that the used car market seems to be heating up pretty meaningfully. We're seeing kind of really big sticker inflation, that type of thing. Does that Does that move the needle when it comes to the refinish side of your business? Is there any correlation that we should be thinking about in terms of used car sales picking up and used car values picking up where we could see some lift on the refinish side, or is that a little bit too much of a stretch? How should we think about that? I would say that that element is a fairly minor variable in the total equation that drives refinish activity. So I wouldn't spend too much time on that particular area. Got it. Thanks very much for the call.

Thank you. Our next question has come from the line of Arun Viswanathan of RBC Capital Markets. Please proceed with your questions.

Great. Thanks, guys, for taking my question. Congrats on the strong performance here. I guess first off, just on light vehicle, could you just elaborate on your earlier comments about the ship shortage potentially elongating the cycle and not necessarily being as much of an impact longer term on 22? Thanks.

Well, I think forecasters estimated approximately that about 1.4 million vehicles were impacted in the first quarter and then expected another million in the second quarter with some additional bleed through into the third quarter. The expectation is that many of those vehicles will still be made up in the second half of the year, though some of those units will probably now not be built until 2022. Exalta saw a fairly similar impact to financial results relative to the global impact and expect some lost sales to be made up in the second half. And those updated market forecasts actually came out last week, and that's why some of the data that you may hear from us on this topic versus some of our competitors may differ slightly. It's because we have, you know, as of the time of this call, the updated forecasts. Okay, that's helpful. Back when we gave year-end guidance, IHS was forecasting auto bills to be up 13% to 14%. We're closer to 12% now. Still around a little over 83 million cars to be built in 2021. So certainly a good amount of the 2.4 million cars Robert referenced is going to be made up in the second half, but we will see slippage in 2022. Okay.

Thanks. And then maybe I can ask a question on commercial as well. Have you seen any impacts there due to this chip shortage? Or what's your outlook for, I guess, how that business evolves over the next couple of quarters?

We did see some impact in commercial vehicle, but I think we expect it to be mostly focused in the first quarter and then a little bit of perhaps a little bit of impact in the second quarter. For the full year, we expect strong continuation of truck strength in the Americas and EMEA, potentially with some retraction in China as C6 and government incentives cease. I think we expect strong continued performance from trailer and constructors, especially those associated with some of the last mile delivery scenarios. Power sports and RV also continue to show pretty good performance resilience and favorable order intakes. BUS is going to be a little bit more dependent on vaccination and herd immunity, but government incentives for EV-powered assets could really play quite favorably later this year and beyond.

Thanks.

Thank you. Our next questions come from the line of Vincent Andrews with Morgan Stanley. Please proceed with your questions.

Thank you. Good morning. Maybe just an update on the cost savings. And I guess in particular, you know, there are obviously costs that came out last year that were COVID specific, and some of those were supposed to come back this year. So maybe just an update on where we are there. And I think, Robert, you also mentioned, or maybe it was Sean, you know, that you have some flexibility, you know, to manage sort of the price raws scenario. So maybe just help us bridge where you are versus your expectations and how much incremental flex you think you actually have that you could put to work this year. Yeah, on the temporary savings that we initiated last year, most of those are starting to tell off. We had roughly $20 million in savings in the first quarter. It'll be a marginal benefit in the second quarter as those costs will start to come back in as we support volumes, especially heading into the second half of the year where we're expecting a strong recovery. As it relates to Exaltaway, we have roughly $50 million baked into the guidance construct. A big part of that are the initiatives that we announced last year and getting a full year run rate impact this year. Vincent, at this point, we are expecting globally on a consolidated basis that we will offset the role of inflation with pricing. To the extent we see a little slowness in a particular end market, that's where we may have to do a little bit more on the productivity side. But right now, we are contemplating an offset from a top-line perspective. Robert, if I could just ask you, the board obviously made a strong statement with the incremental share repurchase authorization. My question, this has been discussed over the life of your organization. you know, being a public company, what's the latest thinking from the board on not paying a dividend versus buybacks and so forth? And I just ask because, you know, not paying a dividend, you know, there is a group of the long-only investment community that is income-oriented, and if there's no dividend, you know, they just don't buy the stock. And likewise, you know, maybe you could throw in the latest comments just on managing the debt level, because obviously also, you know, high leverage levels, you know, are an issue for some folks. So just how the board sort of thinking about buybacks versus the other opportunities. Thanks. When it comes to capital allocation, we always look at returns and what can generate the highest returns for investors. So anytime we're going to make a decision, to invest a significant amount of capital. We're looking at what are our opportunities to deploy that capital internally, which tend to be pretty high RR and very low risk type of projects. We also have, of course, the ability to buy back our stock and depending upon where it's trading, That also has a certain return associated with it. And then we look at M&A, and depending upon what type of an acquisition it is and the risk profile of that acquisition, we also calculate a risk-adjusted return, and we compare all of those as well as the return from initiating a dividend into our thinking. So that's going into our calculus any time we make an investment decision. At this point, we feel that fueling our innovation engine internally, which is yielding, you know, I think very good results. And you'll see and you'll hear about it in Vestor Day, some of the exciting things that we're working on. And I think you'll see over the next couple, three years, some really revolutionary developments. So that's obviously a very attractive area for us to invest is in continued innovation. So as we've looked across all of those investment possibilities and the benefit that we get from innovation as well as the value that we can create from making acquisitions that are consistent with our long-term strategy, not acquisitions just to add sales to the company, but rather acquisitions that are specifically aligned with our strategy. We feel that acquisitions, investing in innovation and share buybacks are our best pieces of capital at this time. Also, as we bring down our leverage level over time, and we are a little bit more mature in some of those areas, it is possible that we would start a dividend. And we've talked about this a lot at a board level, but it doesn't feel like the right time for us at this juncture. Thank you very much. On your question on debt, we are not concerned. Investors should not be concerned. Net leverage is at $2.6 billion when you look at our net leverage ratio. It ticked down to 3.2 times. And when we get to the end of the second quarter, if we don't do anything meaningful as far as share repurchases or M&A, we'll be closer to 2.6 or 2.7 times as the second quarter of 2020 drops off. And when you look at the midpoint of our range from an EBITDA perspective, we're going to have $135 million of interest expense opposite EBITDA at the midpoint of the range at $970 million. So when you look at our interest coverage, you know, there's plenty of room there. So we're not at all concerned on our current leverage where it sits today on our balance sheet.

Thank you.

Thank you. Our next questions come from the line of David Begleiter with Deutsche Bank. Please proceed with your questions.

Thank you. Robert, can you quantify the gap between RAS and selling price in Q2 2021? and how that will trend in Q3 and Q4?

So, Dave, we're not going to get into the gap, but certainly that is adding a little pressure from a margin perspective in the second quarter, and we expect to be fully caught up as we get in the third and fourth quarter.

Understood. And just in the operational matter, have there been any customer repercussions from this event? Do you expect to lose any business longer term? Or is this a one-off event that will have no impact on the ongoing company's operations?

Yeah, it's a great question. We don't believe that there's going to be any ongoing underlying impacts. You know, we've been working very collaboratively with the customer group. We feel really confident, you know, that there won't be any loss.

Thank you. Thank you. Our next question has come from the line of Kevin McCarthy at Vertical Research Partners. Please proceed with your questions.

Good morning. Aside from the external issue of shortages of semiconductor chips, did you encounter any shortages of raw materials that you buy? And if so, which ones and what were the effects related to that? Well, there are quite a number of shortages of varying degrees and quite a number of companies that have declared force majeures. I would say in general, we're seeing supply shortages largely in monomers, resins, and isocyanates. And then there are specifics within some of the other categories of certain items. So I think it's across the raw material basket in general, but as I said, predominantly concentrated in monomers, resins, and isocyanates. And, you know, I think for the most part, in the first quarter, we didn't see a meaningful impact on our businesses. But certainly, you know, we are monitoring and managing this on a day-by-day basis. And it is a little bit, you know, kind of hand-to-mouth each day in certain products.

Okay, that's helpful.

And then I wanted to follow up a little bit on the semiconductor chip shortage issue. What we've heard from some other companies outside of the coatings industry is that there were some mitigating factors, such as a mixed shift toward SUVs and trucks, and in some cases, auto manufacturers making cars without the chips with the intention of installing the chips later on. Did you see any behavior along those lines, or is it more straightforward that your sales are simply ebbing and flowing with the auto production? Yeah, we've heard the same thing from some of our customers in terms of directing the chip availability in subassembly, trying to direct more of that to trucks and SUVs. where, of course, that's our bread and butter and where Exalta is strongest. So I think that's certainly helpful for us. I think what will be interesting is if we see auto manufacturers start to pay higher prices for chips in order to get a greater allocation of chips that are going into other product types. Thank you very much.

Thank you. Our next question has come from the line of Lawrence Alexander with Jefferies. Please proceed with your questions.

Lawrence Alexander Good morning. Can you flesh out the new business models you referred to? Give a sense for what kind of departures from your business model you're taking or how significant this could be over, say, three, five years?

Lawrence, hi. It's Chris. You know, as much as we could spend time on that, I think, you know, with our capital markets, say, coming up very shortly, I'd really encourage people to tune into that where we can get into a little bit more detail around business models. It's just kind of a lot to cover on an earnings call. So if you don't mind, I think we'll defer that.

Okay. Thank you.

Thank you. Our next question is coming from the line of Mike Sasson with Wells Fargo. Please proceed with your questions.

Hey, guys. Nice quarter. Just one question. Your performance codings, EBIT margins, pretty impressive in the first quarter. If you did get back to 2019 levels of sales for performance codings, your EBIT margin in 19 was 15%. Are you run rating something more like 19-20? Is that kind of what's implied in the first quarter?

Well, I think what I would keep in mind there is that the 2019 levels, we had not yet done the global restructuring at that time. So compared to the 2019 levels, we would have the benefit of the global restructuring. And then as we talked about on previous calls, in terms of just the cost mentality and only putting cost back into the business as we see volume recover, you know, we're continuing to run things very tightly. So I think you could expect to see higher margins on the performance side. There's a certain amount of cost that naturally flows back into the business as you ramp up volumes. but there's another large portion of the cost that is discretionary and in particular related to staffing that we're really keeping a tight control over.

Great. Thank you.

Thank you. Our next questions come from the line of Josh Spector with UBS.

Please proceed with your questions. Hey, guys. Thanks for taking my question. I wonder if you could provide some color on some of the industrial demand, and particularly products into OEM channels, so thinking maybe powder-coating customers. Are you seeing any changes in buying patterns through the quarter that might give any read-through in terms of how those customers are thinking about inventories at this level, or perhaps building or taking things down based on changing OEM forecasts?

Well, overall for industrial, and I know you're asking specifically about our general industrial line, which, you know, goes into auto. I'd say, you know, overall, we expect sales to be up significantly in 2021 versus 2020, even with the strong performance of industrial in 2020. We've implemented price increases across all the industrial submarkets and expect to exceed raw material inflation to the year. In the general industrial area, we continue to see strong demand from automotive, agricultural and structural equipment, and structural steel markets. And for the portion of powder coatings that also goes into the auto OE segment, we are seeing pretty strong demand there. So I think it's really more reflective of the fundamental issue or the fundamental dynamic that demand for vehicles is extremely high. And if you look at dealer inventories in the U.S., they're running in the mid-40s or lower. So the demand is there, and automotive manufacturers are trying to make as many vehicles as they possibly can. But it's an imperfect science to get all of the supply chain aligned to be producing at the same level, given some of the parts shortages that are out there. But at least in what we supply that goes into auto OE, we're seeing pretty good demand.

Thanks. No, I appreciate that. And maybe a quick one, if I may, on just RAS. I mean, the high single-digit inflation that you guys guided towards Are you willing to quantify that at all in terms of what your expectation is on the cost line, what that means for the rest of the year?

Well, when you think about, you know, our roles going through COGS, it's, you know, $1.2 to $1.3 billion. So, I mean, you can do the rough math there. Got it. Thank you.

Thank you. Our next questions come from the line of Jaideep Pandya with On Field Research. Please proceed with your questions.

thank you first one is really on uh evs if you look at your traditional sort of automotive oem quoting business and compare it to you know some of your new ev customers how should we think about market share technology and also profitability in sort of coding an ice car versus an ev car That's my first question. And just a second question really is around raw materials. It's more about purchasing patterns. So in a time where you're seeing good demand from your end markets, and raw material shortages. How much pre-buying do you guys generally engage, or how much pre-buying would your procurement organization engage in sort of the first half of all of 2021, really, to secure raw material supply, you know, to feed sort of that demand? Thanks a lot.

On your first question regarding internal combustion engines versus electric vehicles, We're very supportive of the growth in electric vehicles because not only do we coat the exterior of the vehicle, but we also, as you know, have a very growing business in electric motor coatings. And that business is growing and expanding and is going to expand into other portions of the electronic powertrain in electric vehicles. So we're happy to see vehicles switch over. In fact, every electric vehicle that switches over from ICE is great because we have that additional content for vehicle. and those coatings are very attractive margins so we're very supportive of that and we work with some of the top electric vehicle companies in the world and are rapidly expanding our portfolio in that in in that regard in terms of essentially what you're asking about operational hedging of raw materials, we will pre-buy or engage in other contracts to secure raw materials at attractive prices just depending on market conditions. So, yes, operational hedging is something that we do engage in.

Okay. Thanks a lot.

Thank you. That is all the time we have for questions this morning. I would now like to turn the call back over to management for any closing remarks. Yes, it's Chris McRae. Thank you all for joining this morning. I just want to remind everybody that we're hosting a Capital Markets Day on May 5th.

You can pre-register for that on our website, and we really hope that you join us for that. It should be well worth the time. Thanks for joining this morning.

Goodbye. Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. Have a great day.