Axalta Coating Systems Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Exalta's third quarter 2021 earnings conference call. All participants will be in a listen-only mode. A question and answer session will follow the formal 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 may no longer be current. I will now turn the call over to Mr. Chris McRae. Please go ahead, sir. You may begin.

Thank you, and good morning. This is Chris McRae, VP of Investor Relations and Treasury. We appreciate your continued interest in Exalta and welcome you to our third quarter 2021 financial results conference call. Joining me today are Robert Bryant, CEO, and Sean Lannan, CFO. Yesterday afternoon, we released our quarterly financial results and posted a 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 their potential effects on exalta's operating and 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, everyone.

I'd like to welcome you to our third quarter earnings call. Our third quarter profit highlighted Exalta's excellent execution against the challenging macroeconomic, supply chain, and cost environment. Our earnings exceeded not only our pre-announcement in September, but also our original third quarter guidance provided in July. I would like to thank all Exalta employees for their exceptional efforts in the third quarter. But I especially want to recognize and thank our manufacturing, supply chain, and procurement teams for their Herculean efforts to serve our customers in a very difficult environment and to enable the results we achieved. Drivers of the performance in the quarter included continued broad-based demand recovery within performance codings, as well as solid ongoing pricing traction and continued cost discipline across all businesses. These helped to offset persistent raw material inflation and supply chain constraints, with mobility coatings facing unprecedented customer production impacts, principally from semiconductor chip shortages, which continued through the quarter. Exalta reported ongoing strong year-over-year sales growth of 6% compared to the COVID-19 impacted prior year quarter. driven by growth in all end markets other than light vehicle, which was notably impacted by ongoing customer production constraints. Reported growth included a 4.5% positive mix contribution and a 1.8% M&A contribution offset by a 1.6% decrease in volume. Volume was positive in refinish, industrial, and commercial vehicle, and price mix was positive in all four end markets. Our price capture this cost inflation cycle has been faster than the previous 2017-2018 cycle, and we expect to fully offset current cost inflation by early 2022 on a run rate basis. Refinish demonstrated continued recovery from 2020 pandemic impacts, with total net sales up 10.4% year-over-year and also up slightly versus the third quarter of 2019. Refinish underlying demand remained essentially stable sequentially from second quarter, with modest ongoing recovery from some regions linked to economic and pandemic recovery. Refinish volumes remain below 2019 levels by mid-single digits, which remains very encouraging, leaving further room for net sales recovery as we continue to expect mobility patterns to largely return to more normal levels over time. Industrial net sales increased an impressive 19.5% over a strong prior year quarter, including approximately 4% acquisition contribution, which was also a double-digit rate of improvement from the second quarter of 2019, given ongoing global demand strength. Mobility coatings net sales declined 10.1% in the third quarter and specifically 14.8% in the light vehicle end market, as the segment and end market remains constrained by ongoing semiconductor chip shortage for OEM customers. Commercial vehicle net sales increased a solid 9%, even including some customer supply constraint impacts. These impacts were greater in the third quarter in net sales terms, as well as build impacts, with no easing in the supply chain during the period, which was markedly different than the expected improvement that market forecasters had called for in July. Third quarter adjusted EBIT was 146 million versus 210 million in the same quarter last year, which was a record quarterly profit given notable cost measures we had put in during the height of the COVID pandemic in 2020. Adjusted EBIT for the third quarter included the impact of significantly higher variable cost inflation of approximately 21%, an impact in net sales of approximately 70 million in mobility due to customer supply chain shortages and headwinds from the absence of about half of the temporary third quarter 2020 cost savings of approximately 50 million we had quoted for the total company third quarter demand conditions at the end consumer level across our coatings markets remained fairly robust Refinish witnessed ongoing improvement in mobility metrics across various countries where COVID-19-related restrictions have eased since the spring, also supported by incremental vaccinations globally. Refinish net sales dipped sequentially as expected due to seasonal buying patterns from distribution customers, but Xalta's global body shop activity remained steady and showed signs of firming across most regions. Exalta made net body shop and net stock point gains during the quarter in all geographies, as our industry-leading waterborne and solvent-borne technologies continue to take share. We were pleased to close the acquisition of UPOL in mid-September and are now engaged in initial integration steps, which are all progressing well. We're extremely pleased with the transaction and fully expect to generate the planned returns, which are primarily generated from a combination of initial, highly visible cost synergies, and then more materially, the business growth that we expect to leverage in part by taking advantage of the combined company strengths across global refinish markets. As we previously noted, we anticipate annualized net sales of approximately 145 million and adjusted EBITDA contribution of approximately $38 million in 2021, before initial cost synergies of about $10 million, which we expect to be realized over the next 18 months. Industrial and market demand remains strong globally across virtually all end businesses and geographies. The business saw excellent organic growth and benefited from strategic account wins supported by new product introductions, as well as the benefits of the new industrial organizational structure implemented earlier this year. Topline contribution was strongest in North America, followed by EMEA, with solid growth witnessed in both building products, including luxury vinyl flooring, and general industrial, including the agriculture and construction equipment product lines. Net sales growth would have been even stronger absent the effects of supply chain constraints, which were most notable in intermediate inputs to our powder, building products, and coil product lines, compounded by logistics challenges. light vehicle demand was clearly hampered by curtailed oem production rates due to the ongoing semiconductor chip and other supply chain shortages forecasts of global vehicle production during the third quarter continued to be cut and we now assume around 11 million vehicles removed from global production for the full year consistent with our updated guidance issued in september and at the higher end of the current industry forecast consensus range of 10 million to 11.5 million units, as shutdowns impact nearly all OEMs globally. Our forecast essentially assumes little improvement in the supply shortages seen through year-end and are expected to continue through at least part of 2022. Despite this backdrop, we've won significant new business through the end of September that we expect to begin to ramp up during 2022. Our mobility team has done a terrific job winning new business with our advanced technologies, service, and advanced data tools. Commercial vehicle demand remained solid in the third quarter, though supply shortages have also impacted this end market to a degree. We've seen notable demand strength in North America, where truck orders have remained firm since last year and customer backlog support production rates near record highs over the coming months. Exalta continues to reinforce its position as the market leader with new customer business commitments, including those in our non-truck segments, such as recreational vehicles and sporting equipment. Our order books continue to grow, and Exalta is benefiting from new business awards that will fuel growth in the diversified commercial vehicle and market. During the third quarter, we saw substantial variable cost inflation coming from most raw material categories, as well as energy, packaging, freight, and logistics. These cost pressures deepened during the quarter, and Exalta has increased its full-year assumption of inflation headwinds versus our July guidance to now assume mid-teens growth for the full year and nearly 20% for the fourth quarter. We're working hard as a team to offset this inflation via a combination of incremental pricing actions as well as continuing to focus on cost and productivity actions. With regard to pricing, Exalta has continued to implement increases across all our businesses since last quarter, which are necessary to offset persistent inflation that we have seen since 2020. Looking forward, we expect to take further actions to counter ongoing broad-based inflation expected to continue into 2022. Exalta is also focused on continuing to implement structural cost and productivity measures. We continue to benefit somewhat from the temporary COVID-related cost savings that we have continued this year, with around half of those savings persisting in 2021, in addition to the ramping of structural savings from actions announced over the last year. As part of our continuous focus on sustainability, we made ongoing progress in our ESG programs during the third quarter, In support of environmental priorities, we broke ground on a new facility in China, which will help support the increasing demand for environmentally friendly waterborne mobility coatings. We also showcased our coating solutions for electric vehicle batteries and motors at the NOBE Battery Show in September. Finally, we're wrapping up our goal setting for ESG metrics and look forward to sharing more on this topic in early 2022. I'll now turn the call over to Sean for some additional comments.

Thanks, Robert, and good morning. Third quarter saw continued strong execution by Exalta's global team with supportive demand conditions but clear challenges from inflation and customer production constraints. Despite those challenges, we were able to exceed our guidance construct for profitability originally set back in July, overcoming headwinds particularly late in the quarter to deliver on our top and bottom line results. Third quarter net sales of $1.1 billion represented a 6% year-over-year increase and 3% growth on an organic and constant currency basis, including a 10% increase from performance codings and a 12% decrease from mobility codings. Within mobility, light vehicle net sales declined 17%, partly offset by a solid 8% growth result from commercial vehicle. These results were driven by recovery from the prior year pandemic-impacted period. Refinished demand remained firm in the period, showing continued recovery in most regions served, though volumes were slightly lower sequentially as expected due to anticipated seasonal order patterns. Exalta's industrial end markets saw notable continued strength as all end businesses showed solid top-line growth both year-over-year and versus 2019. Automotive demand at the retail sales level was also solid and even strong when adjusted for limited inventory on hand, though not translating to increased volumes in Exaltus light vehicle end market due to the ongoing global semiconductor chip and other supply chain shortages that continue to impact production for global auto OEMs. Commercial vehicle demand, particularly in North America truck markets as well as recreational vehicles, also remains supportive of current production rates. The volume decline of 1.6% for the quarter was driven by the significant pullback in light vehicle, but was almost completely offset by solid increases from the other three businesses. Price mix contribution was solidly positive, up 4.5% in the aggregate, driven by improvement in both segments and all four end markets, so much stronger in performance codings versus mobility codings. Mix was overall a modest headwind, which was notable switch from second quarter where mixed tailwinds were significant when compared to the prior year pandemic impacted quarter from 2020. FX translation was a tailwind of 1.3%, driven by the strength of the Chinese renminbi, the euro, and other currencies during the quarter. Third quarter adjusted EBIT was $146 million versus $210 million in the prior year quarter, given strong demand and volume trends in performance coatings as well as commercial vehicle, more than offset by light vehicle volume headwinds, substantially increased variable input cost inflation, and lower temporary cost savings versus Q3 2020. Third quarter adjusted EBIT excludes the $19 million benefit to operating charges associated with the mobility coatings operational matter we have previously discussed. as well as made solid progress on insurance coverage for this matter, which we expect to largely mitigate any exposure to Exalta, as well as a $9 million net gain on the sale of a previously closed manufacturing facility, offset partly by incremental restructuring charges of $10 million and certain other discrete adjustments noted in the reconciliation tables to our posted earnings materials. The performance coding segment reported Q3 adjusted EBIT of $123 million versus $134 million in Q3 2020, driven by ongoing volume recovery and growth and drop-through benefits of stronger average price mix, offset by headwinds from significantly higher variable costs and the lack of temporary cost savings, which benefited the prior year quarter. The adjusted EBIT margin from the segment decreased to 15.8% from 19.6% in the prior year, record-setting quarterly margin, given the drivers noted. Mobility Coatings reported a third quarter adjusted EBIT loss of $3 million versus income of $49 million in the third quarter of 2020. Adjusted EBIT and associated margins in Q3 were impacted by the volume reduction during the quarter due to the semiconductor chip shortages, which impacted production at the customer level and net sales volumes for Exalta. Results were further impacted by significantly higher cost inflation with modest offsets in positive pricing, which began to accrue during the third quarter. Exalta's balance sheet and liquidity profile remained solid in the third quarter. The company ended the quarter with over $1.1 billion in total liquidity, including $620 million of cash on the balance sheet and $516 million of available capacity in our undrawn revolver. Free cash flow for the quarter totaled $112 million versus $223 million in the third quarter of 2020, driven by somewhat lower operating profit and inclusive of $25 million in higher CapEx versus the comparable year-ago period. Exalta's net leverage ratio ended the quarter at 3.5 times versus 2.6 times at June 30th, driven by lower trailing 12-month operating earnings and lower cash balances due to increased cash deployment for M&A and share repurchases, offset somewhat by solid ongoing free cash flow. Exalta used approximately $596 million in cash from the balance sheet to fund the acquisition of UPOL, which closed in mid-September. The company also purchased 90 million in total shares in the third quarter for a year-to-day total of $214 million. Given stronger seasonal cash flows during the fourth quarter and inclusion of a full quarter of the U-Poll operating earnings, we anticipate that the year-end net leverage ratios will tick down slightly from the third quarter levels. Regarding our financial outlook for the full year 2021, despite ongoing firm demand across our businesses, we have factored in expected impacts from persistent inflation and supply chain effects, which will constrain reported growth and profit near term. For full year net sales, we now assume net sales growth of approximately 19%, including approximately 2% FX tailwinds and approximately 2% of M&A contribution. This forecast includes continued overall strength and performance coatings aligned with our prior assumptions and similar negative impacts in mobility coatings resulting from continued auto OEM production constraints. We assume 11 million vehicles deferred in 2021, as noted in our September guidance update. In dollar terms, mobility coatings is expected to be impacted by approximately $70 million in net sales in the fourth quarter and $215 million for the full year from continued supply chain impacts, which is $80 million higher than our previous forecast from July. For mobility coating volumes, we continue to expect to perform at least in line with global market forecasts for the full year, given our market positioning. Mobility Coating's net sales are expected to grow approximately high single digits this year versus 2020. For refinish, total net sales have performed largely as expected year to date. We continue to assume that market recovery will progress gradually through year end and into 2022, though still ending the year with volumes below 2019 levels by around mid-single digits despite net sales expected to exceed 2019 totals. We expect to generate adjusted EBIT of $645 to $665 million in 2021 and adjusted diluted earnings per share of $1.70 to $1.80 versus $1.85 to $2 anticipated in our July guidance construct. Additional income statement line items are noted in the guidance sections of our posted earnings materials. The primary drivers of the reduced range of expected profit are the impact of reduced mobility coding volumes, as well as the impact of higher inflation, now expected to increase approximately mid-teens or approximately $190 million. We expect free cash flow of between $410 and $430 million, or $35 to $55 million below the July guidance, inclusive of CapEx, of $155 million for the full year. The forecast excludes outflows related to the mobility coatings operational matter, which are now expected to be modest given anticipated insurance recoveries. Looking beyond the fourth quarter, it is now apparent that the global supply chain issues and those impacting mobility coatings with semiconductor chips will not be fully resolved fully in the near term. We now expect that some impact will continue well into 2022. Thank you, Sean.

In closing, I'd like to highlight that the current environment, though challenging and even historic with regard to cost headwinds and supply constraints, is one which Exalta is well suited to manage through and overcome. This begins with the adjustments we've taken to our operating processes, our organizational structure, and our leadership team in the last year. We have a great team in place and continue to execute well, as seen in our reported earnings year-to-date in a tough climate. In addition, I want to reiterate that we have a sound and clear strategic plan in place, and we are confident in our execution and value delivery around this plan. Finally, despite the headwinds noted, we see our 2024 growth and earnings targets that we set out in May as achievable, given the strong underlying market demand across our markets around the world. Some of the adjustments to inflationary pressure that we are implementing may actually create additional value for shareholders over a longer-term horizon through a reduced cost structure and a stronger margin profile. We look forward to continuing to deliver this value and updating you along the way. With that, we'll be pleased to answer any questions. Operator, please open the lines for Q&A.

At this time, we'll 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 to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up your hands up before pressing star keys. One moment while we pull for questions. Our first question comes from the line of Ghashan Punjabi with Baird. You may proceed with your question.

Thank you. Good morning, everybody. Hope you're doing well. I guess first question is on performance codings, and I'm just trying to clarify it. So if I look at the operating profit for performance, Q321 versus last year, you know, margins down almost 400 basis points. I was hoping you can kind of bridge that differential. And I guess on slide four where you're talking about performance codings, you know, unless I'm missing something, largely offset inflation with price VIX. Are you implying that you're fully caught up on performance in terms of pricing, or is there more to go? And, yeah, I have a follow-up to that as well.

Hey, good morning. So the biggest driver as far as margins versus Q3 2020 are really the temporary savings that we had implemented back during the pandemic lows. And you're seeing roughly 50% of that fall away. So that's really the biggest driver. And, yes, as far as our opening commentary, we are largely caught up on the performance side of the business as far as pricing offsetting roles at this point.

Okay. And then, Robert, in your comments in terms of the early 2022 catch-up on price-cost, are you starting to see a moderation or plateauing in terms of raw material cost? I guess I'm just trying to understand what that confidence is based on.

I think the confidence is really – based on our ability to continue to control our cost structure and to implement price increases to offset any incremental raw material inflation that we see from this point forward. But I think we've demonstrated in, as Sean pointed out, the price increases that we've been able to implement to offset inflation on a run rate basis to date and essentially be caught up in performance coding and odds of total company on the road to being caught up by the first quarter of 2022 at a total company level on a run rate basis, as well as our performance in the 2017-2018 inflationary cycle, that we are able to do that. So that's what really gives us the confidence that we'll be able to offset any incremental inflation that comes as we go into 2022. Okay.

So have raw material costs stabilized sequentially?

I think if you look at our raw baskets, I mean, we've seen some stabilization of key categories, namely a slight dip in monomers and powder resins from the highs mid-summer. That said, I think all categories remain elevated, and some have continued to climb, including isocyanates, pigments, and liquid resins. Solvents are more level from the summer, but the recent oil price hikes will cause that category to rise further. So I think in terms of perhaps an element of peaking, but it's hard to really confidently say that there is any sense of an easing kind of going on at the moment. So to some degree, we may see this as some of the force majeures come off over the next few months, but it's likely too early to call a turn here with oil still hovering around year highs and some forecasters calling for an even higher feedstock pricing. But as I said before, as we've demonstrated before, we will price through the raw material inflation.

Very helpful. Thank you so much.

Our next question comes from the line of Chris Parkinson with Mizuho Securities. You may proceed with your question. Chris, you may proceed with your question.

Sorry, I was on mute. Good morning. Can you just quickly comment on the overall industry price discipline versus the last inflationary cycle in 2017 and 2018, whether it's worse, roughly the same, or arguably better, and how this overall just sets up for the industry to hold on to value once RAS hopefully moderates, just better reflecting the value you actually create for your customers? Thank you.

I think overall what we're seeing in coatings is that the timing of this raw material cycle has really been beneficial to kind of everybody getting a little bit more ahead of it than in the 2017-2018 cycle. We really started to see the inflation bear its head in the fourth quarter of last year. So we certainly incorporated that into our operating plans and our budget, as I suspect many of our peers did. So the timing of when it happened was actually quite beneficial. And it's not that you can't, you know, increase price regardless of when it happens during the year, but from fully having your commercial teams and your supply chain teams fully aligned across the entire company, it's easier if you're kind of doing it through your natural budgeting and operating cycle. So I think that's been beneficial not only for us, but for everyone else as well. You know, I think really in terms of, you know, holding on to price, I think it's important to remember that in coatings, We create so much value in the non-product area of our total solution that really as long as we're all continuing to innovate in terms of labor, energy, and the amount of investment that our customers have to make as well as the various performance characteristics, I suspect that we will be able to hold on to pricing. And as it pertains specifically to Exalta, over the last three years, we have dramatically sped up our innovation engine and are really focused on more leapfrog technologies and innovation. So I think specifically in the case of Exalta, we're pretty confident in our ability to be able to hold on to price, given that we're delivering more value to customers, regardless of what happens in the raw material environment.

That's very helpful. And just for the follow-up, can you just walk us through the regional refinish markets regarding what you're seeing versus 19 levels? You hit on this a little in your prepared remarks. And just your perspectives on miles driven versus actual collision trends and what you're seeing in terms of body shop flow through. Just anything to give us a sense of your platform's performance versus the industry. Thank you very much.

We continue to see gradual progress in global refinish business metrics in Europe, which is our largest market. Exalta's body shop activity improved from down 10% compared to pre-COVID levels in the second quarter to down just 7% in the third quarter. We've really had great performance in Europe. We've had some material customer wins. in some of the under-penetrated markets that we've highlighted for years as an opportunity. And we finally, in the last 12 months, really... Sorry? Chris?

Is not available? Record your message at the tone. When you are finished, hang up or press pound for more options.

And we've seen the amount of volume that are going through Exalta's body shops in Europe recover to 93% of pre-pandemic levels. And we're also capturing price in that region. So very happy with Europe. In the U.S., Exalta's body shop activity stayed about constant between second quarter and third quarter. down around 12% compared to pre-COVID levels. We continue to outperform the market and capture price in the U.S., so we're very happy with how things are going there as well. Asia and Latin America have really improved as per the improvement in COVID rates and reduced lockdowns. In Asia Pacific specifically, we've had very good net body shop gains, and net new stock points. So we've seen the penetration of our mainstream and our economy products there continue to be successful. So we really believe that demand will return to more normal levels over time, given ongoing vaccination progress, along with increased return to work, and an overall return to more of a more normal mobility environment.

Our next question comes from the line of John McNulty with BMO Capital Markets. You may proceed with your question.

Yeah, thanks for taking my question. Just a quick one. On the auto OEM front, you had indicated you had some decent business wins. Can you give us a little bit of color on that? If it's more geographic kind of in nature or if it's new product lines, non-existing vehicles, I guess how should we be thinking about what some of those wins at least characteristically kind of came in at?

So our light vehicle coatings business has won significant new business this year. In fact, we've won roughly a third of the business that's come up for bid this year, and we've retained about 97% of the preexisting business that came up for bid this year. So I think I'm very pleased with how our mobility coatings team is performing. And we've won business in all regions. And it's really been a function of service and some of the advanced technologies and data solutions that we're offering our light vehicle customers.

Got it. That's pretty significant. Maybe just another question. On the working capital front, obviously there's a lot of challenges, especially around with all the supply chain issues, raw material issues. But working capital definitely seems like it's crept up. this year, even relative to 2019, so taking 2020 out of the mix. I guess, as you look forward, are there levers you can pull to streamline or clean out some of the working capital hits? Or is it really just a function of, hey, look, it's an inflationary period, and the challenge is what it is, and there's not necessarily a lot of things you can necessarily do about it in this type of an environment? How should we think about that?

Yeah, I mean, you certainly talk about all the elements in working capital. I mean, AR is, you know, seasonally upticking just in Q3. But given all the pricing actions, you're seeing a further uptick on AR, you know, that will come down. in the fourth quarter per normal course. Inventory is probably a single point of the biggest pressure, about $108 million of a cash bill, largely due to inflation. But that's going to be the area of potential opportunity. But as we look around assurances of supply, it's a dynamic situation that we need to make sure we're balancing how much inventory we're on hand. So we're not actually stocking out any of our customers. But we still generally target working capital percentage of annual sales of around 8%. But I'd say inventory is certainly going to be a focal point for us as we head into 2022.

Got it. Thanks very much for the caller.

Our next question comes from the line of Steve Byrne with Bank of America. You may proceed with your question.

Yes, thank you. Robert, can you comment on the price actions, how much of that would be structural versus what fraction would you say is indexed to particular raw that flows through as a surcharge and is thus reversible?

At this point, all of the pricing that we have pushed through to offset raw material inflation has been a combination of pure price increases And then we do have in our light vehicle business and a small piece of our industrial business, raw material index contracts that have also had price increases. So I think you'll continue to see from a pricing perspective as we go forward in Q4 and forward. greater price capture as we see more of those indexing contracts have more months, since most of them are on a six-month lag, as the inflation flows through and those roll up in the indexes, you should see price capture increase in subsequent quarters even more. And just wanted to drill in on... Yeah, as far as your question on surcharges, you know, we have in the previous cycle, we actually implemented surcharges as a construct to supplement pricing. And what we found is that many of our customers, it requires them to modify their systems to actually incorporate a new line item. So many of our customers just prefer that we just go ahead and put it through in price. And that's the approach that we've taken thus far this year.

I see. Thank you. I wanted to drill in a little bit on those new products that you talked about in your press release. You got this one-coat kitchen coating. You know, where did that technology come from? Is that a cross-sell from another coating technology developed? And maybe the other one being that electrical steel coating provides some dielectric and corrosion protection technology. Were those just transferred from other technologies you have, or is this something new, and therefore you could transfer into some other end markets?

Yeah, thanks for that question. We're really, as I said before, we really over the last three years have tried to make a step change in the level of investment as well as the level of return in our technology and in R&D. And, you know, seen in our wood coatings business, the one-coat kitchen cabinet application, that's something that was developed internally inside Exalta over the last several years. So kudos go to our R&D and technology teams. And then in terms of the multiple innovations that you've seen in our energy solutions business, I think you'll continue to see more and more coming out of there. In fact, most of you already know that Exalta is one of the world's leaders in in coatings for electric motors with our wire enamel steel coatings and impregnating resin products. And these products are used on a variety of applications, including transformers, wind energy, and other electronic applications. But we also have significant offerings in battery coatings for battery cells, battery modules, and battery packs for dielectric and corrosion protection, fire protection, EMI shielding, and thermal management. And you're going to be hearing a lot more about our energy solutions portfolio in future quarters.

Thank you.

Our next question comes from the line of Jeff Sakakis with JP Morgan. You may proceed with your question.

Thanks very much. The other day, Celanese was thinking through global auto production for 2022. And what it said was that as a base case, it thought it would be flat with 2021. And it thought that the IHS estimates were really much too optimistic. And I think they thought that the first half in particular really wouldn't really be very different from the fourth quarter of 2021. Do you have any views on this subject or you gravitate to the IHS estimates?

Jeff, I think our view at the moment, you know, we've taken a lot of time to speak with our customers as well as different people in the semiconductor supply chain. And I think our view would be somewhat similar. We expect the semiconductor shortage to continue through at least part of 2022. How much of 2022 is not yet clear. It depends on a number of supply and demand variables and how much production they're able to get back up in the size of chips. that automakers typically use, as well as some of the reconfiguration of some of the Tier 1 systems that go into vehicles. There are some options that some of the OEMs are looking at there in order to route some of those systems through more central control units and to be able to use some of the newer chip sizes as opposed to some of the older ones. So I think everybody's focused on it and everybody's working on it. Now, in terms of the timing of the resolution of that, I think it is not a reasonable assumption, not an unreasonable assumption, I mean, to assume that that continues to be a headwind through at least the first half of next year. Beyond that, we're just not experts in that field, and we have to rely on what we're hearing from customers as well as from others in the supply chain.

Okay, great. And then, secondly, you talked about catching up with raw materials and performance coatings. Are you caught up both in auto refinish and industrial, or is auto refinish, you know, more than caught up, but industrial is lagging? And is the rate of raw material inflation in industrial the same as it is in auto refinish or auto OEM, or is it a different rate because the raw materials you use is different?

Yeah, it's Answer your last question first, Jeff. I mean, it's a similar rate. The variable margins in refinish are higher, so you're feeling a little bit more pain at the bottom line for industrial. But I'd say the overall rate is very similar between refinish and industrial. As far as price for all, again, overall performance, we're caught up. I would say we have a little bit more on refinish on average as compared to industrial.

I'm sorry, a little bit more means you have more price.

A little bit more price. So we have a little bit more price on the refinish side. But again, we're very, very happy with the progress we've made across both of those end markets to date. Yep. Okay, good. Thank you very much.

Our next question comes from a line of Vincent Andrews of Morgan Stanley. You may proceed with your question.

Thanks very much. Could I just ask on the new light vehicle wins, you mentioned that they were brought across regions, but is that new capacity from customers? Is it a new entrant or is it share gains at existing customers that's driving those wins?

I think we'd prefer not to get into too many details here, but it is share gain at existing customers as well as other customers where maybe we might have had a lower share of wallet or share of pocket. But I would highlight that in our Asia business, we have been successful in securing new business at Chinese OEMs over the last 12 months.

Okay. And then if I could ask you, you referenced in the prepared remarks At some point in the quarter, maybe there have been concerns at body shops about labor, parts shortages, but you didn't think that that kind of ultimately came to be too meaningful of an impact. So is that something that you're now sort of, you know, it's off the list of things to worry about, or is that something that we need to keep monitoring as we go through the next few quarters?

Well, I think at the moment it's certainly something that we're working to support our refinish customers with in terms of just maximizing the productivity of our products as well as the data that we supply them so that they can maximize the effectiveness of labor. But yes, you've seen in the industry, the body shop industry is also not unaffected by the shortage in labor. And then also, when it comes to parts shortages and supply chain issues, they've also not been unaffected. But I don't think it's anything specific to that industry. It's just all the chaos that's going on right now globally in the supply chain that things get delayed in transit and so forth. So I think, again, it's very much a general comment as opposed to a specific observation. Okay.

That's very helpful. Thanks very much.

Our next question comes from the line of PJ Juvicar with Citi. You may proceed with your question.

Yes. Good morning, Robert. You spent some time talking about the refinish market and miles driven You know, it seems that the morning rush hour and traffic jams are back, starting in September, October, when the lockdowns were eased. You know, and it seems like people are driving more to work rather than taking mass transit. They want to be in their own cars. That's kind of a phenomenon we saw back in China back about a year ago. Are you seeing a similar phenomenon in the U.S.? ?

Well, I think we are seeing certainly a pickup in driving activity. We're talking specifically about the U.S. in morning and afternoon traffic, but it certainly has not recovered to pre-pandemic levels. We also do see more traffic throughout the day. And in terms of the comparison to China, at the time period that that occurred, the kind of hybrid work model was not really fully implemented in the country at that time. When it was back to work, people were essentially back to work pretty quickly. So I think we're comparing two things that are comparable and interesting to compare, but not necessarily comparable because they occurred at two different points in time with two different dynamics in terms of the office environment.

Thank you. And then in commercial vehicles, you mentioned that production rates are near record highs. I mean, one would think that the cheap shortages impacting light vehicles are also impacting larger heavy-duty trucks and commercial vehicles. Is that the case, or maybe these commercial vehicles don't need as much sophistication and there's not as much cheap usage, and so they can continue to produce?

That's correct. The number of chips that are required in the heavy-duty truck environment is much lower than it is in the light vehicle environment, so we're not seeing the same degree of of impact from the semiconductor shortage to our commercial vehicle business as we are in light vehicle. But I think if we look more broadly at commercial vehicle, I mean, the current picture from industry forecasters continues to be pretty positive and better rebound in 2022. to some degree, compared to 2021 volumes. Just if we look at kind of backlog, I think North America Class A trucks right now are at 279,000, and Class 4 to 7, I think, are about 145,000. And that's the highest level that they've been at since January 2019. So I think that's going to set up really well for us, given our strong position in that business.

And just to put some data on that, I mean, heavy-duty truck class 4 through 8 is expected to grow around 20%, excluding Asia. And the comparable number for 2022 to Robert's point is around 14%. So we're very positive on the outlook in that market.

Great. Thank you.

Our next question comes to the line of Kevin McCarthy with Verical Research Partners. You may proceed with your question.

Thank you and good morning. Robert, I was wondering if you could provide an update on UPOL now that you've owned it for nearly six weeks. How is the integration going? Are the challenges of inflation and supply constraints any different from your other businesses? And maybe for Sean, what would be the step-up in amortization associated with that deal in the fourth quarter?

So six weeks in, as you point out, Kevin, I'd say, as we call it, the value creation planning is going extremely well. It's progressing as per our original value creation plan. We've seen really good reception from UPOL employees as well as from Exalta employees. We've been leveraging shared learnings and areas of expertise between both companies because, frankly, there's a lot that Exalta can learn from how UPOL operates as much as there is what UPOL can learn and leverage from Exalta. We're moving quickly on the cost synergies, and we're ramping up commercial synergies given the strong pull from our customer base. In fact, the desire of our customer base to begin carrying UPOL products has frankly been overwhelming. And with regard to price, that was one of the first conversations that we had as soon as we owned the business. And yes, they are seeing some of the same raw material inflation and logistics and energy challenges that anybody else operating a business in today's world is seeing. So we have spoken as a team about that and have price increases underway in that business.

And, Kevin, on your amortization question, I'll remind you the purchase accounting is still very preliminary, but DNA for that business is going to be about $20 million on an annual basis, so you can expect about $5 million in the fourth quarter.

Thank you for that. And then, secondly, I wanted to come back to raw material cost inflation. If I understood your comments correctly, you're looking at a rate of 20% year-over-year in the fourth quarter. One of your peers... in their conference call, put out a rate of 30% year-over-year. And perhaps it's a bit unfair of me to ask, but it's obviously quite a wide range. And so I'm curious if you're cognizant of any mixed differences or differences in business practices that would account for a lower rate of inflation in your own case versus some peer companies.

Kevin, it's hard for us to comment on competition. I suspect mix is part of the story there. But we don't know strategically how they price their raw, so it's hard for us to really react to that.

And then the other element, Kevin, is I think when people talk about raw material inflation, is it just pure raw material inflation? Does it include logistics? Does it include packaging? Does it include energy? Those are all questions that could also account for the differences in the numbers.

Mm-hmm. Do you have energy in there?

Yes, we do.

Okay. Thank you very much.

Our next question comes from the line of David with Deutsche Bank. You may proceed with your question.

Thank you. Robert, mobility coatings lost money on an EBIT basis in Q3. Do you think it will lose money as well on an EBIT basis in Q4?

So, Dave, I mean, we're expecting to be marginally better, but it's very marginal, but we do expect to be positive in the fourth quarter.

Very good. And just on the temporary cost savings headwinds in 2022, how should we think about those?

We haven't provided guidance yet. I suspect we will continue to maintain some of the discipline around travel and entertainment, but it'll be modest compared to what we're seeing in 2021. And

Can you remind us what the impact was in 21 versus 20?

So we ended up doing about $150 million in temporary savings. It's somewhere between $50 and $60 million in temporary savings for 2021. Great. Thank you very much.

Our next question comes from the line of Mike Sison with Wells Forgo. You may proceed with your question.

Hey, guys. Good morning. Just a quick follow-up on mobility codings. You know, clearly I understand why margins are where it's at given build rates this year, but where do you think those margins can get back to, and how do you sort of get there over time?

Well, I think overall when we look at that business, again, it is a very good business. The team there has made several changes to the operating model and to the cost structure. And as I've mentioned, we've won a fair amount of business in our mobility coatings business, both on the light vehicle as well as the commercial vehicle side. On the technology and technological development, you know, we've launched some great products and we have some more great products. in the pipeline that are going to be rolled out. So I think when we see the semiconductor situation start to get better and then eventually become fully resolved, we're going to see a tremendous growth in volume in that business, and it should fall through at very attractive margins. So it's painful now, but we have a very good business, and we're continuing to invest in that business, both in our people as well as our technology, to position it

so that when that snapback does happen that we're extremely well positioned right thank you our next question comes from the line of josh specter with ubs you may proceed with your question yeah hi guys thanks for taking my question um so just looking at your updated guidance for the fourth quarter if i back out the incremental m a you know you're maybe guiding for about five percent sequential sales increase I was wondering if you could kind of quantify that between how much you're assuming for sequential pricing versus volume coming back. And on the volume side, are you assuming any sequential improvement in any segment other than refinish?

So we're expecting net sales to be up in every end market, Q4 versus Q3. We actually haven't quantified price versus volume for Q4, but the way to think about price for the full year, it's going to be somewhere between 3.5% to 4%, so you can annualize that based on what you're seeing Q3 year-to-date.

Okay, thanks. And just on the mobility side, Talked a lot about new wins there. Curious how much of the portfolio is typically rebid each year and thinking about in the context of price mix for next year, how much of your non-indexed pricing contracts in the mobility side have already been repriced and you expect to therefore get priced in 2022 on those contracts?

So typically what we'll see is, you know, about a quarter of the business in mobility will come up for bid in any given year. And then in terms of the pricing dynamics, obviously the index contracts, they adjust themselves. And then contracts that are off-index, those are negotiations that occur between the manufacturers and the OEM customers, but we don't comment on the specificity of those negotiations.

Okay. I guess if I could try, if I look at the index portion plus the portion that's been rebid now, I mean, is it fair to say 75% of your portfolio would see better pricing next year? No, I think that number is too high. Okay. All right. Thank you.

Our next question comes from the line of Bob Court with Goldman Sachs. You may proceed with your question.

Thank you. Good morning. I wanted to ask some more on the Ross situation, I guess. I've seen spot prices, propylene, phenol, methacrylates, epoxy kind of flattening out. It looks like maybe the worst of the storm has passed. But what I wasn't sure about is how much have you guys had to go out into the spot markets and maybe get tagged with exceptionally high prices? How many forced matures do you guys still have out there? What are sort of the key raw materials that are still giving you some indigestion here as you go into the end of the year?

Well, Bob, we continue to see tightness in various materials due to supply chain disruptions and also some alternative value chain demand. Isis ionates, acrylic emulsions, and certain polyester resins have been the most challenging. And acrylics have, as we talked about earlier, impacted the industrial business perhaps a little bit more so than the other businesses, including wood coatings. While for, you know, Isis Ionates, the biggest impact has really been in North America from the HDI side. Now, despite that market situation, we've secured supply and have largely been able to keep pace with the strong demand for our products. But we have seen, you know, some impacts on sales volumes as well as impacts at the customer level. which has constrained getting everything made and shipped at the end of any given month or any given quarter. So I think in terms of your comment about things peaking and leveling off, certainly we're seeing it in some areas, but we could kind of tick through all the categories. There are some unique elements at specific SKU levels that exist in each one of the categories. And then the other element is just if you go through some of the other categories, packaging, plastics and tin plater up, oil, Brent currently in the mid-80s, you know, potentially forecasting to be around 90 or so for next year. Energy inflation, natural gas is up 76% in the U.S. and about 230% in Europe. And then in logistics, everyone's seeing cost inflation from shortage of drivers, port workers, warehouse workers, slow turnaround of ships in China that's adding to delays. And logistics companies, at least in Europe, are certainly importing drivers from other countries and having to pay higher wages, which translates into wage inflation for them and then higher costs for logistics carriers. So I think we see an environment in which we expect to see some continued cost inflation as we go forward. But in terms of the tsunami that we saw On the pure raw material side, at least at the current oil price level, you know, the peak of that will probably occur, either occurred in Q3 or will occur in Q4. But we still have some of these other cost categories that have inflated that we expect will carry forward. Now, again, we will price through that, but that's just, you know, kind of the nature of the market that we're in at the moment.

Gotcha. Makes sense. And then have you changed, you know, given these challenges, have you changed the way you procure raw materials? Is there anything unique or different that you've done to give yourself more flexibility? And do you typically buy your raws on monthly, quarterly, semi-annual contracting? Give us a sense of what the portfolio contract terms might look like.

So I think everything that you could imagine that any company is doing right now in terms of managing their supply base and the current raw material environment, we're obviously doing. We're first and foremost focused on keeping our customers supplied and our customers happy. In terms of our existing supply base, we've been working with them on really defining are there certain SKUs for maybe C-type products or lower volume products that we can eliminate to make sure that the A and B movers you know, that we get increased allocation in terms of some of those raw materials. We've been doing that. I think everybody has been working to an extent with alternative suppliers, but, you know, it's a tough market out there. But again, as I said in my opening remarks, I think our procurement and our supply chain and manufacturing teams have just done you know, really a yeoman's job over the last several quarters in managing the situation. And I think that we may actually have fared a little bit better than most. Great. Thanks for the help.

Our last question comes from the line of Lawrence Alexander with Jefferies. You may proceed with your question. Lawrence, you may proceed with your question.

Hello?

Hi, Lars.

Can you clarify? You made a comment about mixed headwinds. What should the dynamic for mixed be as volumes improve outside the off-chain and then as the off-chain improves? Is that a mixed benefit or a mixed drag?

I mean, by and large, you should assume, you know, mixed going forward should be somewhat steady. We did see a little bit of mixed headwinds. in the third quarter, you know, reversing from a significant amount of mixed benefits in the second quarter. And quite frankly, it was just an easier comp versus the lows of the pandemic in 2020 that we saw such a, you know, staggering mixed benefit, you know, come through in particular on the refinish side of the business.

Okay, great. Thank you.

Ladies and gentlemen, we have reached the end of today's question and answer session. I would like to turn this call back over to Mr. Chris McRae for closing remarks.

Thank you, everybody, for joining us this morning. And we're available through the day in the next couple of days if you have any follow-ups. But thanks for joining us. Good day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.