Axalta Coating Systems Ltd.

ladies and gentlemen thank you for standing by welcome to exalta's second quarter 2023 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 the replay will be available through August 9th 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 Evans. Please go ahead, sir.

Thank you and good morning. This is Chris Evans, VP of Investor Relations. We appreciate your continued interest in Exalta and welcome you to our second quarter 2023 financial results conference call. Joining me today are Chris Villavarayan, CEO and President, and Sean Lannan, CFO. Yesterday afternoon, we released our quarterly financial results and posted a slide presentation to the investor relations section of our website at Exalta.com, which we will be referencing during this call. Our prepared remarks, the slide presentation, and our discussion today may contain forward-looking statements reflecting the company's current view of future events and their potential effect 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. Our remarks and this slide presentation also contain various non-GAAP financial measures. In the appendix of the slide presentation, we've included reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information regarding forward-looking statements and non-GAAP financial measures, please refer to our filings with the SEC. I will now turn the call over to Chris.

Thank you, Chris. I would like to welcome everyone to our second quarter 2023 earnings call. Let me begin by thanking Sean for his decade of service to Exalta. As you're aware, we recently announced that he is leaving the company to pursue another opportunity. Sean has had many notable accomplishments during his time with the company and was instrumental in building the foundation of an exceptional finance organization. I'm especially grateful for his partnership during my first seven months as CEO of Exalta. On behalf of the entire board, thank you, Sean. We wish you well in the future. Effective August 14th, Carl Anderson will be joining Exalta as our new Senior Vice President and Chief Financial Officer. Carl was most recently CFO at XPO, one of North America's largest freight transportation providers. Prior to that, he and I worked closely together at Meritor, where he also served as the CFO for more than three years, following other key leadership roles in finance, treasury, tax, investor relations during his 16 years with the company. Carl has decades of corporate strategy and financial leadership experience in the global industrial and automotive sectors. As we strive to grow shareholder value at Exalta, Carl's background leading a finance organization through a strategic transformation and his track record as a true partner to the business leaders will be invaluable. We look forward to him joining us mid-August and appreciate that Sean will be staying a few weeks to ensure a seamless transition. In addition, we're delighted to welcome Kevin Stein to the Exalta Board effective September 1st. Kevin has served as the CEO of Transdyn Group, a leading global designer, producer, and supplier of highly engineered aircraft components since 2018. He brings a wealth of experience leading global industrial businesses and holds a PhD in inorganic chemistry. His track record in growing and creating value at companies will be a true asset to Exalta. Let's move to slide four, where I will cover the highlights of the quarter. Our second quarter adjusted EBIT was 155 million and adjusted diluted EPS of 35 cents. Earnings were within our guidance range, despite ERP-related operational issues in North America, a modestly softer industrial market environment, and exchange losses from hyperinflationary impacts in Turkey and Argentina. Given these items and the costs associated with our productivity investments, we have demonstrated considerable underlying earnings and profitability improvement year-over-year as well as sequentially. Net sales improved 5% driven by strong pricing across all end markets and substantial growth in our mobility coatings business. A focus on price mix was evident again this quarter with a 7% increase year-over-year. As a result, we are seeing steady margin improvement. It is essential that we continue to prioritize more attractive returns in every end market and product category. Therefore, pricing will remain an active area for us even as we start to see the initial benefits of modest raw material deflation. Free cash flow of 99 million was a good result and much improved versus the prior year. This is an area where our productivity efforts are generating early wins as we right-sized inventory balances from historically high year-end levels. This improvement in cash flow is strengthening our balance sheet, one of our highest priorities, and for the second consecutive quarter, we have voluntarily paid down an additional $75 million in principal of our term loan. Given improved visibility heading into the second half of the year, we have provided a 2023 guidance framework. This guide reflects an expected improvement in second half earnings versus the first half and puts us on a full run rate to exceed pre-COVID earnings levels. My main focus since joining Exalta has been to drive improved efficiency and performance across the portfolio of businesses. This past quarter, we kicked off the launch of a significant upgrade to our ERP system, which sets us the foundation for supply chain and pricing intelligence among other attributes. Second, the further acceleration of a purchasing optimization program meant to address recent cost inflation, de-risk the supply base and reduce variable cost volatility. We expect this to provide substantial benefits which will start to be realized in the fourth quarter. Third, a supply chain enhancement program to improve planning, throughput and working capital utilization. This work enabled us to drive down inventory and increase our free cash flow for this quarter. And finally, we also have a group looking at areas where we can optimize the structure of the company to enable us to be more responsive, resilient and profitable. We will begin to give you more detail about these programs as we execute our plans and begin to see tangible benefits later this year. As we indicated last quarter, these programs require considerable investment. The ERP-related costs will step down in the third quarter. Others, like the consulting spend, will continue through the year end, but much more muted than the second quarter as initial fixed-cost investments begin to be offset with the realization of the benefits. This dynamic is reflected in our Q3 and 2023 guidance frameworks. I believe these initiatives are attractive investments in that they have short-term payback and accelerate our strategic goals. Please turn to slide 5 for more detail on our ERP implementation. An ERP upgrade was needed to replace an inefficient 25-year-old legacy system. This implementation has been planned for years. Globally, we have been evolving from six ERP systems to one, and in doing so, we will be eliminating hundreds of applications, improving data redundancy, and minimizing the need for costly manual interventions. We believe this system will significantly reduce our complexity and provide real-time insights into supply chain and pricing management. We went live in May with a North America launch that included 11 plants and several distribution centers. Despite comprehensive preparation, the scope and complexity of this launch led to some operational issues primarily centered in our large refinish manufacturing site. Yet we ended the quarter on a very strong note operationally and commercially. June was one of the strongest sales months in history for North America. As such, we believe the operational issues are now substantially behind us. Despite the near record month we had in June, the operational issues limited our ability to fully deliver on customer demand in May, which resulted in sales shortfall for the quarter. We're now working to normalize the elevated backlog in the second half of the year. Given the magnitude, I consider the implementation a success. We needed to launch the system and begin operationalizing the tool. In doing so, we gained valuable learnings, including insight into effective change management that gives me greater confidence for our remaining global implementations. I want to thank the team for their tireless work to stand up the system and manage the myriad of new processes to deliver a solid quarterly result. Moving back to the results on slide six, Let me elaborate on our second quarter volume performance. Globally, volumes declined by 4% year-over-year as growth in mobility coatings was offset by declines in performance coatings. We estimate that the operational issues we encountered had an estimated 2% to 3% negative impact on consolidated volumes, predominantly impacting our performance coating segments. Mobility coatings volume increased 13% supported by improved light vehicle and commercial vehicle production rates, as well as previously discussed customer wins. Performance coating volume declined by 11% due to weak industrial markets and a lower refinish volume primarily related to our ERP launch. China was the bright spot in the quarter as volumes increased 26% driven by light vehicle and the reopening of the local economy. Let's move to slide seven for more detail on our refinish and market. Refinish net sales improved by 6% in the quarter. Price mix was very strong and improved by 10% year over year, supported by a blend of carryover and new pricing. Refinish volumes declined by 8% year over year, largely due to operational delays in North America, as we saw stable underlying demand. Refinished market activity was largely consistent with the prior period. We see opportunity to grow market share and expand into adjacent markets. In premium customer segment, we have over 850 new premium body shop wins year to date. In mainstream and economy, growth has been solid with over 200 new distribution points. This quarter, we launched Iris Mix, a fast, efficient, fully automated, and completely hands-free mixing machine for the automotive refinish industry. IrisMix is a great addition to our productive single visit base coat and industry-leading digital color management process. It is built on decades of innovation from award-winning spectrophotometers and AI-based color match software. With IrisMix, customers benefit from High-speed mixing and enhanced body shop productivity that completely eliminates the need for manual mixing. Accurate color matching every time. Simple to use automated operation which frees up painters to do other jobs while paint is being mixed. And finally, an environmentally thoughtful design that utilizes 50% recycled plastic and reduces waste by delivering every last drop of paint. In June, we launched Iris Mix commercially in Europe, and we expect to serve the rest of the world beginning 2024. Early customer feedback has been incredibly encouraging. The order book is exceeding our projections with first deliveries beginning in August. Our success is predicated on remaining the most innovative solution provider in the industry. Iris Mix expands our competitive differentiation and deepens our customer-centric ecosystem. When Exalta Iris is paired with our single-visit application system, no one has a faster, more productive end-to-end process. This is why we believe we will continue to win and grow in refinish. Moving to slide eight, I will now cover the industrial business. Constant currency net sales decreased modestly in the quarter as very strong price mix growth of 7% year over year was more than offset by 15% volume decline. Volumes were better in Asia Pacific, but this was more than offset by double-digit declines in EMEA and North America due largely to the construction market slowdown. Yet, there is encouraging signs of stabilization as bookings in the second half appear modestly stronger than the first half rates. In our building products category, we're seeing big investments from customers as they anticipate favorable long-term market growth beyond 2023. Several markets appear to be bouncing off historic lows, such as architectural extrusion and COIL, which is forecasting improving into 2024. The industrial team executed very well, again, on price and cost management. which helped to offset the volume decline. Moving to slide nine, we continue to build momentum in mobility coatings. Volume improved 13%, reflecting a step up in global auto and truck production versus the prior year, as well as previously discussed new business wins. Growth was broad-based, but especially strong in China and EMEA light vehicle. Price mix contributed 3%, which included a 2% customer mix headwind. In light vehicle, 2023 auto production forecasts have modestly but steadily improved year to date. Industry forecasters now project 86.7 million global bills, representing more than 5% growth over 2022. This incremental volume growth is driving improved fixed cost performance in our business. Given the elevated age of the global auto fleet, we expect to see sustained global production for the near and medium term. In commercial vehicle, our customers remain bullish and the production outlook is strong for 2023. For Class 8 OEMs, black logs remain elevated, especially in North America. We are monitoring demand into 2024 as some forecasters believe there could be a soft pocket but as of yet, we see limited signs of a slowdown. With that, let me turn the call over to Sean for a review of our financial performance. Thank you, Chris, and good morning.

Second quarter constant currency net sales increased 5% year over year to $1.3 billion. Adjusted EBIT improved to $155 million from $151 million in the prior year period, inclusive of $15 million in headwinds associated with consulting, and ERP-related costs in the quarter. Underlying earnings growth was driven by better price mix in addition to the lower raw material, energy, and transportation unit rates. This quarter marks the first deflationary benefit we have recognized since incurring nearly $650 million of variable cost inflation through 2021 and 2022, representing an approximate 40% increase over this period. Variable costs declined 5% year-over-year in the second quarter, with epoxies and isocyanates being the largest categories of drivers of the improvement. Market prices for most import categories are now trending favorably from historically high levels at year-end. We are also encouraged by early success in accelerating our cost recovery efforts due to the launch of our purchasing optimization program earlier this year, which we are clearly now seeing in what we are procuring today. The better variable cost environment in the quarter was offset by $9 million in realized foreign exchange losses in the quarter, as well as higher compensation expense driven by variable incentive compensation, labor inflation, and stock-based compensation expense due to the expected profit improvements in 2023. We are thoughtfully managing these increased costs and expect to largely offset their impacts over time through our ongoing productivity enhancement programs. The cost of our productivity programs and the expenses related to the North American-European implementation, as noted earlier, also drove $15 million of temporary spending in the period, in line with our second quarter guidance provided back in May. I will now cover performance coding's results on slide 11. Performance coding's second quarter net sales were flat year-over-year at $856 million, 9% better price mix, and a 2% benefit from the absence of a customer contract restructuring charge impacting net sales in the second quarter of 2022 was offset by lower volume. As Chris told you, operational constraints in the quarter drove a sales shortfall in North America, which disproportionately impacted refinish volumes and the associated profitability. Performance coding second quarter adjusted EBIT was $118 million versus $125 million in the same period last year. Improved price-cost dynamics drove a significant benefit to segment earnings in this quarter, but the impact of lower volumes and the allocation of roughly $10 million in costs associated with the enterprise projects led to the year-over-year decline. Industrial earnings were relatively stable year-over-year, as proactive cost management and favorable price costs mostly offset lower volumes. Moving to Q2 mobility coding results on slide 12. Mobility Coatings net sales increased 16% year-over-year to $438 million. Mobility Coatings adjusted EBIT improved to $24 million from $2 million in the second quarter of 2022, despite the allocation of $5 million in costs associated with enterprise projects in the quarter. Growth was supported by strong volumes and a favorable year-over-year price-cost benefit. Notably, Our China business made considerable contributions to year-over-year improvement given an attractive mix of high growth customers at healthy contribution margins. There's clear improvement in the underlying earnings power of this segment. Momentum is building into the second half of the year where I expect us to show further earnings and margin improvement in addition to volume growth. Now turning to our debt and liquidity summary on slide 13. Exalta's balance sheet continues to improve and our liquidity profile remains strong. We ended the quarter with just over $1 billion in total liquidity, including a cash balance of $518 million. Free cash flow in the quarter totaled $99 million compared to a cash use of $14 million in the second quarter of 2022. This is an excellent result that we expect to continue as we prioritize working capital and realize profitability improvements. For the second consecutive quarter, we voluntarily paid down $75 million in principal on our term loan, which now brings the year-to-date voluntary paydowns to $150 million. Gross debt reduction remains a high priority as we look to offset the impact of higher interest rates and strengthen our balance sheet. Note that we are also well-positioned to explore other opportunities to reduce our interest expense, given the recent expiration of the soft call penalty on our term loan. and following a favorable turn in capital markets over the last few weeks. Our net leverage ratio was 3.6 times, reflecting a slight improvement from 3.7 times at March 31st, and we expect operating performance improvements to drive meaningful deleveraging on both a net and gross basis throughout the remainder of the year. Before concluding, I would like to extend my gratitude to the exceptional Exalta team and the board of directors with whom I've had the pleasure of working with for the past decade. Being part of this journey over the last 10 years and being part of such a talented organization has been an immense privilege. My best wishes go out to each one of you, including our analysts and shareholders. Your partnership, trust, and support have been greatly appreciated during my tenure here at Exalta. Now, I'll hand the call back to Chris for an update on guidance and concluding remarks.

Thanks again, Sean, for a decade of commitment to Exalta. Moving to slide 14 to review our Q3 and 2023 guidance. Third quarter adjusted EBIT is expected to be between 160 to 175 million or 230 to 245 million in adjusted EBITDA. For the full year 2023, we expect adjusted EBIT to be approximately 630 to 650 million corresponding to adjusted EBITDA of 910 to 930 million, inclusive of 15 million in consulting costs incurred in Q2, which will amount to 13% increase over the 2022 at the midpoint. This reflects an EBITDA level we have not seen since 2019 and an improved earnings run rate entering 2024. Our full year guidance framework assumes a mid single digit price mix benefit for the full year which implies a low single digit exit rate in Q4. Typical seasonal demand patterns are expected in the second half, but volume for the year is fairly flat with mobility recovery offsetting industrial softness. This view does not currently contemplate fully addressing elevated backlogs and raw material procurement is trending favorably. We expect to realize a mid to high single digit percent benefit in our variable costs for the second half of the year, which should provide a boost to margins and help mitigate elevated operating expenses. We are increasing our full year 2023 free cash flow guide to $385 to $425 million from $350 million following a stronger pace of working capital release than was previously expected. as well as a slightly lower CapEx forecast as we focus on capital allocation prioritization. I'm encouraged on how 2023 is shaping up. We're well on our way to returning to pre-pandemic levels with a path to unlock even more earnings power in the quarters to come. I'm proud of our global team for their focused execution and commitment they have demonstrated through the first half. Exalta's potential is robust given our market leadership positions, growth platform, talent and technology, all of which I believe will not only support but drive long-term growth and profitability. Sean and I will be pleased to answer your questions. Operator, please open the lines for Q&A.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions.

Thank you.

Our first question comes from Christopher Parkinson with Mizuho Securities. Please proceed with your question.

Thank you so much. You know, just given everything that's going on in the 3Q Guide and with FX, some carryover pricing trends in the marketplace, it obviously implies a fairly, you know, a decent hit on volumes. And, you know, can you help us just kind of think about what we should be seeing on a segment level in the third quarter and what actually flows into that, presumably some of that's the ERP, and probably just as importantly, how to bridge that with your 4Q expectations just given the annual guide. Any color on that would be very helpful. Thank you.

Hey, Chris, it's Sean. Maybe I'll start here. So from a volume perspective, we're actually expecting third quarter to be somewhat similar to the second quarter. We're not baking in any sort of broader recovery as far as bringing the backlogs down. We're not expecting them to get any worse, and certainly that could provide a little bit of upside if we're able to close that gap. But when you think about volume and pricing, it should look relatively stable opposite the second quarter. We'll certainly start to see a little bit more of that benefit from a BCOGS perspective. Again, we're probably a little bit conservative, you know, just given some of the priorities around bringing down working capital. We're certainly not procuring as much from the raw materials. perspective as we have historically given the prioritization there, and then just the lower dollar inventory actually working its way through the balance sheet. That's part of the reason why you're not seeing bigger margin uptick in the third quarter. And then it's a similar cadence into the fourth quarter. Again, there's probably a little bit of upside if we're able to close the gap. Internally, we're certainly focused on closing that backlog gap. And again, that would probably get us to the higher end of the range that we provided on the guidance slide.

maybe just picking up from Sean and I'll break it down into each of the individual three businesses. So, you know, obviously mobility with the seasonality of the, you know, Europe and North American shutdowns, the two weeks in July, plus there's the standard August shutdowns in mobility. So you do see a little bit of that softness that we have baked into the forecast. Industrial, as Sean put, we've essentially looked at it being flat with what we have in Q2. And again, the real story here is in refinish. And what we do have is we have the backlog being resolved by Q4. And we're giving ourselves time, obviously, with the impact that we had with our plant on the refinish side. But any work that we do in improving that does provide us upside into Q4.

If we could just dig in very, very quickly on just the refinish trend. I mean, if we kind of do the very quick back of the envelope math on the ERP hit of what you publicized in your press release and look at that versus the volume decline in the second quarter, is there anything else going on there? Because I think, obviously, presumably, it seems like everything's going very well. It seems like you're gaining shares with the MSOs, top 10s, as well as a lot of the tail Is there anything else that, you know, you think investors should be paying attention to? I mean, it seems things are going pretty well with Iris and the launch there in Europe, but just anything else we should be monitoring into 2024 would be very, very helpful. Thank you.

Sure. Sure, Chris. And maybe I'll, you know, absolutely. The story is very, very strong. And, you know, if you look at it purely from a volume perspective and look at that 8%, a portion of that is some volume compared to last year. that we exited some low margin business in LATAM. The rest of it is all associated with our ERP launch specific to the North American impact. And so any resolution that we have there over the next two quarters essentially shows stable and growth in that business. And to your point, IRIS will do nothing but help us enhance and grow the business going forward. So yes, with the exception in Q2, and Q3 of our decision to exit some low-margin business in LATAM. Everything else is just the impact from the ERP launch.

Chris, just to add on, I mean, we're still expecting record profitability in 2023 for refinish. We still have a lot of the underlying tailwinds as we think about market recovery, both in North America as well as Europe. You still see WIP at the body shop level at all-time highs. as well as occupancy rates have essentially stalled at roughly 50% in North America, so we continue to see upside. But we're going to bring down this backlog over time, and I think what we saw in the second quarter was stability around demand. So we're really happy with how that business is performing, and the expectations are extremely high as we move forward.

Thank you. You're welcome.

Thank you. Question comes from John McNulty with VMO Capital Markets. Please proceed with your question.

Yeah, good morning. Thanks for taking my question. And, Sean, thanks for all the help over all the years. Just wanted to dig a little bit more. Chris, you spoke to – when you first came in, I guess, on the last quarter call, you spoke to price recovery, ROS productivity, supply chain optimization, et cetera. I guess now that you've been there for, you know, call it six, seven months or so, I guess, can you help us to frame a little bit in terms of how you're thinking about the upside or margin opportunity, maybe how you're thinking about 2024, if you're comfortable kind of giving that kind of color at this point as to how you're thinking about some of the improvements that you can see coming out over the next, say, 12 months or so?

Yeah, good morning, John. That's a great question. I mean, I think if you look at our Q2, we had good performance in the quarter, which was just unfavorably impacted by our ERP launch and that was primarily around one plant. And if you take that out, our guidance puts us on record earnings levels despite our investments in enterprise programs and obviously some elevated compensation spend comparing this year to last year. And if you talk about all those positive catalysts, price mix as we talk about this quarter is up 7%. Price cost improvements continues to track well. And again, we do see as we head into Q3 and Q4, pricing will be a little bit more muted. As we started the year, we had about $120 million of QM price cost gap across two of our businesses. We have about 60% of that resolved across the mobility and industrial business, and we expect to have that solved through the year. And then talking about additional positive catalysts, specialty raws, with the exception of specialty raws like TiO2, the raw material benefit, as Sean talked about, continues to track well for the second half. And we do see that being a positive tailwind into Q4. And so when you take all that, and I think if you take a look at our Q4 guide to what we have built, even with the guide we had without the upside of solving the backlog in the refinish side, it puts us at a midpoint at, you know, 243. And at the high point, what you will get is the second best quarter in the history, the 10-year history of Exalta in terms of a down and if you take the top half the top end of that guide it essentially puts you as the best best performance of Exalta has seen with the exception of 2020 where we've obviously had to take some actions to get there so it just talks to the underlying performance that exists in the company obviously once we get past these operational issues that I do believe we will have more than solved over the next two quarters

Got it. That's helpful color. Thank you. And then maybe just the second one, you mentioned some mix issues in the auto OEM area. And admittedly, the price mix was a little bit lower than I guess what we were looking for. It sounds like the pricing is actually pretty solid and it was really just a mix issue. Can you just give us a little bit of color on and suss that out a little bit?

Yeah, John, I wouldn't characterize it as an issue. It just happened that we sold a little bit more volume in a particular layer that has a lower price point. It's not anything structural as far as changes from a mix perspective, but it was about a 2% headwind when you think about price mix. But nothing to be worried about on that front.

Got it.

Thanks very much for the call.

Thank you. Our next question comes from Joshua Spector with UBS. Please proceed with your question.

Good morning. This is Lucas Foley. I'm for Josh. I just wanted to go back to the sequential assumptions in your 3Q Earning Guidance in the bridge there. So we have the help from the low overall materials. We've got the impact of the ERP and the consultant investments rolling off, and then the impact of the lost volumes catching up. So each of those three buckets might be about $15 million each. So we've got a $45 million sequential improvement overall. Normally your seasonality is a sort of 15 to 20 million step down. So that's like a 25 to $30 million sequential benefit. So, but your guidance is only up kind of 10 to 15. So I'm just sort of wondering what are the other offsets there that I'm kind of missing, missing in the bridge.

Thanks. Yeah. Yeah. Lucas, we are not currently contemplating bringing down the backlog in the third quarter. This is why I hit on earlier. That's, you know, potentially upside, but right now that's not baked into our guidance. So when you think about pricing, it's going to be stable from the second quarter, third quarter. From a volume perspective, you know, we're expecting stability across all the end markets. You know, light vehicles just the one call out and you'll see it in some of the industry forecasts. You know, Europe is just typically down and we're expecting. China just had a fantastic June and, you know, industry forecasters are expecting a little bit of a pullback just, you know, seasonally. And then, yes, to your point, there will be a benefit from the consulting cost. They don't entirely go away, but the majority will go away, and then we'll see a little bit more of a VCOG step up. And that's essentially your bridge.

Great, thanks. And then just on mobility, so just wondering there if you could help us and understand sort of why earnings didn't kind of sequentially improve into the second quarter. So shouldn't there have been some benefit flowing through from lower ROAs in the quarter? And What are you thinking in terms of margins implied in the third quarter guide?

Yeah. So again, we try to cover some of the underlying or the overview remarks, but there was about a $5 million headwind as far as the consulting and ERP spending from an enterprise perspective. They got allocated to mobility, so that 24 in EBIT becomes 29. And certainly year over year, we are seeing some variable incentive headwinds as well as stock-based compensation. which is impacting margins from a year-over-year perspective.

And maybe, Lucas, just staying on mobility for a bit and just, you know, I view this as a great story as we look heading into 24. And I just want to jump off maybe Sean's comments here. If you look at a $24 million EBIT for the quarter and you tack on the $5 million, you pretty much have a run rate. You can for 22. And if you take that in perspective and look at a very good year of 2019, we were about 140 million of the EBIT with 89 million bills. So we are about 3 million bills lower. And as we see the strength in the auto market driven by seven months of backlog. So certainly something that you can see that the business is really well on track to double-digit EBITDA here. The teams are doing a great job outpacing the market as well as our peers here.

Thank you.

Our next question is from Alexey Yufrimov with KeyBank Capital Markets. Please proceed with your question.

Thank you, and good morning, everyone. So your implied fourth quarter EBITDA guidance is about $242 million. How should we think about this as a base for 2024? So does this 4Q include the majority of your price cost? benefit and where do you think there's additional margin opportunity in 2024? And also, is there a volume opportunity next year?

Yeah, Alexi, I mean, at the high end, it would apply about the 252 EBITDA contribution in the fourth quarter. When you think about the price-cost dynamics, regardless of inflation or deflationary environment, we'll continue to push price within refinish. I mean, that's an area where we continue to innovate and provide value to customers, and we look to push through price. Some of the other businesses, as Chris mentioned, we are largely catching up and expect to be caught up by the end of the year. There could be some marginal pricing. It just depends on the pace of deflation. The bigger benefit really is expected from a run rate perspective around deflation. So today, where we're procuring inventories, we're probably down low double digits. As far as the back half of the year, you know, we're expecting mid to high single digits as far as the benefit in the P&L. So that will continue to unwind and provide, you know, potential margin upside as we round the corner in the 2024.

And maybe, you know, we have talked about consulting, and obviously there are three elements of the consulting spend. The one, obviously, was specific to the ERP project and the support that it provided IS folks. But on top of that, we have efficiency projects, one focused on reducing our inventory, which is how we were able to increase our working capital guide for the year, as well as drive about $90 million in reduced inventory. But the next one here, Alexi, is a purchasing initiative that will favorably impact our material performance beyond just the indexing, which we expect to see a better the drop through after the inventory flow through to hit the P&L somewhere in Q4 and prepare us for 2024 as well.

Yeah, thanks for the caller. Related to this, I guess by my estimate, you'd be spending somewhere around $45 million this year on ERP and another consulting costs, right? $15 million in the second quarter and perhaps $10 million

uh per quarter in the or so in the back half how how would you think all these costs uh all in compare in 2024 versus 2023 well i i think if you total what we have it's about 30 million and what we are saying 15 million is obviously associated with our erp launch and alexis simply put this was a 25 year old This essentially takes six ERP systems globally and puts it into one. It's four years in the making and it's certainly something that we need to be able to manage our systems and essentially have the ability not only to have pricing but also operational and supply chain intelligence. So again, this was a project that had over 300 folks working on it, impacted 1100 employees. and impacted 11 plants and a multitude of distribution centers. And we went through this, obviously had the impact at one plant, but it had a banner launch at all the other sites. So obviously very little in terms of payback from that. However, on the $15 million of additional expense on consulting, this was really to prepare ourselves

the back end of this year and really get us ready for 24 and all of these have less than a two-year payback thanks a lot you're welcome thank you our next question comes from duffy fisher with goldman sachs please proceed with your question yeah good morning um if we could

I mean, I'm just looking at your margins, both what you've done this year. So, 16.6, and this is EBITDA margin, 16.6 in Q1, 17.5 in Q2. The midpoint of your guide for Q3 is 18.4. So, basically, you're stepping up almost a percent per quarter sequentially. But then the implied guide when you get to Q4 is for a 17.8 EBITDA margin. And with raw materials kind of falling throughout the year and they're trending down as we speak, why wouldn't Q4, with its increased revenue sequentially from Q3, continue that trend of improving margin?

You're seeing the dynamic in the fourth quarter just seasonally with some of our end markets dropping off with the holiday month in December.

But I guess I'd push back on that because your sales are up $100 million at the midpoint from Q3 to Q4. So some things may be falling off. But what you're saying is actually the company is still growing nicely, 5% sequentially. So something in there doesn't triangulate.

Duffy, I'll point to there is certainly opportunity from a margin perspective focused on the procurement side as well as closing the backlog. And, you know, if you look at the upper end of the fourth quarter being 252 million EBITDA and potentially providing upside if some of the other aspects come to fruition, there certainly could be upside from a margin perspective.

Okay. And then, just because I'm getting pinged quite a bit, you know, on Bloomberg, there still seems to be some confusion around the sequential revenue build, and maybe we can attack it kind of year over year. In your guide, you're up 0% to 2% year-over-year in Q2 on revenue, excluding FX. And price mix should still be a pretty significant benefit, I would think. So that would imply year-over-year Q3 volumes may be down 2-ish percent. So, one, could you help with that? And then if that's the case, kind of where will we see it? But then it seems like, again, with that bigger revenue number in Q4, we start growing volume, kind of low single digits in Q4. What improves in that number from Q3 to Q4 in your mind?

So the Q2 to Q3 guide, I think we covered this, but it's industrial and refinish are largely flat. And then mobility, you're seeing a slight pullback just given the European and China dynamic. And then from Q3 to Q4, you are seeing a slight uptick as it relates to industrial volumes and a little bit of mobility just as seasonally you recover from Q3 to Q4.

Okay. Thank you, guys.

Thank you. Our next question comes from Vincent Andrews with Morgan Stanley. Please proceed with your question.

Thank you and good morning. Just wondering with the issues with the ERP implementation in the second quarter, do you have to provide any terms or make holes or anything for customers in order to maintain that backlog in the North American market? And or are you baking in any conservatism into the back half of the year for any further ERP implementation issues?

Yeah, so I'll take that. And good morning and thanks for the call, Vincent. So Yes, we are in terms of having some cushion. And let me just walk through it. Again, the primary impact of our ERP launch was specific to our refinish business. And what we did here was obviously we launched on May 1st, and May was a tough month across our refinish business associated with our plant in Virginia. However, just to put it in perspective, the teams across the globe rallied in June and we had, if you put Exalta into perspective, Exalta has been around for 10 years, just over 10 years. In 123 months, we had the second best month in the history of the company from a sales EBITDA and a margin performance. So it just talks to the foundation and what the teams were able to rally back and accomplish in the month of June. coming out of our issues in May. And so as we built our forecast for Q3 and Q4, we did have a backlog. Obviously, as you know, there is a pickup in Q3 for refinish. So on top of that, we have the backlog. And what we've done in our forecast is provide the ability for us over two quarters to be able to bring down, normalize that backlog. But the benefit of that is not in our forecast. So all that said, in terms of the loss of customers, as you are aware, this is the refinish business and we believe we can hold these customers. We don't have the issue of the stocking that you might have heard from others. What we have done is obviously reduce our inventory levels at our distributors and through the channel. And what we're doing is replenishing that as well as making sure that we deliver to our customers what they need. So that's exactly what we're focused on over the next two quarters.

Thank you. And just as a follow-up, the SG&A is up $30 million. Can you just help me understand what the components of that are? Is the consultant spending in there? Is some of that investment spending or just sort of what's the bridge there and how should it play out over the balance of the year?

Yeah, the vast majority of the increase relates to incentive compensation. Last year, we tracked well below our target from a budget perspective. You know, global incentive comp, you know, ranged around 70% of the payout. We're tracking above the incentive comps this year, so that's really the vast majority of the headwind from an SG&A perspective.

Okay. Thanks, guys. Good luck, Sean.

Thank you.

Thank you.

Our next question comes from David Belliter with Deutsche Bank. Please proceed with your question.

Good morning. This is Anthony Mercandetti on for David. Just back on the ERP, can you quantify the benefits that you're expecting to realize by Q4 and then how we should think about this flowing through the P&L in 2024?

yeah so we'll be providing the benefits with the ERP launch as part of the 2024 guide you know we're expecting limited benefit other than the absence of the cost that we incurred in the second quarter as relates to third quarter and fourth quarter right now it's it's to focus on you know continued stability of their plants but you know then we'll quickly turn to value realization you know as part of this ERP implementation you know we redid our integrated business planning. We put in new pricing tools, and obviously we get a lot more visibility into transactions and working capital that we expect to benefit in 2024. But again, we'll provide more guidance when we're out with the 2024 guidance construct.

Understood. And then as other geographies roll out their own ERP implementations, do you expect similar, I guess, operational hurdles and costs that we saw in North America, or is this process more more streamlined since it's been done already?

Well, that's a great question. One of the things that we are doing is going to take a bit of a pause for about a year and get launched with other regions such as Asia and LATAM and then start with Europe, which would be the next large region. So we're going to probably take this over the next two to three years. And obviously, a big lesson learned that we have from here as well for us But again, as I said, when you consider the scope, scale, and magnitude of the project, I am pleased with the implementation. And so there are some lessons learned on warehouse management and shipping management that we will take and apply as we go forward in future launches.

Got it. And just to be clear, so Europe would be the next large launch when that time does come, followed by Asia and Latin?

No, no, no. The next two launches would be Asia and Latin. Europe will be last.

Understood. Thank you.

Thank you. Our next question comes from Ganshama Punjabi with Baird. Please proceed with your question.

Good morning, everyone. This is actually Matt Krieger sitting in for Gansham. So given the major shift in pricing over the last couple of years now, transitioning to a more favorable raw material sourcing environment, Can you talk a bit about what you're seeing from a competitive backdrop perspective, maybe highlighting any key gains by end market or region, as well as where you may be facing some comparatively stiffer competition?

Sure. Maybe I'll start and I'll turn this over to Sean. But as I look at PriceMix as a company, as we said in our prepared remarks, 7% in industrial even with the volumes going down 15% and in mobility even with the 2% headwind we did 3%. So overall as a company we've accomplished 7% and shows the continued focus on driving both price and cost. It is becoming more muted in the back half and let me talk to it in this sense. We started the year with about $120 million of cume price cost negative specifically in two out of our foreign markets light vehicle and industrial and the teams have done a stellar job with more than half of that being resolved as we sit here today and my expectation is by the end of the year and starting into 2024 most all of that will get resolved so we will pricing will become more muted as we have stabilized and as as So far, we've obviously had some pushback with customers. But again, the performance of the business indicates how well this has been sticking.

Great.

That's very helpful. And then your earnings release and presentation is fairly unique in that it doesn't reference destocking at all. It may be the first release that I've seen like this throughout the reporting period. You know, can you provide some details on any potential impact from supply chain destocking across the business during the quarter? And if there wasn't an impact, why is Exalta's business so uniquely immune at this point?

So, Matt, I mean, we just don't go through distribution, and most of our customers are just not holding as much refinish, you know, keeping that aside. We actually, you know, destocked in North America within distribution just because of the ERP element. So that certainly provides some upside for us. Where we saw some marginal destocking was really within building products in North America. And so you saw the 15% pullback within industrial. You know, building products was really a core driver to that. Certainly building products, market weakness, but there was some element of destocking. Again, it's just not as pervasive an issue for us and why we're not calling it out.

Okay. That makes a lot of sense across the mobility businesses.

Okay. Thanks. That's it for me.

Thank you. Our next question comes from John Roberts, Risk Credit Suisse. Please proceed with your question.

Thank you. Best wishes, Sean, and welcome, Carl and Kevin, if you're listening in. I believe Exalta sells coatings for auto OEM parts that are painted offline and then shipped to OEMs. Does that part of the business serve as a leading indicator for the OEM business? And what are you seeing in the parts business?

Well, overall, John, we're seeing very, very strong demand across the light vehicle business. I mean, we're exceeding initial demand forecast. As you can see, IHS keeps ratcheting it up a bit, a bit, a bit. We're up at 86.7 million bills right now. On top of that, preparing for this, all the initial checks that we've done with the customers also shows a very strong underlying demand. On top of the fact that the aged auto fleet and the fact that we had four years of underbuilding is creating what I would call is a short to mid-term upside case. And then on the heavy side truck, backlogs remain incredibly strong. Again, doing some customer checks, what we're seeing is that our customers, even with record outputs, are sitting with almost seven months in backlog. So both businesses do look very strong. On the heavy side, there is some concern in 24 of a possible softness from some folks, but certainly we're not seeing it at this point.

Thank you. You're welcome.

Thank you. Our next question comes from Kevin McCarthy with Vertical Research Partners. Please proceed with your question.

Yes, good morning. In your mobility segment, you've talked in the past about commercial courage and an effort to restore margins. My question would be at this juncture of the cycle where we have raw material costs coming down sharply in some cases, do you think you can continue to move price higher on a sequential basis in mobility exclusive of mix? Or does that become impractical based on your recent customer experiences?

What we're seeing right now is, so I would say the pricing on mobility, especially I believe on the light vehicle side, started off pretty slow. And as we rewound the clock, A year, year and a half ago, the most significant, let's call it price cost, QM negative was sitting in our mobility business. As we sit today, we still have the largest price cost QM gap sitting in mobility. But the teams are doing a great job trying to resolve that, working with our customers. And as I look at the second half of the year, we do see that becoming more muted. We are starting to essentially get to a point level out. So we do believe that it will get more muted but overall our customers understand that we need to invest in this business. There is absolutely significant amounts of investment especially on the light bakeable mobility side that we have to keep doing to keep ahead in terms of the product requirements for our customers. So certainly it has been a long discussion.

discussions going forward yeah just maybe to add you know roughly 40% of those contracts are on indexation so you'll see you know some price give back but you should you know continue to see variable margin improvement as we're seeing the deflationary benefits the team is very focused you know still we're still 40 to 50 behind at the end of q2 from a price cost gap so the team is continuing the drive it's just a lot more selective looking OEM by OEM, region by region. So I do think there's continued opportunity as the team continues to execute on margin recovery.

Okay, thank you for that. And secondly, how would you compare IRIS to your existing Daisy Wheel product and also your competitor's Moonwalk product? Is it essentially... Daisy Wheel 2.0 or something that's more of a step function change? And are there financial implications we should be thinking about as you ramp up in Europe and elsewhere in terms of providing the equipment and those sorts of considerations on margins, for example?

I absolutely love that question. So, you know, it's 2.0, 3.0, I look at it as just an absolute game changer. IRIS is next level technology. It's a fully automated max and mix system that I believe sets us apart from our peers. As you're aware, in the refinish space, this is an absolute necessity and a table stakes as you play in this space. And I believe this process advancement really differentiates us from differentiates the refinish business and our extraordinary team of people that work here it's really special because it's the only fully automated machine that I believe is faster than anything in the market and I'll give you a couple of you know data points here in terms of benefit to our customers obviously even starting with our existing customers this is less than a year's payback on this product for them and And if we move from that to sustainability, this uses Exalta's own bottles, which is made from 50% recycled plastic. And in this sense, on just our customers, within a year, we've reduced about 400 tons of plastic that goes into landfills. And then on top of that, in just our launch in Europe to what you mentioned, tremendous in my first seven months and just spending time with the team and and spending time in Europe listening to customers this has just been absolutely great feedback and see this as as our next evolution on how we grow this business going into next year thank you very much thank you there are no further questions at this time

Thank you so much for your participation. This concludes today's teleconference. You may disconnect your lines at this time.