Axalta Coating Systems Ltd.

Ladies and gentlemen, thank you for standing by. Welcome to Exalta's third 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 November 8th. Those listening after today's call should please note that the information provided in the recording will not be updated. and therefore may not longer be current. I will now turn the call over to Chris Evans. Please go ahead.

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 third quarter 2023 financial results conference call. Joining me today are Chris Villavarayan, CEO and President, and Carl Anderson, CFO. We released our quarterly financial results this morning 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 these forward-looking statements. Please note that the company is under no obligation to provide updates to these forward-looking statements. Our remarks and the 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. Good morning everyone and welcome to our third quarter 2023 earnings call. I'm pleased to report on a great third quarter. I want to thank the entire global team for their tremendous efforts in delivering an exceptional result. I'm proud that Exalta is back on track with the momentum we began earlier this year. Both commercially and operationally, we have made many notable accomplishments this quarter that I will highlight for you. I'm particularly pleased that the North American ERP implementation issues we experienced last quarter are now resolved and production volumes at our refinish facility in Virginia are ahead of pre-implementation rates. Q3 net sales increased by 6% year-over-year to $1.3 billion, a new company record. The top-line improvement was led by a solid quarter from mobility coatings, which delivered double-digit organic net sales growth. Price mix increased by 6% year-over-year, with strong contributions from every end market. This was a great outcome for the team. We will maintain our pricing discipline going forward as we face pressure from higher labor costs and strive to recover margins to pre-pandemic levels. Adjusted EBIT of $188 million and adjusted EBITDA of $261 million increased by 27% and 24%, respectively, year over year, and both were near record levels. Mobility coding strove the majority of the improvement in earnings. and the segment is now at a quarterly run rate consistent with 2019 levels. The team has done a great job prioritizing margin recovery while also building an attractive book of business wins in high growth areas. Company-adjusted EBIT margins improved by 240 basis points year-over-year to 14.3%. This improvement largely stems from raw material deflation, cost discipline, and continued pricing efforts. Sustained margin improvement remains a key priority for us going forward and will remain an important target heading into 2024. Free cash flow increased by 131 million year-over-year to 182 million. This positive trend is a direct result of our ongoing focus to reduce working capital. We believe that we are well-positioned to deliver approximately 400 million of free cash flow for the full year 2023. Given this degree of earnings and cash flow growth, our balance sheet has now strengthened considerably. Exalta's net leverage ratio continues to improve and is significantly lower than Q3 of last year. Given our strong commercial and operational performance, we have increased our full-year financial guidance. This updated forecast puts us on pace to deliver record-adjusted EBITDA in 2023. The pieces are coming together at Exalta, but before giving you more color on the quarter, I want to briefly discuss leadership updates on Exalta's board of directors. Steve Chapman, who has been a director since 2020, has chosen not to seek reelection. We extend our gratitude to Steve for his significant contributions to Exalta. His wealth of experience, specifically his global operational insight, has played a pivotal role navigating our journey through the pandemic and post-pandemic dynamics over the last several years. Also, we're delighted to welcome Mary Zappone to our board, effective October 25th. Mary will serve on the Audit and the Environment, Health, Safety, and Sustainability Committees. Mary is currently the CEO of Sundyne, a leader in design and manufacture of mission-critical pumps and compressors for the chemical, industrial, and energy markets, a position she has held since 2021. Mary brings a wealth of experience to our team with more than two decades in senior leadership positions, including CEO of Brace Industrial Group and service champ. She has a proven record in industries directly relevant to Exalta. I'm confident that she will make a meaningful contribution to our board. Let's now go to slide five with the highlights of several notable accomplishments this quarter. In October, we acquired Andre Co., a long-term refinish distribution partner. This acquisition is immediately accretive and aligns neatly with our strategy to diversify and expand our refinish offerings. It also increases our presence in Switzerland, an attractive region for us. We're excited to welcome the Andre Co. team to Exalta. Next, we were recently named the exclusive supplier for BMW Group's private paint label in 15 European countries plus South Africa. This agreement includes BMW's network of 730 franchise dealership repair shops and adds to the existing supplier agreements with BMW Group in other regions. We're thrilled with this expanded relationship. It speaks to the strength of our deep customer relationships and the Refinish team's dedication to the highest standards of quality, efficiency, and sustainability. Innovation is critical to the health of our business long-term. This is why I'm excited about our new partnership with Czar to introduce Axelta's NextJet, an advanced paint application tool that allows for precise paint placement. This emerging technology enables inline customization of color schemes, including two-toning and striping. NextJet is being tested with customers today, and we plan to bring it to limited commercial use in 2024. This is an excellent example of how we're working with our customers to understand their requirements and developing technology to meet those needs. Lastly, I want to highlight the official opening of our new mobility coatings manufacturing facility in Jilin, China. This site produces waterborne and solvent-borne coatings for the automotive OEM space. Adding local capacity enables Exalta to meet the growing demands for the China market, where we have continued to expand our position and see sustained long-term growth. Let's move to slide six. My main focus since joining Exalta has been to drive improved efficiency and performance across the portfolio. Our financial performance is beginning to reflect the operational initiatives underway that are driving these improvements across the enterprise, including managing price. We have instituted a more rigorous pricing approach, which is helping margins return to target levels across all end markets. Pockets of opportunity are being pursued as well, and we will remain disciplined given the inflationary pressures in labor and select raw materials. Next, we have been focused on cost optimization. We have initially prioritized this opportunity in procurement given the cost we have incurred in the past two years and the favorable buying environment. In the last nine months, We have bid out more than two-thirds of our total $2.5 billion of spend and have driven substantial savings. This is a direct result of our consulting initiative we put in place earlier this year. We have invested in our manufacturing capabilities. As I said earlier, our North American operations have made great strides following our ERP implementation. Production volumes at our Virginia plant are ahead of pre-implementation rates, and we're making good progress at reducing the backlog. And finally, we have improved inventory levels to drive better free cash flow. We have reduced inventory by approximately 80 million year-to-date. This is yet another consulting initiative that we have seen great return on investment. I'm pleased with our progress, but this will be an ongoing effort with more actions underway. I look forward to sharing our strategic plan for the company at a capital markets day early next year. I could not be more excited for what the future has in store for Exalta and all our stakeholders. I will now turn the call over to Carl for a review of our financial performance.

Thank you, Chris, and good morning, everyone. I am thrilled to have joined Exalta at this opportune moment as we set out to transform the company and unlock our full potential. There is incredible talent at Exalta, and I look forward to working with the entire team to drive value for our stakeholders. Let's turn to slide seven. In the third quarter, net sales increased 6% year-over-year to $1.3 billion, with positive sales contributions from both segments and strong price mix improvement in every end market. Volumes were 3% lower as growth in mobility coatings was offset by declines in performance coatings. Adjusted EBIT improved $188 million from $148 million in the prior year period, a 27% increase. Adjusted EBIT margin improved by 240 basis points to 14.3%, led by a significant step up in price-cost recovery. All end markets are now price-cost positive on a cumulative basis from 2021. raw material deflation was a benefit for the second consecutive quarter as a consequence of a few factors. First, as Chris mentioned, our teams have done a great job negotiating with suppliers. They have driven significant savings and improved contract terms to help solidify these benefits. Second, Softening demand in adjacent markets alongside improved global arbitrage has moved supply-demand balances in favor of Exalta across many of our input categories. On a regional basis, we have seen considerable relief across much of Asia Pacific and expect these markets to be balanced going forward. Trends in EMEA and North America are expected to remain favorable into the fourth quarter. In addition, pricing discipline remains critical as labor inflation persists globally and was again a significant headwind this quarter, offsetting a portion of the RAS relief. In the quarter, we also continue to incur costs associated with our productivity investments and ERP implementation, which totaled $15 million in the period. We expect these costs to start trending down in the fourth quarter and will be mostly behind us as we cross into 2024. Adjusted diluted earnings per share increased 15% year-over-year to $0.45, despite an approximate $0.08 headwind from the net change in interest expense and tax rate. Free cash flow in the quarter totaled $182 million compared to $51 million in the third quarter of 2022, an increase of 257%. Targeted working capital improvements were the primary driver of this result. Moving to slide 8. Performance coatings third quarter net sales were $856 million, a 2% improvement year-over-year. Refinished organic net sales improved by low single digits year-over-year. This was driven by strong price-mix growth as well as from modest mix enrichment given the near-term deprioritization of low-margin product categories such as thinners this quarter. Volumes in our core premium and mainstream customer segments were above expectations. led by strength in EMEA. However, declines in the economy customer segment and non-core areas led to lower reported volumes year-over-year in refinish. We continue to see a favorable backdrop for our industry-leading products and services. This is exemplified by the BMW win mentioned earlier, as well as ongoing market share opportunities in mainstream economy segments and adjacent markets. We remain on pace for record refinish earnings again in 2023. Industrial organic net sales were down year over year as better price mix was more than offset by softer volumes as challenges persisted in construction-related sectors. We see signs of stabilization, but certain areas, like our building products business, are still facing customer destacking headwinds. In the meantime, the teams are doing a great job managing costs and increasing profitability despite volume decline. Performance Coating's third quarter adjusted EBIT was $135 million versus $122 million in the same period last year. Both end markets contributed to improved segment earnings as better price-cost dynamics more than offset lower volumes, higher labor, and cost allocations associated with enterprise productivity projects. Let's move to mobility coatings results on slide 9. As Chris told you, this was a solid quarter for mobility. Third quarter net sales increased by 13% year-over-year to $453 million, driven by a balance of better volumes and price mix. Light vehicle organic net sales increased by 12%. Volumes were very strong in the quarter, led by above-market mid-teens percentage growth in China. In North America, organic sales were up 12%, as we had a very limited impact in the quarter from the UAW strike. Price mix improved by 7%, year-over-year inclusive of a modest mixed benefit. The performance was supported by resilient auto builds and continued execution of a multi-year customer strategy to align with the fastest-growing OEMs. Our growth in China was noteworthy and should be further enabled by investments we are making in the region. We are closely monitoring the UAW strike in North America, and our fourth quarter guidance reflects a modest impact, but it is important to recognize the diversity of our regional and global sales mix, which in 2023 has increasingly been driven by growth in other regions. Commercial vehicle organic net sales increased by 10% versus the prior year period. The year-over-year improvement was driven by strong price mix in North America and a mid-single-digit improvement in volume. Mobility Coating's adjusted EBIT improved to $40 million from $4 million a year ago, driven by higher selling prices and lower variable input costs. This is a significant improvement and represents a run rate consistent with pre-pandemic 2019 levels. Adjusted EBIT margin also increased by 790 basis points to 8.8%. Turning to slide 10. We ended the quarter with $1.1 billion in total liquidity, inclusive of a cash balance of $606 million. Note that the acquisition of Andre Koch, mentioned earlier by Chris, occurred after the third quarter closed. And as a result, the closing date cash outlay of approximately $108 million will be reflected in our fourth quarter cash balances. Our total net leverage ratio is now 3.2 times, reflecting an improvement from 3.6 times last quarter and almost a full turn from a year ago. Additionally, we still expect to finish the year at a three times leverage ratio inclusive of the impact from the acquisition. Continuing to strengthen our balance sheet is among our highest priorities. We are targeting a net leverage ratio of two to 2.5 times and a gross leverage ratio of 2.5 to three times from a combination of natural deleveraging and continued cash generation. This quarter, we also repurchased $50 million worth of Exalta shares. We see strong value in our equity today and will remain opportunistic as we prioritize capital deployment to drive shareholder value return. This prioritization includes a need for incremental CapEx to support operational objectives. Going forward, we will accelerate internal investments with a modest step up from our recent annual CapEx ranges as ERP-related spending begins to wind down. We are focused on improving return on invested capital across all areas of investment. I will now turn the call back over to Chris for an update to our fourth quarter in 2023 financial guidance. Thanks, Carl.

In Q4, we expect net sales to be up year over year with an improvement in both segments. We project volume growth to be muted in Q4 due to the growth in mobility codings with a slight decline in performance codings. We expect global mobility sales to remain strong with the exception of the forecasted impact from the UAW strike. Refinished sales are expected to remain stable with a slight sequential decline in fourth quarter driven by typical seasonal cyclicality. On the cost side, we anticipate that raw material deflation and significant cost initiatives will drive a high single-digit benefit in the fourth quarter partially offset by higher labor expense. Margins are expected to be greatly improved year over year. However, we expect a typical seasonal mixed headwind quarter over quarter, which is likely to drive a modest margin headwind from Q3 to Q4. Fourth quarter adjusted EBIT is now expected to be approximately $180 million or about $250 million in adjusted EBITDA. Full-year adjusted EBIT and adjusted EBITDA are projected to be approximately $670 and $950 million, respectively. We're pleased with the trajectory of our earnings into year-end. At these levels, our full-year guidance implies 17% year-over-year growth and a potential record adjusted EBITDA. As we look ahead to 2024, we see opportunity for yet another year of solid growth and margin expansion. We expect a supportive environment in our resilient refinish end market, and we expect to outpace robust demand in light vehicle, which together should offset potentially lower volumes in industrial and heavy truck markets. We also see the potential for a weighted benefit in the first half of the year from lower raw material costs slightly offset by select RMI linked contracts. We are committed to transforming Exalta. The actions that we're implementing are already showing results, and this is just the beginning of a strategy that we are confident will bring the positive change we want for the company. This concludes our prepared remarks.

Operator, please open the lines for Q&A.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your headset before pressing the keys. And our first question comes from John McNulty with BMO Capital Market. Please go ahead.

Thanks for taking my question. So I guess the first one would just be on pricing. You've had some really strong pricing. It's continued to flow through. If anything, in some areas it looks like it's even gotten better. I guess, can you speak to the pricing environment going forward and how we should think about it, excluding the pieces that are on index? I think that's an automatic pass-through with a little bit of a lag type thing. But when you think about the rest of the business, I guess, how should we be thinking about the pricing dynamic as we go into 4Q and into, say, the first half of 24? Yeah, thanks, John.

I think if you look at – the last year, certainly the team's done an exceptional job at pricing across all three segments. And as I think about Q4, as well as preparing for 2024, again, in our mobility business, 40% of it, to your point, is on RMI. But that said, if you look at Exalta as a whole, RMI indexing represents about 10%. So as you think about the rest of the basket, we certainly have the opportunity to price. And as I see, where labor is going as well as, let's call it some select raw materials, as well as freight, there will be the need to continue pricing. So I do believe that we will continue low single-digit pricing going into 24 as our base. Got it.

And then just as a follow-up, your gross margins snapped back nicely. I mean, you're kind of back to some really strong levels in 3Q. I guess when you think about the cost dynamic and raws at least looking like they're going to continue to come up a little bit lower pricing. It sounds like you may still have some, some price opportunity ahead. I guess, can you speak to how you're thinking about the gross margin trajectory? And can you get to the, you know, the 2018, 2019 kind of levels where it was 34% percent or so or better, can you get there without volumes? Can you get there with the help of some of the cost cuts that you're doing in the productivity initiatives, or do you need the volume really to get you there?

Well, I think it's a question of time. We've certainly seen significant improvement this quarter, and I do believe that there is more structural enhancements that are already underway and that there are more to come. And we certainly are benefiting from the reversal of, let's call it some cyclical factors of nine quarters hyperinflation that's obviously shifted to some deflation but as I said in my prepared remarks if you look at it we're seeing deflation but we certainly also did some structural initiatives we put two and a half billion dollars of our purchasing spend under bidding and so we have seen I would say single-digit benefits and material performance and I do believe that will continue into 24 and So I would say let's call it, you know, where we're performing in the last two quarters as the base. And I do see that there's more opportunity. And I'll probably turn it over to Carl to put some more comments on this one.

Yeah, John, just to add to Chris's commentary is I look at, you know, our plans next year, especially on capital expenditures. We think there's opportunity to drive more productivity in our network and in our plans as well that will actually help accelerate, you know, our increased margin profiles as we move forward.

Got it. Thanks very much for the call. Great job, guys.

Thank you. Thanks, John.

Our next question comes from Alexei Yefimov with KeyBank Capital Markets.

Please go ahead. Thanks, and good morning. Your acquisition in Switzerland, I believe it's not the first one for European distribution for the company. Could you discuss how does owning distribution there fit India strategy? Why is it necessary in Europe and not perhaps in North America or other regions?

Well, I think, great question, Andre. I think, you know, we're just absolutely thrilled to announce Andre Coe. It's an exceptional story for us in many sense, but, you know, one is, you know, it's in Switzerland, certainly a creative, it's a strong margin profile for the business, and it the business comes in at, let's call it refinish margins. It's $50 million. And in terms of investing in the business, over the last two quarters, I've always talked about investing into our strong refinish business. And last quarter, we talked about the Iris Mix. This quarter, distribution gets us closer to our customers. And in our sense, in terms of essentially getting us to the ability to get closer to over 500 customers is an ability that I think we can probably do more easily in Europe just with the distribution dynamics. So that's certainly one of the main reasons we're playing here. Another reason is Andre Coe has a system called WrapperNet that pulls together the insurance providers, the body shops, as well as Exalta as a codings provider. And we believe this network is something we can expand through Europe and really play on growing in the European market, which is extremely accretive from a margin profile for us over time.

Thanks. And just to clarify on this, was this distributor unique to, were they just distributing Exalta paint or was there other suppliers who may fall off after the deal?

Yeah, there are other suppliers that are also in the profile. They've distributed Exalta for two decades, but they do also cover other paints that provides us an opportunity to obviously grow here.

Thanks a lot. You're welcome.

Our next question comes from Dajan Punjabi with Bird. Please go ahead.

Hi, good morning, everyone. This is actually Matt Krieger sitting in for Gansham. Thanks for taking our questions. You know, just to kick things off, you know, we've talked a lot about some of the investments that have been made and some of the groundwork you've laid in 2023 to allow the company to, you know, add additional earnings power and you know, in future years. Can you detail some of those projects specifically, maybe talk about some of the cash outlays that you've made and then also the specific returns that you expect on these types of investments, you know, into 24 and then on a multi-year basis would be great.

Sure, absolutely, Matt. So I'm going to kick it off with the investments and the three projects that we kicked off and I'll let Carl walk you through the spend and how we see that going forward into 24. So the three projects we kicked off, first one was on the ERP implementation, which obviously from my prepared remarks, it's certainly progressing well and we're certainly seeing efficiency gains that have helped us reduce the backlog in refinish, which is one of the primary drivers to our performance as I look at Q3. The second one was on the purchasing initiative. And here, again, we put out a significant portion of our material spend to bid, and here we're seeing single-digit improvement on top of what I would call is mid-single-digit improvement in deflation, which puts us at high single-digit performance in our material performance for the year, which is one of the primary drivers for how I see Q3 and Q4 coming out. And obviously we should see that tailwind feeding into 24. And on top of that, the last initiative that we kicked off was focused on inventory. As I look coming in, one of the things that we wanted to work on was reducing the inventory buildup that we had seen over the last two quarters coming out of the pandemic. And here we had an initiative focused at taking down close to $100 million of inventory. And to date, we have seen $90 million of improvement here. So certainly a significant driver that's helping us with our free cash flow targets. And I'll turn it over to Carl to give you specifics on the numbers.

Yeah, Matt, just to add to it. So if you look at through nine months of this year, in total we had spent about $34 million as far as related consulting as well as S4 implementation costs. And as we look forward in the fourth quarter, we see that stepping down pretty much kind of by half as you kind of compare it to the third quarter. And as we get into 2024, most of that will be completely behind us going forward. So as Chris said, it was very strategic. It really allowed the company to add more horsepower and velocity as it relates to a lot of these activities. So we are setting ourselves up for 2024 as we go forward.

Got it. That's helpful. And just to follow up on profitability, obviously the improvement in mobility was very impressive. Should we expect to see double-digit EBIT margins for that business into 4Q or something close to it? And what level of profitability should we expect on a run rate into 24? Can we hold the levels that we're at currently, or is there something unique that's going on that we would expect to revert?

No, I think that you characterized it well. The team has done a really, really strong job this year as far as on pricing as well as on overall kind of cost discipline for that business. Obviously, the fourth quarter will be a little bit impacted just based off here in North America with the UAW strike, which appears to be moving in a direction to kind of be behind. But again, there will definitely be a smaller impact as we think about what happened in the month of October for us. But as we go forward, you know, that is, you know, that mobility margin profile, we do expect to continue to be able to grow that, especially as we get into 2024.

Okay, great. That's it for me. Thanks. Thank you. Thank you.

Our next question comes from Patrick Cunningham with Citi. Please go ahead.

Hi, good morning. You know, just given the magnitude of the guidance raised, can you maybe quantify or rank order the biggest changes in expectations, you know, from the previous release, you know, whether it be backlog normalization, price, cost, or other factors? And is there any additional conservatism baked into the 4Q outlook?

So, you know, certainly an exceptional order, I would say, you know, whether it's all regions and all the three segments were hitting on all cylinders, but maybe to break it down for you. First, the improvement in our ERP efficiency really enabled refinish to reduce the sales backlog. And then obviously the material performance, whether it's the tailwind from the material deflation as well as the structural initiatives that we had from our consulting initiative on material. And when you put those together, as well as the OE production, which was well ahead of third quarter projections, and this was globally, and we had an extremely strong quarter in China. And as I look at Q4, that sentiment and that strength exists in mobility. And to the earlier questions, we've seen a 300 basis points jump in mobility year over year, or 200 basis points jump quarter over quarter. So great performance there. All that said, you put, let's call it the pricing initiatives we've been driving as well as the cost initiatives. As to Carl's remarks, we've had just all four end markets be price-cost positive for the first time in nine quarters since 2021.

Got it. And then just on the BMW group partnership, you know, it looks very promising, but can you help, you know, help us understand the timing of getting penetration into those body shops and then maybe the volume and earnings potential from that partnership?

Yeah, it's certainly going to be sometime in 24. So, you know, we have to convert these shops and our, you know, as we see it every quarter next year, we're going to work on converting more and more of those shops. It's certainly a true testament to the group. This year, as I look at it, you know, we're on path to win 2000 net body shops. If I look at the last three years, the team's done an exceptional job winning 10,000 body shops. So, you know, this 730 is a great step right off the get go in how we're set up for 2024. Great. Thank you.

You're welcome.

Our next question comes from Joshua Spector with UBS. Please go ahead.

Good morning. This is Lucas Bowen. I'm for Josh. So I just wanted to get back to our finish if we could. So could you please kind of comment on the base volume growth there for us by region and just sort of highlight as well what was the impact of the low margin exits in the quarter and kind of how much of that is like left to go now as we sort of roll into 2024?

So, you know, if I look at it quarter over quarter, let's call it, you know, what we're seeing is I would call it, you know, a 5% decline in volumes. And a lot of this obviously related to what we went through with our refinish market. But if I look from this quarter into next quarter, we're essentially flat. And going into next year, I would say from a volume basis, we expect that to remain flat. Just explaining the dynamic quarter over quarter Q2 to Q3 again, primarily driven from our S4 implementation. We made a large step up, but still there's more opportunity obviously with us burning more of the backlog as I think about Q4 and prepping us for next year. But Q3 to Q4 we expect volumes to be overall flat and heading into next year to be flat. If you were to break that region by region, I would say Europe and North America somewhat stable, and then China continuing to be soft on the refinish side.

Great, thanks. And then I just sort of wanted to talk about kind of the ones on bridge items going into next year. So just in terms of where we stand now with like what you know, so you highlighted the sort of $35 million in the consultant spending that's not going to sort of occur. But then, you know, we have the other factors like the low margin product exits, change in mobility, contract pricing, just anything else sort of that you'd like to highlight for us that's known at this time, if you could kind of walk us through that, please.

Yeah, I think just to add what Chris said earlier in some of his comments, as you think about, you know, the bridge into 2024, we do expect a little bit more pricing, especially as we think about what we can do and refinish, as well as in some of the other verticals as well for us. And we think also VCOGs, at least on a year-over-year basis, will continue to trend favorably, especially at least through the first half of 2024. So those would be the primary areas of the bridge that will help lock you to where we think 24 will end up. Thank you.

Thank you.

You're welcome.

Our next question comes from Kevin McCarthy with Vertical Research Partners. Please go ahead.

Yes, good morning. Chris, it sounds like you've made a lot of progress with regard to your purchasing initiatives. Can you provide a little bit more color on the raw material cost outlook heading into 2024 and perhaps where you're seeing the most deflation or the most stickiness in your input costs?

Sure, I'd love to. So I think, you know, I would say... As we look at Q4 and also into 24, I would call it mid-single-digit opportunity on material. This is still going to provide us a tailwind. Now, in terms of, there is a few outlying factors. We are monitoring oil, but at this point, we're certainly not seeing any impact on our downstream market. But, you know, oil does play a key factor in solvents as well as if we think about freight. But again, no pressure that we are seeing at this time. But epoxies, isocyanates, and resins are all trending favorably. So as I think about 24, we still, you know, from a planning standpoint, I would say we see single-digit opportunity in material performance.

Okay.

And then... Would you comment, Chris, on your outlook for auto builds? I think Exalta used to provide some fairly specific numerical guidance. I didn't see that unless I missed it, but maybe you can kind of talk through what you're thinking about for the fourth quarter as well as 2024 as it relates to a production backdrop.

So fourth quarter, you know, obviously, you know, going around the world, Europe seems to be stable and growing. China is just going to gangbusters. If I look at Q3 and also, you know, as we look at our forecast for Q4, the team's just done a stellar job also on top of our wins. You know, if we look back a year ago, we talked about $200 million of new wins running through the P&L. at the back end of 24, and we're certainly seeing our share of not only growth, but also the market rebounding in China. So, so far, as I look at Q3 and Q4, I would say globally, the markets seem to be trending the right way. Specific to North America, obviously the step down with the UAW strike, we certainly saw a minimal impact from the strike in Q3, as you can see from our performance, In Q4, I would say we're guiding to 1% of our revenue being impacted possibly from the strike. But if that gets resolved here based on where the discussions are going, we do see some level of opportunity there in our guide as well. Now, looking at 24, all indications, to your point, are that markets are going to start building up. So, you know, for the global bills, we see that going up to 89 million. So certainly a positive trend there heading back to, you know, the numbers we saw, let's call it pre-pandemic. The one outlier is on the commercial vehicle side. On the commercial vehicle side, I would say ACT has markets going down to 275,000 bills. Obviously, we're running at well north of 300 right now at 325,000. So there's a bit of a risk there, but that said, I think the team's doing well with winning new business and also driving price and cost actions that we should see overall margin continuing to improve into 24.

Perfect. Thank you so much.

You're welcome.

Our next question comes from Steve Barney with Bank of America. Please go ahead.

Thanks. I wanted to drill in a little bit on refinish. Your low single-digit organic sales in the third quarter seems a little modest given you have these pricing initiatives, you have the MSO partner keeps acquiring, you got your automated mixing technology. would you expect organic sales in refinish to, you know, post higher gains in 2024, perhaps bolstered by, you know, these recent acquisitions with the Andre Koch and the BMW group? What's your outlook for 2024?

Yeah, let me address it in two ways. I think first, let me address it from a volume standpoint. And I think, you know, going back to the questions we had last quarter and also this quarter. One of the primary drivers from a volume perspective, you would notice that we've been taking a bit of a step back, but that's primarily because we've been focused on driving the margin. And what we have done is, whether it's in thinners or in certain businesses in South America, architectural business in South America, we decided to, let's call it, made a decision to exit these to ensure that we were driving the margin and ensuring that we had the capacity for higher margin products. So that was a decision we made because the focus was, again, to make sure that we maintained and grew margins. In terms of, let's call it sales, to your point, yes, we do see opportunity as we continue to win, that we will continue to drive growth into 24 as well, especially with the acquisition we just announced. And on top of that, the team has done a great job continuing to win net sales. And that'll be the growth trajectory as I look at 24 as well. But I would say X thinners and X, let's call it the decision we made in South America, our volumes have been somewhat flat. So it's not like we're going down. And if anything else, there's only opportunity from a growth standpoint. both from the acquisition as well as the net sales wins for 24.

And then perhaps in mobility, what would you attribute the new business wins that you're talking about? Is this a technology game for you to have better technology that benefits your customer? And how significant is this this new technology, this two-tone technology. What is it? NextJet. How significant of an opportunity is that in your view?

Well, let me break it up into two things. I think, you know, if I go back a year ago and talk about the wins that the mobility team has done, I would say here it's a pure focus around service and the relationships that the mobility team has built with the customers. And it's not... specific to a region, it's globally. The winds are in North America, the winds are in China, significant winds in China, and also in Europe. And this has been, you know, I credit this to two things, certainly technology, but also purely the service and the relationships that the team has done an incredible job building. Now, in terms of the ZAH relationship or the NextJet announcement we made today. Here it is technology and if you think about a Mustang or where you have a different color roof, a two-tone roof with the rest of the car, what we do with this technology is provide the opportunity for our customers to not pull them out of the body shop or the paint line and take them to a separate process to paint the roof separate from the rest of the vehicle. We provide the ability for our OE partners to essentially run it through the paint shop and apply both applications at the same time. That provides enormous opportunity and gets away from an offline process we which we believe will drive enormous levels of productivity in cars that need two-tone painting and these are custom cars these are very expensive cars so i think this is an opportunity that we believe will provide a lot of value for our customers going forward thank you you're welcome

Our next question comes from Michael Cecil with Wells Fargo.

Please go ahead. Hi, this is Abigail. I'm from Mike. Thanks for taking my question. So I believe this was already touched on a bit, but some of your peers have noticed in the reconditioned space share gains in, I think, mostly in the last quarter. Do you have a response to that? Have you been experiencing any share loss? And then twofold, thinking back to your refinish day last December, you mentioned Europe as being a key new market for growth for you. How has that changed in the last year given macroeconomic trends in the region?

So I think, you know, great question. Thanks for the question, Abigail. You know, we certainly win many and we also lose some customers. But what I can say is we're on track this year for 2,000 net body shop wins. So overall, I would say we continue to win. And looking back at the last three years, this team has done an exceptional job with 10,000 net body shops. And I think the broader perspective of measuring this year over year is if I look at the refinish team and joining this company, The best thing you can talk about is the fact that in 21, the Refinish team had record sales. In 22, the Refinish team has record sales. And in 23, at the rates they're going, they're going to hit record sales in 23. So an exceptional team. And talking about the BMW win this early in the year sets up beautifully, as I think about 24, with 730 new body shops just starting out the year. So I would say the team is, you know, is well positioned to continue to grow. And, you know, it all aligns with the strategy that, you know, Troy and the team kicked off, you know, a year ago at Refinish Day. It was actually my first day in Exalta and I actually hadn't even been in the role. And I, you know, to your point, we talked about the growth in Europe and the best part is today we announced two things. One is the BMW announcement, which mostly impacts our growth in Europe. And the second one is the acquisition of Andre Co, which again shows our focus and our attention to Europe and the growth there. So net-net across both of these, I think the refinish team is absolutely positioned to grow in 24 in Europe and are actually taking the right steps a quarter ahead.

Got it. Thanks for the color.

You're welcome.

Our next question comes from Vincent Andrews with Morgan Stanley. Please go ahead.

Hey, good morning. This is on for Vincent. Just wanted to maybe ask a quick question on the M&A pipeline and kind of how you're thinking about that going forward. And on the flip side of that, maybe,

you've kind of walked away from some business and we finished but you know are there other areas of portfolio that you'd you know think about pruning and uh yeah just any kind of additional thoughts on that would be great thank you yeah uh thank you this is carl so yeah just on the m a uh you know pipeline obviously chris talked a lot but we just accomplished here with andre coke here in uh in october uh but as we look forward here at least in the near term from a capital allocation perspective We are really focused on our net leverage ratio is, as you saw on the slide deck, you know, we have an opportunity where we set new targets, especially on that leverage to 2 to 2.5 times. The company's done a really great job in delivering this year. And we think that we have a lot more that we can do and potentially even achieve that. Maybe the top end of our objective is we finish out 2024 on a net average ratio. But having said that, as we look at the overall pipeline on M&A, we will continue to evaluate those opportunities. But at this point, I think the primary focus will be a little bit more inward-looking as we continue to de-lever and also reinvest back in the business.

Thank you. Thank you.

Our next question comes from Mike Harrison with Seaport Research Partners. Please go ahead.

Hi, good morning. Congrats on a nice quarter. You noted the opening of the Jilin manufacturing facility in China. Can you give a little bit more detail on how that's going to help you grow in the mobility business there in China? Maybe what additional capabilities does that facility provide for you?

Certainly. Thanks for the question, Mike. As we think about China, the growth in China for us, if I think about that $200 million of net wins, that is skewed a little bit more towards China. And the best part of it, I was looking at some numbers last night, and our growth in, not only are we growing faster than the market on the ice side, But our growth on the EV side is 5% higher. And that is an important, it's an incredible market for EV. And as you look at that, we're certainly positioned for that growth. And so what the facility provides is the ability to make both waterborne and solvent-borne products. It's great in a sense that it gives us capacity both on the refinish side And as the market starts to trend towards more waterborne products, it gives us extra capacity, which obviously gets us ready for the growth in region. So across the board, I would say, as I think about next year and where we're going, this facility certainly provides us the capability to continue to grow. We just had our official opening this last week. And again, just a great story as the production ramps up through 24th.

All right, and then also curious, it sounded like you're going to be accelerating some of your capital investments into next year. Can you walk through what some of the key projects might be that you're investing in?

Yeah, so as I referenced on my prepared remarks, capital expenditures, the one thing you'll see is our investment in S4 and the ERP system will trend down as we get into 2024. But that will be replaced and probably even a little bit more just with overall really primary focus productivity investments in the network. And so we believe there's an opportunity for our facilities to get more efficient. And so we're going to be taking a closer look at where we can invest those dollars really just to drive overall productivity improvements across the entire global network.

All right. Thanks very much. Thank you. Welcome.

Our next question comes from with Barclay. Please go ahead.

Great. Thank you. Good morning, guys. Chris, just one higher level question for me. There's been a number of board refreshments, say, the past few months in addition to yourself and Carl joining Exalta. Can you maybe just speak to what the new board joiners bring to the table or any sort of specific attributes or qualities the board is really looking to refresh or enhance going forward?

Sure. I'd love to, Mike. I think, you know, just looking at the last two announcements and, you know, starting with Kevin Stein, you know, Kevin, obviously a sitting CEO of TransDyne, And, you know, in terms, we have a great board that has walked this company through a lot of the pandemic. And as looking forward, one of the things that we want to continue to drive is obviously value accretion. And as I look at, you know, the new board members, what they bring is, you know, two. One is, you know, sitting CEOs, which will provide a base for me to also work with. and also the fact of the value creation story that both of them have done. Transdyn has gone through an amazing journey and as I look at Mary and what she brings in, it's certainly both on the private equity side as well as on public boards, just done an incredible job in driving value. And this is just not only with what she's done at Sundyne or is doing with Sundyne, but also previously with Tyco, Exxon, and Alcoa. And both of them also bring quite a bit of experience from the standpoint of chemical background. Kevin being a PhD in chemistry helps, and obviously Mary with a background in chemical engineering. So certainly the right mix for our board. And certainly as I look at the board structure that we have, certainly we have an incredible talent that we have from all aspects, whether it's operational, finance, and I think this just rounds it off with folks that are currently sitting CEOs.

Great. I think if you can get your margins anywhere near where trans times are, investors would be very, very happy.

That's a goal.

There you go. That's the set.

Our next question comes from Laurence Fave with BNP.

Please go ahead.

Thanks, and good morning. Chris, you've talked a couple of times about backlogs. I was wondering if you could talk about the bottlenecks. Is that on the customer side still, or is it something on your side? And I guess what can you do to solve those? Thank you.

Yeah, so absolutely. So I would say the bottlenecks, the one place that we have just the bottlenecks is just on the refinish business, and this is just with our facility in Virginia. We've done an exceptional job bringing down the backlog from Q2 to Q3. And, you know, as we noted this in our Q2 guide, we did say that, you know, we were being conservative and driving to, you know, if we reduced the guide, we would obviously see better performance, and this is obviously tracked through as we see in Q3. There is more of the backlog that we can take out and we will be focused to do that. And I believe we'll be back to normalize backlogs in the refinish business in Q1 of next year. So we still have some backlogs through Q4 and it's just in our refinish business. And just to answer the question, there is still opportunities to drive efficiencies with S4. On all that said, As I look into 24 operationally, I do believe that there are more efficiencies that we can drive through the entire company. And this talks to the investments that Carl talked about in productivity investments that we're going to drive next year.

Thank you. And if we combine the backlog, the comment on the ERP, the fact that this year wasn't great on volumes, the pruning on products, is it fair to assume that you should outperform meaningfully volumes compared to your assumption of a stable market for refinish next year?

Yeah, I think, you know, we'll provide a little bit more commentary as we think about 2024 coming up here in the next couple of months. But so right now, you know, the focus is obviously to finish out the year strong and really position Exalta for 2024, but overall, I think what's in front of us, especially not only in refinish, but in some of the other protocols as well, we continue to think there's additional upside as we get into 2024 and beyond.

Thank you.

Thank you.

This concludes today's conference call.

You may disconnect your lines at this time. Thank you for your participation and have a great day.

Thank you.