Axalta Coating Systems Ltd. Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to Axalta's Third Quarter 2020 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 replay will be available through October 30. 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 Mecray. Please go ahead, sir.

Thank you and good morning. This is Chris Mecray, VP of Investor Relations. We appreciate your continued interest in Axalta and welcome you to our third quarter 2020 financial results conference call. Joining me today are Robert Bryant, CEO; and Sean Lannon, CFO. Last evening, we released our quarterly financial results and posted a slide presentation along with commentary on the Investor Relations section of our website at axalta.com, which we'll be referencing during this call. Both our prepared remarks and discussions may contain forward-looking statements reflecting the company's current view of future events and a potential effect on Axalta's operating and financial performance. These statements involve uncertainties and risks and actual results may differ materially from those forward-looking statements. Please note that the company is under no obligation to provide updates to these forward-looking statements. This presentation also contains various non-GAAP financial measures. In the Appendix, we've included reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information regarding forward-looking statements and non-GAAP financial measures, please refer to our filings with the SEC. I will now turn the call over to Robert.

Good morning everyone. As you've seen, we achieved outstanding financial and operating results in the third quarter, thanks to the snapback in demand in our end markets, the rapid cost structure adjustments we made in response to COVID-19, and the unbelievable effort and commitment of our employees around the world. First and foremost, I'd like to thank all the employees of Axalta around the world for the strong financial and operating results, which were the product of hard work and focus during a challenging time, while many of our colleagues continued to work remotely with a myriad of restrictions, both business and personal. Despite these, in the third quarter, we delivered record quarterly adjusted EBIT, adjusted EBITDA and adjusted EPS. Before we discuss our third quarter results in more detail, I'd like to step back and provide some perspective about the journey Axalta has been on. Now that we've completed our strategic review and appear to be through the worst of COVID-19, we were finally in a position to be able to pursue the many opportunities I've wanted to go after, since I first became CEO in late 2018 and also those we identified during our strategic review. We're now actively making changes that include aspects of our strategy, how our organization functions, and refining our operations to lower our cost structure globally to unlock additional growth. These changes will allow us to accelerate growth, be more nimble, and create more value for our shareholders, while also increasing our focus on our people, our customers, and the communities in which we operate. We plan to hold a Capital Markets Day in the spring, where we will provide more detail about our vision, strategy, and specific value creation opportunities. In the meantime, you'll hear more about certain changes in the coming months as you have in the past few months. From a corporate governance perspective, we've strengthened our board by adding two outstanding board members with specific expertise in two areas that are important for Axalta: growing businesses in China and emerging markets, and leveraging innovation to grow in transportation-related markets. Over the past six months, we've also added key talents at all levels of the organization that will help drive innovation and a focus on people development. These are two of my highest priorities as CEO. And I'm confident they will take Axalta to the next level of performance. Regarding our operating model and cost structure, despite the great financial results in the third quarter, we need to continue to drive down our costs in certain market segments and geographies where we operate to enable a higher level of revenue growth. We've begun this journey and have much more to accomplish. We can and will do this without sacrificing capabilities, market positions or impacting the organization's ability to innovate. Since Axalta's IPO, we've been asked how the company would perform in a downturn like we saw back in 2008 to 2009, what levers could be pulled and how quickly management could react. COVID-19 has been a much more severe test case than any of us could have ever imagined. And I think this question has been answered. Since the start of the COVID-19 pandemic, we have substantially reduced our cost structure. With $195 million in expected savings during 2020 alone we've taken further actions to maximize our cash flow and liquidity, with an additional $140 million in incremental cash savings expected this year. Both costs and cash actions offer immediate and real offsets to the unprecedented volume impacts, all while our global team continues to serve our customers at the highest levels of quality, delivery and technical support. These results speak to the strength and resiliency of Axalta's business model: the speed at which management took action, and the truly unbelievable support and dedication of the company's employees around the world, I could not be prouder of our global team. Now I will discuss a few highlights from our third quarter financial results. On the top-line, we were pleased to see significant ongoing recovery during the third quarter with net sales 57.3% higher than second quarter, a major achievement as we saw rapid recovery in all end markets. The 7.2% net sales decrease from the prior year also beat our expectation going into the quarter. The improvement was driven by broad-based economic and business recovery, including monthly net sales recovery globally in nearly every geography served. While net sales recovery was a major component in the third quarter, there was clearly more to the story, given the robust profit that we reported. We saw record quarterly consolidated adjusted EBIT of $210 million coming on the heels of a loss during the second quarter. We also reported record adjusted EBITDA with margins of 26.5% and a record quarterly adjusted earnings per share of $0.59. Finally, our free cash flow of $223 million was also a stellar outcome. Given substantial excess cash at this point and the broader recovery in the business, we expect to begin to shift back to a more normal capital allocation approach, although we're mindful that we could see further COVID-19 impacts in certain businesses or regions. We expect capital deployment across a combination of return accretive uses, including M&A, and opportunistic share repurchases, assuming a more stable, forward-looking demand picture holds. We're actively building an M&A pipeline at this time, with sell side activity clearly picking up in recent months. Over time, we would expect to deploy the majority of free cash flow between these uses. But we would also expect to reduce our net leverage to our target of 2.5 times which could happen from a combination of normalized adjusted EBITDA as well as executing on strong cash flow conversion, which you saw during the quarter. Regarding the overall demand environment, we're pleased to see ongoing business recovery through the third quarter. In Refinish, total miles driven globally continues to improve aligned overall with pandemic-related lockdowns in each country we serve. In the U.S., traffic during the third quarter recovered to roughly 10% to 15% lower than prior year after rebounding strongly from the lows during the spring and closing the gap with pre COVID-19 baseline levels by mid-June. In Europe, traffic levels improved even earlier than the U.S., though renewed lockdowns do suggest caution is warranted on the pace of the recovery. In China, traffic appears to be continuing to recover and body shop activity and Refinish volumes have recovered to prior year levels. In the third quarter, body shop customers saw activity in the range of 85% to 90% in the U.S. versus the prior year toward the end of the period, 95% in Europe, and around even in China. This represented a continued recovery in the second quarter and is an encouraging trend for our global Refinish business. For the industrial end market, net sales trends continue to demonstrate the resilience of our business, with some differences showing year-over-year increases for the quarter and all end businesses up in September. At the market segment level, homebuilding, construction, agriculture and construction equipment have recovered to operating grades above prior year levels, notably in North America. In Europe, our business has seen strong recovery to-date in both Powder and Energy Solutions. In China, all industrial businesses have fully recovered with notable strength in Powder and Energy Solutions tied to wind energy customers. In Transportation Coatings, third quarter recovery well outpaced expectations, including fairly strong recovery in most regions. In China, we've seen significant production and recovery as well. In China automotive retail sales have increased from the prior year in each of the last three months, including 8% in September, possibly indicating a measure of pent-up demand after the Chinese automotive pullback in 2018 and 2019. China light vehicle net sales for Axalta decreased mid-single-digits during the third quarter, reflecting specific customer exposures in the country, slightly lagging the broader market. In the U.S., aggressive auto sector incentives coupled with low financing rates continue to help the recovery. Auto sales during the third quarter increased in sequential months with September's expected 16.4 million SAAR well above earlier expectations and only moderately below the year-ago level of 17.2 million to solidify what appears to be a potential V-shaped recovery for U.S. car sales. For the quarter, global light vehicle production declined 3.5% including a 1.4% decrease in Asia-Pacific and a 10.7% increase in China. North America production increased 2.5% on the heels of a 66.2% drop suffered during the second quarter. Current industry forecasts call for a 17.9% drop in global builds for the full-year, including a small decrease of 2.7% for the fourth quarter. This forecast has increased at each of the last several months and appears to show that automotive could be experiencing a form of V-shaped recovery presently. For the Commercial Vehicle end market, overall global truck production increased 0.8% in the third quarter in a dramatic and unprecedented sequential rebound, driven principally by strong growth from China but also better production in other regions.

I will now turn the call over to Sean for some additional comments. Thanks, Robert, and good morning. As noted, we're very pleased with the record operating profit results we posted for the third quarter, including excellent volume recovery versus our original expectations and fantastic execution by our team to deliver significant margin expansion across both segments in this period. We're also very happy to report strong cash flow and showcase our ability to flex the business to meet the volume challenges of a recessionary environment. Overall, the mitigation actions we have undertaken to respond to COVID have succeeded in offsetting much of the volume headwinds, while bolstering our balance sheet and liquidity considerably. During third quarter, we made strong ongoing progress on our cost reduction programs. We exceeded our planned temporary cost actions target in the third quarter with total savings of approximately $50 million and we're reiterating our in-year 2020 savings target of at least $130 million. Likewise, we exceeded our cash flow action targets during the quarter delivering $60 million of incremental discrete cash flow savings separate from cost actions. We still expect to deliver total incremental cash flow for 2020 in excess of $270 million, including the temporary costs reduction actions. Regarding structural cost programs, we believe, we're on track to deliver the planned $55 million of Axalta Way savings for the year, as well as the $10 million of the total $50 million incremental restructuring savings we targeted in our July announcement. So including temporary and structural savings, this totals around $195 million of in-year 2020 cost savings expected across all active initiatives. Regarding our balance sheet and cash flows, Robert noted our strong third quarter performance with $223 million in free cash flow and closing the quarter with total liquidity of over $1.7 billion. We also lowered net leverage to 3.7 times from 4.0 times to June 30, a ratio that still reflects the punishing COVID effects on adjusted EBITDA from the first half of 2020. Touching on some of the income statement highlights. Robert noted a rebound in net sales with a 7.2% consolidated decline year-over-year, substantially exceeding our earlier expectations for the period. Performance Coatings third quarter net sales decreased 6.8% from the prior-year, on a constant currency basis, with Refinish decreasing 10% and industrial decreasing 1.8%. Transportation Coatings net sales decreased 8.6% on a constant currency basis with light vehicle decreasing 5% and commercial vehicle decreasing 20.8%. Consolidated adjusted EBIT for the quarter was a record setting $210 million coming after second quarter's modest reported loss. Performance Coatings adjusted EBIT of $134 million increased 7.2% versus $125 million in the prior-year quarter and benefited from clear tailwinds from cost actions and variable input cost, offset partly by moderately lower average price mix by the impact of lower volumes, despite better than expected sequential volume across both end-markets. Transportation Coatings adjusted EBIT of $49 million increased 30.4% versus $37 million driven by cost actions, moderate variable cost tailwinds, and modestly increased average price mix all set in part by lower volume detrimental impacts compared to the prior-year. Adjusted EBIT margins increased significantly in both segments, reaching new highs on a segment basis of 19.6% in Performance Coatings and 14.1% in Transportation Coatings. Adjusted EBITDA margins for the third quarter on a consolidated basis also achieved a record high of 26.5%, something we're very proud of as we continue to see progress in both recovery and business transformation. Finally, third quarter adjusted diluted EPS of $0.59; a 13.5% increase versus prior-year represented a new high for Axalta as well. Regarding our full-year and fourth quarter 2020 outlook, we expect net sales for the full-year to decline approximately 18% from the prior-year inclusive of a negative 2% related to FX and M&A impacts. This would equate to an approximate 6% to 8% decrease in the fourth quarter from the prior-year with relatively similar outcomes for both segments. Sequentially, the implied fourth quarter net sales guidance is fairly even with the third quarter, given an expectation of broadly steady demands with normal seasonality impacts in December. For the full-year, we expect adjusted EBIT of approximately $495 million to $550 million and adjusted diluted earnings per share of $1.15 to $1.20 per share. The implied lower profits sequentially from the third to fourth quarter is attributable largely to the lower expected amount of total cost savings in the period due to the roll-off of temporary cost actions, offset partly by increased structural cost savings. 2020 interest expense is expected to be approximately $155 million and diluted shares are expected to be about $236 million. Finally, free cash flow is expected to be between $280 million and $310 million including CapEx of about $90 million. With that, we'll be pleased to answer any questions. Operator, please open the lines for Q&A.

Thank you. We will now begin the question-and-answer session. Our first question comes from Ghansham Panjabi with Baird. Please proceed with your question.

Good morning. Can you provide an overview of the volume exit rates on a consolidated basis as we move into the fourth quarter? How did September perform, and what is your assessment for October so far? Additionally, what volume expectations are you factoring in by segment at this stage?

So month over month, yes, as we work through the third quarter, we actually saw a nice improvement as we saw continued recovery across all the end markets, as well as the regions exiting September, extremely optimistic industrial across all the end-markets were actually up volumetrically. We continue to expect sequential improvement as we get into October and November again, across all the end markets. Typically we do our seasonality particular in industrial and light vehicle within December. So that's why you're seeing roughly at the mid-point of the range flat guidance for fourth quarter versus third quarter. But we're seeing continued recovery overall and yes we're happy with the progress and especially coming out of Q2 with headlines now 57% increase versus Q2 and Q3.

Great. And then in terms of the $50 million in temporary savings, you called out for the third quarter, how does that break out by segment? And then related to that just in terms of your current view for 2021? I mean, how much of a flow through should we expect with all of your cost initiatives 2021 versus 2020? Thanks so much.

So the $50 million really breaks down two-thirds performance, one-third transportation in rough estimate. As we think about all the temporary savings, we haven't given any guidance as to what exactly we'll be able to retain into 2021. The vast majority truly is temporary, but there's certainly going to be some benefits in particular around travel and entertainment, where I see is more sustainable fixes. But more broadly on cost initiatives we still have the Axalta Way program out there. And we expect based on the structural savings update that we gave in the July update, that the $50 million savings that actually starts to ramp-up in the fourth quarter, which we're expecting about $10 million in structural savings, with the vast majority of the difference coming through in 2021. But Ghansham we'll be giving more updates when we actually give full-year 2021 guidance as far as expectations on those structural savings falling to the bottom line.

Thank you. Our next question comes from the line of Alex Yefremov of KeyBanc Capital Markets. Please proceed with your question.

Hi, this is Paul Staudinger on for Alex. Mix remains somewhat of a drag in Refinish. What is your outlook for this going forward?

Well, if we look at Refinish our pricing approach has remained relatively unchanged during the pandemic. We've not lowered prices or increased gross to net deductions like discounts. The negative price mix overall is driven almost entirely by the North America region. And there are two factors that play here. First, overall volumes are down or when overall volumes are down skews the traditional price mix cadence that we're all accustomed to seeing. Second, as a reminder, non-MSOs pay the highest prices because their discounts off of list are lower than MSOs. So MSO in large shops pay lower prices net due to a largest discounts off of list in general. Non-MSO shops have been more impacted volume wise during the pandemic than MSO and larger shops. Therefore, this mix impact on price has driven reporting pricing lower. Keep in mind though that our cost to serve to MSOs in some large shops is much lower than traditional body shops. So profit margins between traditional shops and MSOs are relatively the same. We understand that this dynamic has created some unwanted concern. But we can assure you that the health and underlying attractiveness of the Refinish business remains intact. And this dynamic should self-correct as volumes return to higher levels.

Thank you. Our next question comes from David Begleiter with Deutsche Bank. Please proceed with your question.

Hi, this is David Huang here for David. I guess first one, you represent some variable cost tailwind in addition to cost savings during Q3. Can you talk about what those are?

As we look at raw materials, raw material pricing really bottomed out in the second quarter as demand was relatively weak across end-markets and our plants that ramped down production just like everyone else. With the demand pickup that we're seeing in Q3, we saw prices move up for oil-based raw materials in particular. We've seen oil prices recover from the teens to the low 40s per barrel. We expect the overall raw material baskets to be down year-over-year, as the COVID-19 situation has eroded demand across various markets. However, we do anticipate seeing a moderate uptick in raw material pricing in the second half of 2020 relative to the first half of 2020. If we look at it by category, we expect resin solvents and monomers to be up, pigments and additives to be roughly flat and isocyanates to be slightly down.

Thank you. I was actually referencing to the variable cost tailwinds, you referenced in your prepared remarks. But thanks for the comment as well.

Yes, for clarity. When we reference variable costs, we're actually talking about raw materials, by and large, so Robert's comments address that.

Okay. And then I guess on M&A and then you also talked about your focus on emerging markets and Transportation Coatings. Are those kind of the two areas you're looking to gain exposure on through M&A as well?

Well, M&A strategy applies across each one of our businesses. So we have a number of targets identified in each one of our end-markets, both bolt-on transactions as well as larger transactions. And we continue to maintain dialogue with a number of parties. And from an M&A activity perspective, we've actually seen the number of assets available either through traditional processes or through non-traditional kind of one-on-one proprietary situations, start to pick-up in the last few months. And I think that's an encouraging sign for M&A activity overall in the sector.

Thank you. Our next question comes from Arun Viswanathan with RBC Capital Markets. Please proceed with your question.

Great, thanks. Good morning. Thanks for taking my question. I guess, I just wanted to get your thoughts on the Refinish market? There's a little bit of debate out there, that adjustment levels still need to rise a little bit. Maybe if you can just give us your thoughts on that as may be across different regions in North America and China and Europe as well? Thanks.

Sure, happy to. It's essential to remember that the Refinish market operates on a global scale, meaning that events in one region or country do not dictate the overall market dynamics. It's also crucial to understand that Refinish demand depends on three main factors: miles driven, the size of the car park, and accident rates. A change in any of these factors doesn't necessarily lead to a proportional change in overall Refinish demand; it's the interplay of all three that matters. We anticipate that miles driven and the size of the global car park will continue to rise, while accident rates are expected to increase as traffic congestion worsens. Additionally, we are observing trends where people prefer using cars over planes for travel and vacations, as well as increased car usage for commuting to avoid public transport due to the ongoing effects of COVID. Other supportive market influences include the growth of the car park and the expanding global middle class, which will drive automobile purchases. Unfortunately, distracted driving remains a persistent issue. Consequently, we believe that the long-term fundamentals supporting the Refinish business are strong and remain unchanged.

Great. Thanks, Robert. And also just wanted to ask, just given what you said then from a margin standpoint, would you expect continued margin growth in Refinish as volumes recover in 2021 and 2022 maybe just comment on that? Thanks.

Yes, we would expect to see margins continue to move upward as we see volume increase in that business just from the drop-through effect of that incremental volume as well as the number of growth initiatives that we have going on around the world.

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

Yes, hi, thanks for taking my question. Just to dig in a little bit more on the bridge from 3Q to 4Q specifically at the EBIT level. I was just wondering if you could brushstroke, give us some guidance of what the bigger buckets are in terms of, I think you're implying about a $30 million EBIT decline on flat sales. How much of that is temporary cost roll-off? How much of that is higher structural cost or higher raw materials? Any way you could provide any more color around that?

Yes, it really is a function of the temporary cost savings dropping off. So we had called out that we're on track to deliver $130 million. That came in $75 million in the second quarter, $50 in the third quarter, and expected to drop-off to about $5 million in the fourth quarter. That's partially being offset by the structural savings that we announced back in July, where we're expecting to get about $10 million. So really, it's the net change there is really driving the margin differential between Q3 and Q4.

Thanks, that's helpful. And in your prepared remarks, I believe you commented that you expected the mix to be negative in Performance in fourth quarter relative to third quarter. What's the bigger driver behind that?

Yes, obviously given the weight of the Refinish business and the volume dynamics that I described, that would be the primary driver of the combination of price mix together in the fourth quarter. So we don't expect that dynamic to materially change until we see volumes move up from current levels from where they're today.

Volumes within Refinish are largely expected to stay static, sequentially they will move up a percent or two. We're still expecting volumes to be down 7% to 8% in fourth quarter for Refinish, which is having the mix impact on Performance Coatings overall.

Thank you. Our next question comes from Bob Koort with Goldman Sachs. Please proceed with your question.

Thank you. Good morning. Robert, I wanted to ask on the M&A side, your margins are awfully good now. So how do you think about the dilution of margin as you start to bolt-on some other businesses there?

I think when considering mergers and acquisitions, we typically focus on cash returns and earnings growth rather than potential margin dilution. A business with a 25% EBITDA margin might actually dilute earnings depending on the acquisition cost, while a business with a 15% EBITDA margin could be accretive if managed well and with proper growth. Therefore, we aim to maintain discipline with our valuations. However, there are several interesting areas we are actively exploring.

And you sort of teased us or maybe you explicitly teased us with some plans to implement strategic actions that you maybe were had your hands tied before, can you give us maybe a little more flavor or color what you're thinking, is this outgrowth opportunities, M&A opportunities, when you reach out into different verticals in the paint markets, can you give us some help there?

Yes, as mentioned in our prepared remarks, we plan to hold an Investor Day in the spring. In the meantime, we will provide more insights into our plans now that the strategic review is complete. We have implemented several changes that we will communicate in the next quarter or two. I would describe these changes as relating to business growth and our ongoing cost structure transformation. As we have noted before, there is significant opportunity to optimize our cost structure in specific markets and regions to foster additional growth. This is evident from some actions we have already taken and further actions we will take in the future. We also aim to share our updated thoughts on capital allocation strategy and growth avenues for the company. You will continue to see Axalta focus on growth, whether through internal investments like CapEx and R&D or external opportunities, particularly in M&A, concentrating on our current businesses and core competencies that can be utilized in closely related areas.

Thank you. Our next question comes from Mike Harrison with Seaport Global Securities. Please proceed with your questions.

I was wondering if you can give us a little bit of color on what you're seeing in terms of customer inventory levels. If you could touch on all your businesses, that would be great. But I think I'm particularly interested in the light vehicle business. Are you seeing that dealers particularly in the U.S. are continuing to restock? Or was that kind of more of a one-time benefit that you got?

I believe that when considering inventory levels, it's important to view them within the broader context of the overall business. In the light vehicle sector, we've observed that Q3 production exceeded 2019 levels in North America, which has rebounded significantly as manufacturers have replenished inventories that were low due to COVID-19 disruptions. Many manufacturers postponed or scaled back their typical summer shutdowns, which historically take place during this quarter. Moreover, summer production extended beyond the usual timeframe. Incentives are proving to stimulate demand, but it seems we could also see a natural increase in demand as consumers may opt to invest more in vehicles and rely less on public transport, choosing road trips over flying. This creates a favorable environment for auto demand for our products. In Europe, we are seeing indications of a recovery in the auto market, backed by encouraging data from various European automakers. However, we anticipate that the rebound may not match the strength seen in the U.S. due to lower incentives. As for China, sales are steadily improving, and we expect to see significant year-over-year growth in the fourth quarter. There is growing demand from both multinational and domestic brands, alongside sales growth in our automotive plastic parts business. The robust demand for electric vehicles, driven by government incentives, is further benefiting our industrial solutions and energy solutions business. Overall, inventory levels in North America, in particular, indicate strong demand, which is demonstrated by the high interest in used cars, leading to rising prices in that market. This sets an optimistic outlook for North America.

And one other data point, that's extremely encouraging. From an IHS perspective on global auto builds, back when we reported second quarter earnings, fourth quarter was expected to be down 9.5%, that has dramatically improved and now the expectation is fourth quarter is going to be down 2.7% and we continue to see upgrades as it relates to 2021. We now expect them to be up to 13.8% for 2021 versus 2020. So, certainly encouraging data that's out there, bridging off to Robert's comments.

Yes, definitely. Okay. And then in terms of the Refinish business, wondering if you've seen any change in the pace of customers switching to waterborne technologies, are any of those investments I guess on hold because of the pandemic?

I don't think we've seen or have a lot of data that would support an opinion there one way, one way or the other. In terms of the pace of conversion from solvent borne to waterborne, that's fairly mature at this stage. So I'd say probably the level of activity of switches, I would suspect during the pandemic period was static.

Thank you. Our next question comes from Steve Byrne with Bank of America. Please proceed with your question.

Hi, this is Luke Washer on for Steve. I wanted to ask about your cost savings and you've had in the third quarter looking into the fourth quarter. What specific actions did you take both on a structural and temporary basis and how much of that has already reversed so far in 4Q?

So on the temporary cost savings, it's a combination of reduced contractor spend as well as travel and entertainment. And we had a number of labor-related reductions. So short work weeks 20% pay reductions as well as furloughs. So all the labor-related actions really came to a halt at the end of August but that is largely concluding. D&A is probably the one area that will extend into the fourth quarter with a limited amount of contractor spend that's going to be reduced. But as we go third quarter, fourth quarter sequentially really what you're left with is a limited amount of savings on contractor spend in that travel and entertainment component. And then from a structural perspective, back on the $50 million we announced back in July, that's where we start to expect that benefits come through, where we're expecting roughly $10 million. And that encompasses a host of different areas, now back office functional areas as well as back office commercial areas and then to a certain extent operations, efficiencies as well as technology. Salesforce is a more limited area of focus, and we're taking a more surgical approach on that front. And we'll start to see a little bit of that benefit in 2021.

Perfect. If I could ask one more question about the auto body shop industry, have you noticed any trends over the past few quarters regarding MSOs acquiring smaller auto body shops or any significant changes in the industry? Is this at all connected to your new business case?

No, we haven't seen a significant amount of activity during the pandemic, as you're describing and the basic structure. And I think you're referring specifically to North America. But in North America, we have not seen significant movement in that regard. We continue to execute however on our Refinish strategy of supporting all customer types in the market, including our MSO customers and that continues to be a very good business for Axalta.

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

Hi, this is Steve filling in for Vincent. I wanted to ask a quick question, as I don't usually discuss homebuilding and remodeling activity. Regarding Voltatex, could you elaborate on the market trends you're observing there and how much growth potential you see in that sector?

Be happy to. I think that's a kind of a great entree just to talk a little bit about our industrial business because a multitude of the sub segments we have in industrial end up one way or another in that market or move somewhat in relation to that market. So we've seen continued improvement each month in our industrial end markets. And for the quarter, we saw wood, coil and energy solutions with positive growth year-over-year, and slight declines in general, industrial, in powder. But it's worth noting that all businesses were up year-over-year in September. Now specifically, related to homebuilding, our wood business continues to be powered by good growth in U.S. homebuilding and remodeling activity and contribution from new customers and products that we've launched, which you've probably seen in a string of press releases over the last 12 months. Strong demand in coatings for kitchen cabinetry, furniture, flooring and distribution. So pretty much each one of the markets within our wood business. In coil, coil continues to increase thanks to again strong construction fundamentals. And interestingly, good growth in the recreational vehicle market as well. In general industrial, what we've seen is demand for structural steel as coatings for structural steel has increased due to strong demand in the construction space. And then demand for industrial coatings that go into more automotive peers have been increasing steadily during the quarter and we expect that to continue. Powder Coatings, we saw strong demand for Powder Coatings through the quarter. And we have a nice order book in place for the fourth quarter. We see strong demand signals in Powder in North America and positive but not quite as strong demand signals in Europe. And then I would highlight kind of the star of our portfolio at the moment is in our Energy Solutions business. And our Energy Solutions business has grown nicely as electric motor growth continues in automotive and in wind energy. We're also starting to see really good adoption of our mainstream and impregnating resin in our economy segment wire and animal products. And just as a reminder, our Voltatex impregnating resin product won an R&D 100 Award last year and a Gold Edison Award this year for outstanding thermal conductivity, which allows higher motor efficiency and lower motor size and weight. So I think we're excited about the businesses we have that have exposure to the more architectural decorative homebuilding-related type markets, but equally about some of the segments that have exposure to more of the industrial space.

Thank you. Our next question comes from Christopher Parkinson with Credit Suisse. Please proceed with your question.

Hi, this is Harris Fein on for Chris. Thanks for taking my question. So in light vehicle, can you give a walk of where you see the most upside and downside to the estimates that are out there from IHS and other sources? And you mentioned the focus on broadly growing in China. So can you discuss any opportunities you've taken to increase penetration with some of the under penetrated OEMs there? Thank you.

Hi, Harris, it's Chris. In general, the IHS forecast serves as a decent bench for the light vehicle business, given our significant global penetration and diversification globally in that market. You did observe that in the second quarter, we slightly underperformed the global market and that was really exclusively because we have a smaller overall penetration in China and that markets been growing the fastest from the rebound at the lows. That continued a little bit in the third quarter. So a little bit underperformance relative to the overall China market, just because of our customer exposures in that country. Going forward, as China will normalize, and other markets will continue to evolve, you'd expect to see our overall performance closely match the IHS outlook adjusted for wins and losses in the business, and over time, Axalta has been a net winner in the light vehicle business for the last five or six years in general and part of that came from increased penetration in China. We do expect over time that will continue to grow in the Chinese market. We have good relationships with some of the local OEMs. And there's a good opportunity for us to extend that over time. So that's not necessarily a 2020 or 2021 significant lever, but certainly over time, we're having good success there.

Great. And thinking about the COVID situation in Western Europe and the potential for incremental restrictions when you've seen other regions reopen and then impose curfews and things like that, can you just help us frame on how meaningful of an impact that's actually had on underlying miles driven? Thanks.

As we look ahead, our belief is that if we encounter another wave of COVID, it won't lead to a complete economic shutdown like we experienced in the second quarter because we have a deeper understanding of the virus now. We're also better equipped to handle a third or fourth wave since we've aligned with our customers on how to operate under those circumstances. Additionally, we have improved insights into market indicators and our customers’ supply chains, and we've shown our ability to adjust our cost structure as necessary. Therefore, concerning the unpredictability of COVID, we don't anticipate conditions worsening to the extent we saw in April in most scenarios, particularly considering the severe repercussions for the global economy. This approach guides our analysis of each of our end markets.

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

Yes, thanks for taking my question. So I guess a couple of things one on the raw material front, it does sound like things are at least starting to creep up, I guess can you speak to if you think this is a decent enough environment, given the volume recovery, that you can pass-through pricing, either real pricing or through some of the newer products that you have, so that you can cover that raw material inflation? Can you speak to that for us?

As we consider the business, we approach pricing from a different angle than just looking at raw materials and how they affect our operations. We focus on the value our coatings provide to end customers. Since our coating products represent a small fraction of the overall solution cost for each customer, this perspective holds true across all our markets. We remain dedicated to innovation and helping our customers succeed, enhancing productivity in their manufacturing processes and specific applications. Throughout the pandemic, we have maintained our R&D investment and continued to provide technical support without any reductions. Our commitment to supporting our customers has not wavered, and we have sought alternative methods to achieve this during challenging times. This fundamentally shapes our pricing strategy across all markets.

Got it. Fair enough. Robert, you mentioned in some of your prepared remarks and slides a significant number of new products, possibly more than you've highlighted in the past. Can you share your thoughts on the vitality index and where you see it heading over the next few years? It seems to be a focus for your growth strategy. Could you provide some insights on the current baseline and your expectations for future developments?

Yes. When considering the vitality index and defining what constitutes a new product, it's possible to shape that narrative in various ways; even a small modification to an existing product can be categorized as a new product or not. We monitor this closely across our product portfolio while ensuring that as we introduce new products, we also phase out older ones to alleviate complexity for our supply chain and customers. From a product innovation standpoint, we've announced several new products, particularly in our Refinish business focusing on mainstream and economy sectors. In our industrial segment, we've rolled out numerous products in our wood, coil, and energy solutions businesses. We've also launched new products in the light vehicle and commercial vehicle sectors. This is a consistent process for us, but your question highlights a strategic shift for Axalta. We are fostering greater innovation, experimentation, and exploration of leapfrog technologies and products. As we move forward, you can expect to see more innovation reflected in our press releases and in the market, not just on the product side but also in our service offerings. We have separated the service aspect of our transportation business from the product side, allowing us to provide tailored service options based on the specific needs and preferences of our customers. This change has revealed new opportunities and offered us valuable insights in managing this business, so we have more developments to share in the future.

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

Good morning. This is Cory on for Kevin. You spoke earlier about the strength of trends in terms of the car park and miles driven? How would you compare and contrast your auto Refinish volume trends in every major region of the world?

So we did actually put out in the commentary, a little bit of a guide on the relative strength of the market using miles driven relative to pre-COVID by region. So you can see that in the commentary. But in general, the Refinish market recovered globally across the markets that we serve. There's a little bit of variability. You see the best strength in Asia, with China rebounding most strongly. You saw Europe come back earlier and stronger than you did in North America with lockdowns easing over the mid and late summer. And North America has been on a steady path at rebound up to the level of kind of 10% to 15% below normal at this point. So there's a little bit of variability. But the theme is you did see a steady rebound globally across the business.

Got it. Thank you. And do you feel as though you may be gaining or losing market share? Or do you have any sense in any of the regions if you are and what may be driving that?

Of course Axalta has been a net share gainer in Refinish essentially every year for at least five or six years in a row here. There are a lot of reasons for that frankly, and they tend to continue each year. Although we would say that competitively across nearly every business that we serve, the overall environment has been more calm in 2020, which is not surprising when you're in somewhat of a crisis environment or recessionary environment, to see a little bit less competitive activity out there. That said, there's a natural share gain that tends to come to resolve because of the nature of our leading products and services in the market. So being on the bleeding edge of the product side and chemistry, and then couple that with the strong service that we provide to customers around the globe. And the fact that we're introducing new products and new chemistries in multiple markets, not just in North America or in Europe, but across the chain from premium to mainstream and economy. So you're growing by introducing new products, when you're providing leading service. And when you're naturally gonna be an industry leader in terms of technology, you're going to tend to pick-up share over time and that does continue.

Thank you. Our next question comes from P.J. Juvekar with Citi. Please proceed with your question.

Hi, this is Eric Petrie on for P.J. In industrial markets, you noted that all were up year-over-year in September. So is that due to just improving macro or did you see inventory build?

It's a little unique in the case of each individual market. What I say is that if you look at markets that are directly linked to construction and home spending, like wood and coil and parts of the powder market, that's really been a source of the outperformance there and we expect that to continue as we go forward. The Performance Energy Solutions is really just part of a larger macro trend around electrification and we're very strongly positioned there and really like the outlook for that business. And then within the general industrial business, and the powder business, you have to bifurcate what goes into more industrial versus a more architectural decorative type of markets. And then what goes into more of an automotive or transportation application. So the part of that that goes into more construction facing and architectural type of markets that part of the business has recovered quite nicely and continues to improve. The part that's more facing and that may supply Tier 1, I'm sorry, Tier 2, Tier 3 automotive companies or have more of a pure industrial facing nature. Volumes are up there but not quite yet at pre or pre-COVID or prior-year levels.

Helpful. And then secondly, in the Refinish business, how do you see that volumes and pricing trends closing the gap compared to the prior-year including an outlook on the recovery in non-MSOs?

Well think again, just to add to what Chris said in the prior question, our Refinish volumes were down mid to high-single-digits in Q3 on a year-over-year basis. Price mix as we highlighted was down low-single-digits in the quarter with a higher amount in North America and positive price mix in certain geographies. And for Q4, we expect a similar result overall, based on current demand conditions. I think we'd expect to see volume increases compared to third quarter, but still expect to see volumes below prior year due to the ongoing impact of COVID-19. At the point in time that we see some type of a vaccine solution for COVID. And we see congestion levels get back up to more normal levels; I think we would expect to see a full recovery of the market.

Thank you. Our next question comes from Mike Sison with Wells Fargo. Please proceed with your question.

Hi, this is Richard on for Mike. Just follow-up on the industrial. I believe in July you had forecasts of the business to be down 7% in 3Q and then 4% in the fourth quarter. It's obviously performed better than that. What's your expectation now for the fourth quarter and looking on to 2021, are you expecting growth and any color on that would be great.

Sorry, you have to repeat the last part of your question, but the answer to the first part, as it relates to industrial for the fourth quarter; we're expecting roughly similar results to Q3. Industrial being down around 1% but overall really good performances, we continue to see that sequential permit. Do you mind repeating that second question?

Okay. The second question is just I know you haven't given guidance for 2021. But in terms of what you're seeing visibility wise, how should we think about that moving forward?

So I think as we look overall at the industrial markets, there could be some volatility given resurgences of COVID. However certainly the portion of the business that is more home and construction facing as we've seen that business during COVID be quite strong, that would serve to counteract and counterbalance the more industrial side of the exposure within the industrial business.

Great. And now just quickly on capital deployment, just wondering in terms of how do you rank order M&A, or building the pipeline in terms of like debt reduction and cap share buybacks? How would you think about that?

So given our liquidity position, and we covered this in our opening remarks, we're starting to pivot to start to build back that pipeline from an M&A perspective. So certainly expect to start to deploy some of that capital for M&A. As we think about share buybacks, we'll continue to buy back opportunistically. But I think now that we're beyond and what we perceive as the worst of the COVID impacts, we'll start to pivot on that front as well. But that again will be purely opportunistically. From a debt perspective, we are targeting 2.5 times leverage from a net perspective. Again, given our comfort level and liquidity, we may look to pay down some debt; some gross debt marginally, also going to be looking at potential refinancing opportunities here over the next few months. And then we'll just continue to build cash, quite frankly, you saw really nice free cash flow conversion. And hopefully that will continue now for the foreseeable future.

And just add to what Sean said, I think philosophically, you have a general sense of what we want to do from a capital allocation perspective. But at any given point in time, we're always assessing what is going to be the most accretive and create the most value for shareholders, as we look at each one of those opportunities.

Thank you. Our final question comes from the line of Silke Kueck with JPMorgan. Please proceed with your question.

Hi, good morning. I was wondering if you can talk about like where we see the $60 million in structural cost savings that you saw this quarter as you look at the bucket of cost of goods sold and SG&A and R&D, the first question.

Yes, so we haven't given precise guidance on the 2021 impact. But broadly, and I mentioned this in an earlier question, it's across a multitude of categories, being back office, commercial areas, operations, technology and back office functional areas. So you're really going to see the benefits throughout our P&L for 2021.

I was curious about the structural savings you achieved this quarter, particularly the $50 million. It seems most of it is reflected in SG&A and R&D. Could you share any updates on the latest components?

So what you're seeing in SG&A in particular this quarter, as a percentage of sales dropping down so dramatically, it's really the temporary savings that you're seeing the benefit there. And we think about the structural savings from Axalta Way that we had originally communicated back in January, when we gave guidance for 2020, more than half that's coming within the operational areas. So particular to call it an example with the Mechelen, Belgium facility closure, we shut that down in the first quarter and stopped operations. So you're seeing a big uptick, as far as cost reduction and cost of goods sold for that particular project.

That's helpful. Lastly, I was wondering if I could ask one more question about the auto IHS data. When I examine the data alongside the sequential light vehicle production forecast, the only region showing a negative sequential change from the third to the fourth quarter is North America, where production is expected to drop from 4 million units to about 3.8 million. Historically, over the last five to six years, fourth quarter builds in North America have consistently been 4 million units or higher. Do you consider this a conservative estimate? Do you believe that there may have been an overbuild, and could that number potentially be better? I'm curious about your perspective on this.

Typically, market forecasters tend to be somewhat conservative or lag behind what actually occurs. Additionally, we need to consider the specific product mix of Axalta, which is heavily focused on trucks and SUVs.

So I think the other, you just have to keep in mind that August shutdowns didn't occur this year, but the forecasters are still assuming that the December maintenance vacation shutdowns do occur. So if you just look at that alone, it'll account for a slightly lower North American outcome in the quarter.

Thank you. This concludes our question-and-answer session. So I'll pass the floor to management for any closing comments.

Thank you everyone for participating and we look forward to following up with you. Have a good day.

Ladies and gentlemen, this does conclude today's teleconference. Once again, we thank you for your participation and you may disconnect your lines at this time.