Axalta Coating Systems Ltd. Q3 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to Axalta's Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. A question-and-answer session will follow the formal presentation by management. Today's call is being recorded, and a replay will be available through November 2. Those listening after today's call should please note that the information provided in the recording will not be updated, and therefore, may no longer be current. I will now turn the call over to Mr. Chris Mecray. Please go ahead, sir. You may begin.

Thank you and good morning. This is Chris Mecray, VP of Investor Relations and Treasury. We appreciate your continued interest in Axalta and welcome you to our third quarter 2021 financial results conference call. Joining me today are Robert Bryant, CEO; and Sean Lannon, CFO. Yesterday afternoon, we released our quarterly financial results and posted a slide presentation, along with commentary to the Investor Relations section of our website at axalta.com, which we'll be referencing during this call. Both our prepared remarks and discussion today may contain forward-looking statements reflecting the company's current view of future events and their potential effects on 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'll now turn the call over to Robert.

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

Thanks, Robert, and good morning. Third quarter saw continued strong execution by Axalta's global team with supportive demand conditions, but clear challenges from inflation and customer production constraints. Despite those challenges, we were able to exceed our guidance construct for profitability originally set back in July, overcoming headwinds particularly late in the quarter to deliver on our top and bottom line results. Third quarter net sales of $1.1 billion represented a 6% year-over-year increase and 3% growth on an organic and constant currency basis, including a 10% increase from Performance Coatings and a 12% decrease from Mobility Coatings. Within Mobility, Light Vehicle net sales declined 17%, partly offset by a solid 8% growth result from Commercial Vehicle. These results were driven by recovery from the prior year pandemic impacted period. Refinish demand remained firm in the period showing continued recovery in most regions served, though volumes were slightly lower sequentially as expected due to anticipated seasonal order patterns. Axalta's Industrial end-markets continue to show notable strength as all end-businesses showed solid top-line growth both year-over-year and versus 2019. Automotive demand at the retail sales level was also solid and even strong when adjusted for limited inventory on hand, though not translating to increased volumes in Axalta's Light Vehicle end-market due to the ongoing global semiconductor chip and other supply chain shortages that continue to impact production for global auto OEMs. Commercial Vehicle demand particularly in North America truck markets as well as recreational vehicles also remains supportive of current production rates. The volume decline of 1.6% for the quarter was driven by the significant pullback in Light Vehicle, but it was almost completely offset by solid increases from the other 3 businesses. Price-mix contribution was solidly positive, up 4.5% in the aggregate driven by improvement in both segments and all 4 end-markets, somewhat stronger in Performance Coatings versus Mobility Coatings. Mix was overall a modest headwind, which was a notable switch from second quarter where mix tailwinds were significant when compared to the prior year pandemic-impacted quarter from 2020. FX translation was a tailwind of 1.3%, driven by the strength of the Chinese renminbi, the euro and other currencies during the quarter. Third quarter Adjusted EBIT was $146 million versus $210 million in the prior year quarter, given strong demand and volume trends in Performance Coatings as well as Commercial Vehicle more than offset by Light Vehicle volume headwinds, substantially increased variable input cost inflation and lower temporary cost savings versus Q3 2020. Third quarter Adjusted EBIT excludes the $19 million benefit to operating charges associated with the Mobility Coatings operational matter we have previously discussed as well as made solid progress on insurance coverage for this matter, which we expect to largely mitigate any exposure to Axalta as well as $9 million net gain on the sales of a previously closed manufacturing facility, offset partly by incremental restructuring charges of $10 million and certain other discrete adjustments noted in the reconciliation tables to our posted earnings materials. The Performance Coatings segment reported Q3 Adjusted EBIT of $123 million versus $134 million in Q3 2020 driven by ongoing volume recovery and growth and drop through benefits of stronger average price-mix offset by headwinds from significantly higher variable costs and the lack of temporary cost savings, which benefited the prior year quarter. The Adjusted EBIT margin from the segment decreased to 15.8% from 19.6% in the prior year record-setting quarterly margin, given the drivers noted. Mobility Coatings reported third quarter Adjusted EBIT loss of $3 million versus income of $49 million in the third quarter of 2020. Adjusted EBIT and associated margins in Q3 were impacted by the volume reduction during the quarter due to the semiconductor chip shortages, which impacted production at the customer level and net sales volumes for Axalta. Results were further impacted by significantly higher cost inflation with modest offsets in positive pricing, which began to accrue during the third quarter. Axalta's balance sheet and liquidity profile remained solid in the third quarter. The company ended the quarter with over $1.1 billion in total liquidity, including $620 million of cash on the balance sheet and $516 million of available capacity in our undrawn revolver. Free cash flow for the quarter totaled $112 million versus $223 million in the third quarter of 2020, driven by somewhat lower operating profit and inclusive of $25 million in higher CapEx versus the comparable year-ago period. Axalta's net leverage ratio ended the quarter at 3.5 times versus 2.6 times at June 30, driven by lower trailing 12-month operating earnings and lower cash balances due to increased cash deployment for M&A and share repurchases offset somewhat by solid ongoing free cash flow. Axalta used approximately $596 million in cash from the balance sheet to fund the acquisition of U-POL, which closed in mid-September. The company also purchased $90 million in total shares in the third quarter for a year-to-date total of $214 million. Given stronger seasonal cash flows during the fourth quarter and inclusion of a full quarter of the U-POL operating earnings, we anticipate that the year-end net leverage ratios will tick down slightly from the third quarter levels. Regarding our financial outlook for the full year 2021, despite ongoing firm demand across our businesses, we have factored in expected impacts from persistent inflation and supply chain effects, which will constrain reported growth and profit near-term. For full year net sales, we now assume net sales growth of approximately 19% including approximately 2% FX tailwinds and approximately 2% of M&A contribution. This forecast includes continued overall strength in Performance Coatings aligned with our prior assumptions, and similar negative impacts in Mobility Coatings resulting from continued auto OEM production constraints. We assume 11 million vehicles deferred in 2021, as noted in our September guidance update. In dollar terms, Mobility Coatings is expected to be impacted by approximately $70 million in net sales in the fourth quarter, and $215 million for the full year from continued supply chain impacts, which is $80 million higher than our previous forecast from July. For Mobility Coating volumes, we continue to expect to perform at least in line with global market forecasts for the full year given our market positioning. Mobility Coatings net sales are expected to grow approximately high-single-digits this year versus 2020. For Refinish, total net sales have performed largely as expected year-to-date. We continue to assume that market recovery will progress gradually through year-end and into 2022, though still ending the year with volumes below 2019 levels by around mid-single-digits despite net sales expected to exceed 2019 totals. We expect to generate Adjusted EBIT of $645 million to $665 million in 2021, and adjusted diluted earnings per share of $1.70 to $1.80, versus the $1.85 to $2 anticipated in our July guidance construct. Additional income statement line items are noted in the guidance sections of our posted earnings materials. The primary drivers of the reduced range of expected profit are the impact of reduced Mobility Coatings volumes, as well as the impact of higher inflation, now expected to increase approximately mid-teens or approximately $190 million. We expect free cash flow of between $410 million and $430 million or $35 million to $55 million below the July guidance, inclusive of CapEx of $155 million for the full year. The forecast excludes outflows related to the Mobility Coatings' operational matter, which are now expected to be modest, given anticipated insurance recoveries. Looking beyond the fourth quarter, it is now apparent that the global supply chain issues and those impacting Mobility Coatings with semiconductor chips will not be fully resolved in the near term. We now expect that some impacts will continue well into 2022.

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

At this time, we'll be conducting a question-and-answer session. Our first question comes from the line of Ghansham Panjabi with Baird. You may proceed with your question.

Thank you. Good morning, everybody. Hope you're doing well. I guess, first question is on Performance Coatings. I'm trying to clarify: when I look at the operating profit for performance, Q3 2021 versus last year, margins are down almost 400 basis points. Could you bridge that differential? And on Slide 4, where you're talking about Performance Coatings, unless I'm missing something, you say you largely offset inflation with price mix. Are you implying that you're fully caught up on performance in terms of pricing? Or is there more to go? I have a follow-up as well.

Hey, good morning. The biggest driver of the margin difference versus Q3 2020 is really the temporary savings that we had implemented back during the pandemic lows. You're seeing roughly 50% of that fall away. So that's really the biggest driver. And yes, as far as pricing on the performance side of the business, we are largely caught up in terms of pricing offsetting inflation at this point.

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

The confidence is really based on our ability to continue to control our cost structure and to implement price increases to offset incremental raw material inflation. We've demonstrated, as Sean pointed out, that price increases we've been able to implement have largely offset inflation on a run-rate basis to date. We're essentially caught up in Performance Coatings and on the road to being caught up by the first quarter of 2022 at a total company level on a run-rate basis. Our performance in the 2017-2018 inflationary cycle also gives us confidence we can do that.

Okay, so have raw material costs stabilized sequentially?

If you look at our raw baskets, we've seen some stabilization in key categories, namely a slight dip in monomers and in powder resins from the midsummer highs. That said, all categories remain elevated, and some have continued to climb, including isocyanates, pigments and liquid resins. Solvents are more level from the summer, but recent oil price hikes will cause that product category to rise further. So there may be elements of peaking, but it's hard to confidently say there is an easing right now with oil still near year-highs and some forecasters calling for even higher feedstock pricing. As I said before, we will price through the raw material inflation.

Very helpful. Thank you so much.

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

Sorry, I was on mute. Good morning. Can you comment on the overall industry price discipline versus the last inflationary cycle in 2017 and 2018 — whether it's worse, roughly the same, or better? And how does this set up for the industry to hold on to value once raws moderate, better reflecting the value you create for customers?

Overall, in coatings, the timing of this raw material cycle has helped everyone get a bit more ahead of it than in 2017/2018. The inflation really started to appear in Q4 last year, so we incorporated it into our operating plans and budgets. That alignment made it easier to implement pricing and operational responses. Holding on to price is aided by the non-product value we deliver — labor savings, energy, performance characteristics — and Axalta has sped up its innovation engine over the last three years. We're confident in our ability to hold on to price because we continue to deliver more value to customers.

That's helpful. As a follow-up, can you walk us through regional Refinish markets versus 2019 levels? You touched on this earlier. Also perspectives on miles driven versus collision trends, and body shop flow-through — anything to give a sense of your platform's performance versus the industry?

We continue to see gradual progress in global Refinish metrics. In Europe, our largest market, Axalta's body shop activity improved from down 10% versus pre-COVID in Q2 to down just 7% in Q3. We've had great performance in Europe with material customer wins in underpenetrated markets. We've seen the amount of volume going through Axalta's body shops in Europe recover to 93% of pre-pandemic levels, and we're capturing price there, so we're very happy with Europe. In the U.S., body shop activity stayed about constant between Q2 and Q3, down around 12% compared to pre-COVID levels. We continue to outperform the market and capture price in the U.S. Asia and Latin America have really improved as COVID rates and lockdowns have eased. In Asia Pacific, we've had very good net body-shop gains and net new stock points, with penetration of mainstream and economy products continuing to be successful. We believe demand will return to more normal levels over time with ongoing vaccination progress, increased return to work, and a return to a more normal mobility environment.

Sorry. Chris Parkinson is not available.

We finally in the last 12 months have really seen good traction in some of those markets we've highlighted as opportunities.

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

Thanks for taking my question. On the auto OEM front, you indicated you had some decent business wins. Can you give a little color? Are these wins geographic, new product lines, or share gains on existing vehicles? How should we think about what those wins look like?

Our Light Vehicle Coatings business won roughly a third of the business that came up for bid this year, and we've retained about 97% of preexisting business that came up for bid. We've won business in all regions; it's been a function of service, advanced technologies, and data solutions we're offering Light Vehicle customers.

Got it. Another question on working capital: it seems to have crept up this year even relative to 2019. Going forward, are there levers to pull to clean out some working capital hits? Or is this mainly an inflationary effect with limited actions?

We look across all working capital elements. AR is seasonally up in Q3, and with pricing actions you're seeing AR uptick that should come down in Q4 per normal seasonality. Inventory is probably the single biggest pressure, about $108 million of cash tied up largely due to inflation. Inventory is an area of potential opportunity, but we must balance assuring supply so customers don't stock out. We generally target working capital around 8% of annual sales. Inventory will be a focal point as we head into 2022.

Got it. Thanks very much for the color.

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

Robert, can you comment on the price actions? How much is structural versus indexed to particular raw materials and thus reversible?

So far, pricing to offset raw material inflation has been a combination of pure price increases and some indexed contracts. We do have indexed contracts in Light Vehicle and a small piece of Industrial. Going forward, you'll see greater price capture as indexed contracts roll based on their lags. Regarding surcharges, in the previous cycle we implemented surcharges but customers often prefer direct price increases because it avoids changes to their systems. That's the approach we've taken this year.

Thanks. I also wanted to drill into new products mentioned in the release: the one-coat kitchen coating — where did that technology come from? And the electrical steel coating providing dielectric and corrosion protection — are these transfers of existing technologies or newly developed?

Over the last three years we've increased investment and focus in R&D. The one-coat kitchen cabinet application in our Wood Coatings business was developed internally at Axalta over several years. Kudos to R&D. Our energy solutions business innovations — Axalta is a leader in coatings for electric motors, with wire enamel, steel coatings and impregnating resins used in transformers, wind, and other applications. We also have offerings in battery coatings for cells, modules and packs for dielectric and corrosion protection, fire protection, EMI shielding and thermal management. You'll hear more about our energy solutions portfolio in future quarters.

Thank you.

Our next question comes from the line of Jeff Zekauskas with JPMorgan. You may proceed with your question.

Thanks very much. Celanese commented recently that global auto production for 2022 might be flat with 2021 and that some forecasts are too optimistic. Do you have a view on 2022 production versus industry forecasts?

We've spoken with customers and semiconductor supply chain participants. Our view is similar: we expect the semiconductor shortage to continue through at least part of 2022. The extent depends on supply and demand dynamics, production ramp-ups, and whether automakers reconfigure some systems to use newer chip sizes. It's reasonable to assume the shortage is a headwind through the first half of next year; beyond that timing is uncertain and depends on developments in the supply chain.

On raw materials, you mentioned being caught up in Performance Coatings. Are you caught up in both Refinish and Industrial? Is the rate of raw material inflation similar across those end-markets?

The rate of variable cost inflation is similar between Refinish and Industrial. Variable margins in Refinish are higher so you feel a bit more at the bottom line for Industrial. Overall, we're caught up on Performance; we have a little more price in Refinish on average compared to Industrial, and we're pleased with progress across both end-markets.

Okay. Thank you very much.

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

Thanks. On the new Light Vehicle wins you mentioned being broad across regions: is that new capacity from customers, new entrants, or share gain at existing customers?

We prefer not to get into many details, but it's share gain at existing customers and wins where we previously had a lower share of wallet. Notably, in our Asia business we've secured new business at Chinese OEMs over the last 12 months.

You referenced in prepared remarks concerns at body shops about labor and parts shortages that ultimately weren't too meaningful. Is that off the list now or something to keep monitoring?

We're working to support Refinish customers to maximize productivity of our products and the data we provide to help them use labor efficiently. Body shops are affected by labor shortages and parts shortages as part of the broader supply chain challenges. It's a general industry impact from global supply chain disruptions rather than something specific to body shops, and it's something we continue to monitor and support customers on.

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

Good morning, Robert. You spent time talking about Refinish market and miles driven — morning rush hours and traffic jams seem to be back starting in September and October with eased lockdowns, suggesting people are driving more to work rather than mass transit. Are you seeing a similar pattern in the U.S.?

We are seeing a pickup in driving activity in the U.S. morning and afternoon traffic, though not yet recovered to pre-pandemic levels. Traffic has increased throughout the day. Comparing to China, dynamics differ: hybrid work models and timing of reopening were different. So comparisons are interesting but not directly equivalent because the office environment recovery timing differs.

Thanks. On Commercial Vehicles, production rates are near record highs — one might think chip shortages also impact heavy trucks. Are commercial vehicles less affected because they use fewer chips?

Yes. Heavy-duty trucks require far fewer chips than Light Vehicles, so we aren't seeing the same degree of impact from semiconductor shortages in our Commercial Vehicle business. Industry forecasters show a positive rebound for commercial vehicles in 2022, and backlog levels in North America truck markets are very strong, which sets us up well given our strong position in that business.

To add data: heavy duty truck Class 4-8 is expected to grow around 20% excluding Asia for 2021, and the comparable number for 2022 is around 14%. We're very positive on the outlook in that market.

Great. Thank you.

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

Thanks. Robert, an update on U-POL after nearly six weeks of ownership: how is integration going? Are inflation and supply constraints different in that business? And Sean, what will be the step up in amortization associated with that deal in Q4?

Six weeks in, value creation planning is progressing as per our original plan. Reception from U-POL and Axalta employees has been very good. We're leveraging shared learnings and areas of expertise between the companies. We're moving quickly on cost synergies and ramping up commercial synergies given strong pull from our customer base; customers want to carry U-POL products. U-POL is seeing the same raw material inflation, logistics and energy challenges that others are facing, and we've had price increases underway in that business.

On amortization, purchase accounting is still preliminary, but the expected amortization for that business is about $20 million on an annual basis, so you can expect roughly $5 million in the fourth quarter.

Thanks. One more: you mentioned 20% year-over-year variable cost inflation in Q4. A peer reported 30%. Do you see mix differences or business practices that could account for a lower rate for you versus peers?

It's hard for us to comment on competitors. Mix is part of the story, but without knowledge of others' pricing and raw exposure, it's tough to compare.

Also consider what components are included in that raw material inflation metric: are they referring purely to raw materials, or including logistics, packaging, and energy? Those differences can account for variations in reported rates.

Do you have energy included?

Yes, we include energy.

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

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

We're expecting to be marginally better in Q4 and to be positive in the fourth quarter, although it's a marginal improvement.

On the temporary cost savings headwinds in 2022, how should we think about those?

We haven't provided formal guidance yet on 2022, but we expect to maintain some discipline around travel and entertainment and other areas, though the impact will be modest compared to 2021.

Combined, what was the impact of temporary savings in 2021 versus 2020?

We implemented about $150 million in temporary savings at the height of the pandemic. For 2021, roughly $50 million to $60 million of those temporary savings persisted.

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

Good morning. On Mobility Coatings margins: where do you think they can get back to and how do you get there over time?

When semiconductor supply issues resolve and production recovers, Mobility Coatings volume should rebound and drop through at attractive margins. The team has made operating model and cost structure changes and won business that positions the segment well for a snapback. We are continuing to invest in people and technology to be well positioned when the recovery occurs.

Our next question comes from the line of Josh Spector with UBS. You may proceed with your question.

Looking at updated guidance for Q4, backing out incremental M&A, you're guiding roughly a 5% sequential sales increase. Can you quantify how much of that is sequential pricing versus volume coming back? On volume, are you assuming any sequential improvement in any segment other than Refinish?

We're expecting net sales to be up in every end-market Q4 versus Q3. We haven't quantified price versus volume for Q4 specifically. For the full year, price is expected between 3.5% and 4%, so you can analyze based on Q3 year-to-date trends.

On the Mobility side, how much of the portfolio is typically rebid each year, and given indexing and rebids to date, how much of the book is likely to see better pricing next year?

Typically about a quarter of Mobility business comes up for bid in any given year. Indexed contracts adjust per their mechanisms and off-index contracts are negotiated with OEMs. We don't disclose specifics of those negotiations.

Is it fair to say index plus rebid portion means 75% of portfolio would see better pricing next year?

No, that number would be too high.

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

On raw materials, I've seen some spot prices flattening out. It looks like maybe the worst has passed, but I'm curious how much you had to buy on spot markets at high prices, how many force majeures you still have, and which raw materials are still the most troublesome as you go into year-end?

We continue to see tightness in various materials due to supply chain disruptions and alternative value chain demand. The most challenging have been isocyanates, acrylic emulsions and certain polyester resins, with acrylics notably impacting Industrial and wood coatings. For isocyanates, North America has seen the biggest impact from HDI constraints. Despite this, we've secured supply and largely kept pace with demand, but there have been impacts on sales volumes and customer production. In other categories, packaging materials like plastics and tinplate are up; Brent oil is in the mid-$80s which pressures solvent costs; natural gas is up substantially in the U.S. and even more in Europe; logistics costs are higher due to driver and port worker shortages and slow turnarounds. So while the pure raw material tsunami may have peaked around Q3 or Q4 at current oil levels, other cost categories will carry forward. We will price through these costs, but they remain part of the current market environment.

Have you changed procurement practices to give more flexibility? What's the typical contract term profile — monthly, quarterly, semiannual?

We're applying multiple strategies: focusing on keeping customers supplied, prioritizing A and B SKUs, simplifying SKU lists, working with alternative suppliers where possible, and closely managing allocations. It's a dynamic situation; ensuring no customer stock-outs is priority. Our procurement and supply chain teams have done strong work across these actions. Contract terms vary by category and supplier, and we use a mix of approaches to balance supply security and cost management.

Great, thanks for the help.

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

Hello. You made a comment about mix headwinds; what should the dynamic for mix be as volumes improve outside the auto chain? And when the auto chain improves, is that a mix benefit or a mix drag?

By and large, you should assume mix going forward should be somewhat steady. We did see a bit of mix headwind in Q3, reversing significant mix benefits in Q2, which was an easier comp to the pandemic lows in 2020, particularly on the Refinish side.

Okay, great. Thank you.

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

Well, thank you, everybody, for joining us this morning. We're available through the day in the next couple of days if you have any follow-ups. Thanks for joining us. Good day.

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