Axalta Coating Systems Ltd. Q2 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to Axalta's Second Quarter 2022 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 a replay will be available through August 3rd. Those listening after today's call should please note that information provided in the recording will not be updated, therefore may be no longer current. I'll now turn the call over to Chris Evans. Please go ahead, sir.

Thank you and good morning. This is Chris Evans, VP of Investor Relations. We appreciate your continued interest in Axalta and welcome you to our second quarter 2022 financial results conference call. 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 will 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 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. Our remarks and the slide presentation also contain various non-GAAP financial measures. In the Appendix to the slide presentation we've included reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information regarding forward-looking statements and non-GAAP financial measures, please refer to our filings with the SEC. In conjunction with our earnings release yesterday, Axalta also announced that Robert Bryant will step down as President and CEO effective August 31st. Rakesh Sachdev, an Independent Director of the Board and experienced executive in the Chemicals and Life Sciences industry has been appointed interim CEO effective upon Robert's departure, while the Board conducts a search for a successor. The press release can be found in the Investor Relations section of our website. Robert Bryant, CEO; Sean Lannon, CFO; and Rakesh Sachdev, incoming Interim CEO are all with us today. And I will now turn the call over to Robert.

Hello everyone, and welcome to our second quarter 2022 earnings call. Before we discuss our results, I'd like to make a few comments on yesterday's announcement that I will be leaving Axalta to pursue new opportunities. It's been a privilege to serve as Axalta's CEO, and I'm incredibly proud of what we have all accomplished throughout my tenure at this amazing company. I'd like to thank the entire global Axalta organization for their focus on execution, commitment to excellence and dedication to serving our customers. I am confident that Axalta will be in great hands under Rakesh's leadership and will continue to thrive in the years ahead. With that, I'll now turn to our quarterly results beginning with the key highlights on Slide 3. Let me begin by extending my appreciation to the entire global team for another solid quarter. Our results demonstrate that we remain focused on the most important strategic elements, namely driving growth and recovering profitability through pricing actions following an unprecedented rise in variable costs. We made progress on both fronts this quarter and are building momentum into the second half of the year, setting up Axalta for significant earnings upside. In the quarter, we achieved adjusted EBIT of $151 million and adjusted earnings per share of $0.41. Both of which were above the midpoint of our expectations we set out in our Q1 earnings call, despite incremental headwinds of $8 million associated with foreign currency and China lockdowns, both of which were higher than our original expectations. When excluding the impact from foreign currency, we reported constant currency net sales growth of 15%, with double-digit contributions from every end market. We benefited from a broadly constructive demand environment and yielded higher growth versus most of our markets. We also delivered a record of 10% higher price-mix in the second quarter, which nearly offset the raw material and logistics inflation costs in the same period. I'm encouraged by the signs of stabilization we're beginning to see across many input categories, which supports our prior expectation of recovering the majority of the cumulative cost inflation by year-end. Moving on to Slide 4, I'll give some more color on our second quarter performance. Globally volumes improved 3% year-over-year driven by solid demand trends and market share gains across the portfolio. Growth was uneven across the regions with 10% growth in the Americas leading all geographies. This growth more than offset softness in EMEA and China, stemming from the Russia-Ukraine conflict and extended China COVID-19 lockdowns respectively. In total, we believe these two impacts alone account for a 4% net sales headwind in the quarter. We continue to expect a favorable demand environment in the Americas broadly and should see recovery play out in China in coming quarters. Volumes improved in three of our four end markets. Performance Coating segment volume was flat as solid refinish growth was offset by modest declines in industrial. Mobility segment volume was very strong with 9% higher light vehicle and 13% better in commercial vehicle. Both mobility end markets, as well as refinish greatly exceeded relevant industry growth rates. Axalta's differentiated technologies and superior service remain a powerful driver of our above market volume performance. In Refinish, we continue to sign new exclusive agreements with large multi-shop operators and continue to make progress on our new business pipeline. In Mobility, we're beginning to feel the benefits from business wins made over the past six quarters, which in total; we expect to contribute more than $200 million of annualized revenue. And in Industrial, we booked new wins this quarter in the battery protection space where we see great long-term potential with electric vehicles as we gain traction beyond just electric motor coatings, where we have a strong position today. Operationally, the second quarter was our highest production volume quarter since the beginning of the pandemic with 7% sequential production growth. Yet, the backlog of open orders across both end markets and performance coatings continues to be a challenge given supply chain constraints impacting our business. Customer constraints remain prevalent in the quarter and continue to be a significant drag on growth. These are most apparent in light vehicle and refinish where both markets are operating well below normalized levels, given severe parts and labor shortages, creating more pent-up consumer demand that should benefit our business as supply chains loosen. Now, let's move to Slide 5 for a discussion of key Refinish market trends and highlights from the quarter. In Refinish, our industry-leading aftermarket auto coatings business, we had a strong quarter with volumes up 3% year-over-year and 13% sequentially despite the aforementioned geopolitical headwinds in EMEA and COVID lockdowns in China. We're winning new customers at a record pace. Year-to-date, we added nearly 1,000 net body shops globally and over 500 stock points through distribution customers. Our partners continue to recognize that we just have a better way of doing business, centered around the most productive paint system in the industry, with a significant technological lead over our competition. In fact, since 2019, while the market has contracted approximately 8% due to COVID, our Refinish business has grown volumes by 5%. We believe that we have gained several percentage points of share and expect this trend to continue going forward based on recent and expected wins. During the quarter, we noted marginal improvement in body shop activity, quarter-over-quarter, but activity remains in the high 80s percent in North America and low 90s percent in EMEA. We see activity normalizing over time, driven by relief of body shop constraints and also return to office dynamics, which we expect will lead to a step up in congestion rates toward pre-COVID levels over time. Moving on to Industrial. In Industrial coatings, volumes declined 4% year-over-year, a strong demand in the Americas, namely from Building Products and General Industrial was more than offset by declines in EMEA General Industrial and Asia-Pacific Energy Solutions, given the previously mentioned geopolitical and COVID headwinds. Supply and production constraints were again a drag on overall performance in Industrial Coatings by as much as a mid-single-digit percentage. Earlier I highlighted a few wins in battery component coatings with several electric vehicle manufacturers. This is an important milestone for us as we see a long pipeline of opportunity in this space with a long-dated market opportunity.

Thanks, Robert, and good morning. Before I discuss our results, I'd like to thank Robert for his leadership, which was critical in helping us drive our strategy and build a strong foundation for future growth. He's been a terrific colleague, mentor, and friend, and the team and I wish him well. Moving on to our second quarter results, net sales of $1.2 billion, an increase of 10% year-over-year for the second quarter, while constant currency net sales increased 15% driven by pricing actions, demand strength across most of our businesses and benefits from two acquisitions, which were completed in 2021. Constant currency net sales growth included a 12% increase from Performance Coatings and 21% growth from Mobility Coatings, reflecting light Vehicle up 20% while Commercial Vehicle was up an impressive 27%. Second-quarter volume improved 3% year-over-year with positive contribution from three of four end markets offset by a mid-single-digit percent decline in Industrial volumes, which was hindered by supply chain constraints as well as the macro and geopolitical headwinds within our EMEA and China regions. Backlogs also increased from our elevated Q1 levels, as we were again unable to fully meet demand in the quarter. Price-mix contribution increased 10% up from our reported 9% last quarter with improvement across all end markets led by double-digit improvement in Industrial and Mobility Coatings. Notably, we are now lapping the 5% price realization we had in the second quarter of 2021 within both Refinish and Industrial. During the quarter, we incurred a $25 million one-time non-cash charge, which included a $20 million negative impact in net sales, related to the restructuring of an existing customer sales agreement. This impact is excluded from our adjusted earnings during the quarter. The restructuring was triggered as a result of a large Refinish customer realigning their capital structure whereby we gave some concessions. We originally made a large upfront investment in 2018 as part of a long-term sales commitment, which has provided us with very good returns. With our customer exiting their situation with a very sustainable capital structure and balance sheet, we continue to expect this to be a valuable relationship and provide good returns for us going forward. Foreign currency translation was a headwind of 5% on net sales for the second quarter, driven by the weaker Euro and Turkish Lira. Second-quarter adjusted EBIT was $151 million versus $173 million in the prior year quarter. The year-over-year comparison included approximately $23 million of EBIT headwinds associated with the impacts of the Russia-Ukraine conflict, China lockdowns and foreign exchange, complying a nearly flat year-over-year earnings comparison when excluding these effects.

Turning to Slide 10. Performance Coatings second quarter net sales increased 6% year-over-year and 12% ex-FX, driven by a 9% increase in average price-mix and a 5% increase from acquisitions with volumes remaining largely flat. Refinish reported a 6% net sales increase or 12% ex-FX driven by mid-single-digit price-mix benefit, high single-digit contribution from the U-POL acquisition and above market volume growth, partly offset by the one-time non-cash charge. Volumes increased in every region, despite raw material supply impacting our ability to meet all of our demands with the exceptions of EMEA and China, where the geopolitical headwinds drove modest volume declines. Industrial second quarter net sales increased 6%, or 11% ex-FX, driven largely by mid-teens percent improvement in average price-mix as well as a low single-digit acquisition contribution, partly offset by modest volume declines. Strong demand trends in most of the Industrial end businesses were fully offset by supply chain constraints and geopolitical headwinds. Performance Coatings reported second-quarter adjusted EBIT of $125 million versus $140 million in the second quarter of 2021, driven by drop-through benefits of price-mix and acquisition contribution, which were more than offset by headwinds from FX as well as higher variable and fixed costs.

Moving to Slide 11, Mobility Coatings constant currency net sales increased 21% in the second quarter, including a record high 12% price-mix benefit, up from 5% last quarter. Volumes increased by 10%. It is great to see the team building pricing momentum while also growing our footprint with strategic customers. Light Vehicle net sales increased 20% ex-FX in the quarter, including a 9% volume increase, easily outperforming global auto production which was flat for the quarter. Price-mix increased by double digits as the team continues to negotiate with auto OEMs to recover lost profitability. Commercial Vehicle second quarter net sales increased 27% ex-FX, driven by customer wins and recovery from constrained production rates. Price-mix also increased mid-double-digits. Mobility Coatings reported second-quarter adjusted EBIT of $2 million versus $6 million in the prior year quarter. Adjusted EBIT and associated margins in the second quarter were impacted by variable cost inflation, with partial offsets in positive pricing. Overall, price-cost dynamics continue to improve as we saw our strongest performance in Mobility Coatings since the first quarter of 2021. Moving to our debt and liquidity summary on Slide 12. Axalta's second quarter balance sheet and liquidity profile remained solid. We ended the quarter with slightly over $1 billion in total liquidity. Our net leverage ratio ended the quarter at 4.2 times reflecting a slight increase from 4.1 times at March 31. Net leverage remains somewhat elevated due to the seasonal phasing of free cash flow as well as incremental pressures associated with inflation and pricing within working capital, and share repurchases totaling $200 million year-to-date. We expect net leverage to drop as we move to the back end of the year on anticipated stronger full year operating results and the expected free cash flow generation in the back half of the year. On Slide 13, we will review our third quarter guidance frameworks and full-year commentary. For third quarter net sales, we expect between 15% to 17% year-over-year growth, including a 6% FX headwind and a 2% positive M&A contribution. The top-line guide also assumes high single-digit growth for both volume and pricing, continuing the momentum we've shown in the recent quarters. We expect to generate adjusted EBIT of $140 million to $165 million in the third quarter with D&A of $78 million inclusive of $23 million of step-up D&A. Currency translation is expected to be a nearly $10 million year-over-year EBIT headwind driven largely by a stronger US dollar versus the Euro. Interest expense for the quarter is anticipated to be approximately $35 million. For adjusted earnings per share we anticipate a range of $0.37 to $0.45 for the third quarter inclusive of headwinds on a per share basis from FX and the Russia-Ukraine dynamic totaling $0.05.

Regarding cost factors, we see stabilization in the raw material environment but still expect modest quarter-over-quarter increase into the third quarter with low 20% total inflation projected for the year. We continue to make great progress on pricing. Therefore, we expect to cover the majority of the cumulative price cost gap this year, with some lag in Mobility Coatings being offset by strength in Performance Coatings. Lastly, our typical second half weighted distribution of operating cash flow and a favorable outlook for sequential earnings growth should reduce our net debt leverage considerably by year-end. The macroeconomic outlook remains unclear and difficult to forecast. However, there are a number of constructive factors that should support sustained performance, including a resilient Refinish industry and the ongoing post-pandemic recovery. Pent-up demand is projected to drive resilience in our Light Vehicle and Commercial Vehicle end markets and low inventory levels throughout our sales channels. Meanwhile, in the near-term, we should benefit from continued share gains across most of our product categories, a sequential demand recovery in China following severe second quarter COVID-19 lockdowns. However, we do remain somewhat cautious in our third quarter outlook and favorable price cost recovery trends as variable costs stabilize and pricing momentum builds. Axalta is well-positioned to drive growth and generate cash across a range of economic scenarios given how our business is currently positioned. With that, I will now turn the call over to Rakesh.

Thank you, Sean, and hello, everyone. On behalf of the Board, I want to start by expressing gratitude to Robert for his nearly 10 years of service and contributions to this organization. He has played a significant role in building this great company since he joined in 2013, and Axalta has achieved a lot during his tenure. We are especially thankful for his leadership and successful navigation through the unprecedented challenges of the past few years. With the strong leadership team that Robert has established and our industry-leading businesses, he leaves the company in a solid position to accelerate the execution of our strategic plan to create value. Since joining the Board in August 2020, I have come to fully appreciate the potential of our businesses, and I'm eager to step in as the Interim CEO to continue driving growth, implementing our strategic initiatives, and unlocking value for our shareholders. Our senior leadership team is remarkably strong, and the Board and I are confident that our deep pool of talent will continue to perform while I quickly acclimate to my new role. Regarding the new CEO search, the entire Board is diligently working to identify the best candidate for the position. We will inform you as soon as a decision is made. I'm looking forward to connecting with our global teams, investors, customers, and suppliers, as we manage Robert's transition in the coming weeks. While I may not be able to answer many of your questions at this moment, I look forward to getting to know many of you in the weeks and months ahead and sharing our vision and progress as we seize the opportunities ahead. Now, operator, please open the lines for Q&A. Thank you.

Thank you. Our first question is from Christopher Parkinson with Mizuho. Please proceed.

Great. Thank you so much for taking my question. You've made a lot of strides towards ultimately improving the cost structure across the businesses. And in the second quarter, despite the volumes coming back and your very impressive price utilization, Mobility margins were still a bit lighter than most of us were anticipating. Can you just add a little bit further color onto what's going on there? How that result rolls into your 3Q guidance and anything else you think is especially pertinent? Thank you.

Chris, as we anticipated and mentioned during our first quarter call, the gap between pricing and costs widened in the second quarter due to the timing of raw material inflation and the scheduling of the new price increases we have negotiated. We still anticipate market growth, and our additional volumes will continue to enhance profitability going forward. If we take a step back and examine the situation, it's crucial to understand that Light Vehicles experienced significant lows in recent years because of the pandemic and the subsequent supply chain effects. It's also important to remember that the global production levels from 2020 to the current year do not reflect the normal cycle, but rather are influenced by previously unexpected industry conditions. We believe the low point in the cycle for global production will be in the high-80s to low-90s range. However, from 2020 to 2022, production has been in the mid-70s to low-80s, which emphasizes how unusual the last few years have been.

And, Chris, I think the important point, second quarter global auto builds was at 18.8 million, which equates to annualized 75 million car builds. So even though we had outperformance from a market perspective, and we're still at the sort of low, lows from a global build perspective. But sequentially into the third quarter, we're actually expecting total Axalta, the price cost gap will start to close but Mobility will start to build a little further over gap even though we're picking up on price. But certainly the volume impacts going from second quarter to third quarter are going to help overall profitability. So you should see sequential improvement, although marginal; you should see profitability climb in the third quarter.

That's helpful. And just, Robert, obviously, it's been a – a pleasure working with you. And I know you've accomplished a lot as CFO and essentially some incremental cost efforts in navigating very difficult environment during COVID. If I may ask, what are the one or two things you wish, if you were to stay on, that you wish you could have accomplished? I mean, you've got a great team and Sean has done a fantastic job as well. Just what else are you kind of leaving on the table that you hope the team continues to pursue? Thank you.

There are really two main items. One is that in 2018, the team and I prioritized innovation. The company has always been innovative, but we really intensified our focus on it. We've allocated a larger portion of our R&D technology budget toward significant innovations, not just in products, but also in applications, business models, and our interactions with customers. We have a few initiatives underway, particularly one that I believe could fundamentally transform one of the industries we are involved in, and while I would have liked to see that come to fruition, I will be watching from the outside and am very excited about it. The second area we've focused on is making people the top priority in the company. Although people have always been a priority for us, today it's essential to emphasize developing talent and capabilities, ensuring every employee has a clear vision for their career path, and demonstrating how Axalta can support their growth. We aim to create an environment where individuals can build long-term careers at Axalta. In the earlier years, from 2013 to 2018, we faced many potential M&A transactions and uncertainty, but since 2018, we've worked to establish a culture where employees can envision a long-term future with the company and access all the development and career opportunities they need here at Axalta.

Our next question is from John McNulty with BMO Capital Markets. Please proceed.

Yes, thank you for taking my question. Robert, best of luck in your future endeavors; perhaps you can stay in touch with us. You’ve successfully positioned Axalta for solid growth, which I know is a major goal. I appreciate that.

Thank you.

I wanted to discuss two related areas. Regarding the raw material costs, you currently have a $114 million price cost gap. How much of that do you expect to recover in the third quarter based on your guidance? How should we approach this?

Yes, John, that $114 million is going to come down modestly. Fourth quarter, you're going to see a bigger decline. Like we said in our opening remarks, when you look at the two-year cumulative stack, we're expecting about $600 million in cumulative inflation across both raw materials and variable freight. We are largely expecting to make up that entire amount, but we don't fully expect to offset the entire $114 million that you see there. But you will see a step up from third quarter to fourth quarter as far as the progress goes.

Okay, fair enough. And then also on the raw material front, Robert, I think you'd mentioned there's a couple of force majeures out there that are kind of new to the industry. I guess, when you think about 3Q and the supply chain, are you at the point where you feel like you can get all that you need for this quarter, or is it something where you're still going to like the end of third quarter with some backlog that you're going to have to work through as the supply chains continue to clear out? I guess, how should we think about that?

I think overall, I characterize it as we're starting to see things get better from an availability perspective. Overall, from a cost perspective, we're starting to see things get better. The two primary pain points at the moment are really pigments and alkyd resins. But there are a few spots where there are still challenges in getting raw materials. So I think it's something that will still be an issue for us, as I imagine, for other companies in the third quarter. But I think overall, we see the situation getting better. And that's just on the raw material side. On the logistics side, obviously, there are still some areas that are challenging. But as one example, we are starting to see trucking have some additional capacity and driver availability as well. So I think we see some easing starting there.

Our next question is from Ghansham Panjabi from Baird. Please proceed.

Hi, good morning, everyone. Robert, first off wish you well in the future and of course, thanks for all the help with years. Rakesh, we look forward to working with you as well going forward. On the outlook for 3Q, I guess your narrative seems very positive overall as it relates to price cost, auto OEM and auto refinish. Can you help us understand why EBIT would not be up more significantly in the third quarter relative to the second? I mean clearly there's some headwinds with FX and macro uncertainty. But is there anything else we should keep in mind as it relates to operating leverage?

Yes, Ghansham, the main aspect is really the mix of business results. We typically observe a seasonal decline in Refinish in Europe. When considering sequential volumes in Refinish, we expect to be down about 6%. However, year-over-year, we anticipate growth of around 2%, indicating that we are still expanding. This is where the impact of the business mix is evident on the bottom line. On the other hand, Mobility is making significant strides, increasing from 18.8 million builds in the second quarter to approximately 21 million builds. We expect to outperform the market on the Mobility front, but it's important to note that the profit margin for Mobility is significantly lower than that of Refinish. Additionally, foreign exchange will have a slight effect on operating expenses as we continue to support volume growth.

Great. Thanks, Sean. And then, for my second question, just can you give us more color on what exactly is happening in Light Vehicle production globally? What's better versus maybe initial expectations? And then on the new business wins that you picked up, can you give us a sense as to what is that being driven by? And how this incremental business is impacting margins at this point? Thanks.

So overall, I think we're seeing conditions in China because of the business that we've won there; we're seeing that pick up. We're also seeing favorable conditions in North America given some of the business wins as well as some of the build numbers. We have seen some softening in the build numbers in EMEA. However, we are making good commercial progress there. And then, lastly, in terms of Latin America, we've seen surprisingly strong demand there higher than what our expectations were. And that's both on the Light Vehicle as well as the Commercial Vehicle side. So that's quite encouraging.

And we should see about a third of that business actually impact the results for 2022 roughly speaking. And certainly, it's going to continue to help operating leverage as well as variable margins. But certainly, things are being camouflaged just given the 18.8 million builds in the quarter.

Our next question is from Kevin McCarthy with Vertical Research Partners. Please proceed.

Yes. Good morning. In your Mobility segment, price mix contribution accelerated quite a bit to 11.6%. Can you talk about your expectation for price mix in the third quarter and beyond? My recollection is you have some prospective formulaic benefits related to certain contracts in your auto OEM business. So any color there would be helpful for modeling the back half of the year?

In terms of our third quarter guidance, we're expecting growth in Mobility to be in the mid to high single digits. Additionally, as we move through the year, we anticipate continued sequential growth based on our current insights. Regarding raw materials, we expect some adjustments to begin on July 1 after the first six months.

Okay. And then, secondly, Sean, can you update us on your latest thoughts for cash flow items such as CapEx and working capital in this extraordinary environment?

Yes. So I mean we've spent roughly $70 million year-to-date. So the way to think about that, slightly higher than the annualization of the first six months, but that's certainly a lever that we could pull to the extent we start to see signs of recession. But part of that CapEx is to support future growth as well as productivity projects. So, until we actually start to see those recession impacts, we're going to hold on that lever. But yes, slightly higher than the run rate year-to-date.

And I'd add to what Sean said in terms of the step-up in AR, you see there, that's really reflective of the higher selling prices, and in terms of inventory, it's a combination of higher raw material prices as well as higher levels of inventory that we're carrying where we're able to opportunistically buy key raw materials that are in short supply. So that also is reflective of a little bit of operational hedging.

Our next question is from PJ Juvekar with Citi. Please proceed.

Yes. Hi, good morning. And Robert, good luck, Rakesh, good to hear from you. My question is on the OEM share gains. You know, what's driving the share gains in China? Does it have to do with these ICE vehicles or is it with EVs and your new EV product helping there? And secondly, on the margin side, on these new contracts, do you expect higher or lower margins on these new contracts because in the last five or six quarters as you have gained share, that is, it has coincided with lower margins in the business. So I was wondering, can you comment on the margins of these new contracts?

I want to emphasize that recovering margins is our top priority across the company. In the Mobility sector, we are successfully increasing prices while also growing our volumes. Our success is driven by technology, customer relationships, and the quality of our service. Additionally, the execution by our Mobility team, especially on the Commercial side, has been focused on enhancing our presence in the Chinese domestic market, both in internal combustion engine vehicles and electric vehicles. We have had a dedicated team working on this for the past year, which has yielded excellent results. This progress is not limited to China; it reflects our efforts in North America and EMEA as well. Regarding the overall profitability of the business, the margins from the contracts we've been winning are equal to or better than the margins from our historical business because they align with current pricing levels, which means we don't face the lag effects of inflation.

Great. And for my second question, can you talk about you said that OEM producers have more confidence in second half. You talked about Class 8 production growing as well. You know, both of them were suffering from chip shortages. Can you give us an update on where chip shortages are and what's driving the confidence in higher growth or build rates in second half? Thank you.

Our confidence is based on two main factors. The first is the data we are seeing from industry sources regarding their projections for the rest of the year. The second factor comes from feedback from our customers. Additionally, there is a strong push for electrification from customers, which is generating more demand at the consumer level. Together, these elements are instilling more confidence in our customers that they will see an increase in production as we move through the remainder of the year. While we are not yet back to the 95 million builds we anticipate eventually achieving, we are definitely making progress in the right direction.

Our next question is from Alex Yefremov with KeyBanc. Please, proceed.

Thanks. Good morning, everyone. Robert, first, best of luck with your new project. It was a pleasure working with you. I have always appreciated your straightforward style and openness. It seems like we are approaching a positive turning point in the business later this year. Many people would likely agree with that, but it does seem to contradict the timing of your departure. Can you provide any reassurance that the trends are as positive as many are anticipating?

Well, I think on the first part, in terms of the inflection point, it's difficult because of just a series of one macro event after another macro event after another macro event that has pushed out the inflection. But I think in terms of when we look at the business overall, we're confident that there will be an inflection. Refinish, of course, our most profitable business, just even a little bit of higher volume in the Refinish business has a dramatic drop-through effect from a profitability perspective. And as we start to see people, we hope, get back into the office here into the fall. Congestion periods pick up in the early morning and late afternoon, leading to hopefully more low impact type of collisions and repairs. We think that, that will be very positive for the Refinish business. We've also frankly been winning a lot of business in Refinish. Frankly, we've won more business than we're able to convert given some of the part shortages out there. So it really is set up nicely. When we look at our Industrial business, our Industrial team has just been doing a fantastic job in terms of landing new accounts, growing that business, expanding into new areas. That's also on the come. And then in terms of Light Vehicle, we've really stripped out the cost structure down to the bare bones and are operating with a very lean cost structure. What that business most needs at the moment is just volume. And then, of course, we have all the catch-up on price. So I think many of our investors have said to us, look, we don't know exactly when the pivot or the inflection point in Axalta is going to be, whether it's Q3 or Q4 or Q1 occurrence, but we know that it's going to come.

Thanks, Robert. And second question to Rakesh. I don't know if you can say staying at Axalta in a permanent CEO role is an option? Or would you rule this out at this point for yourself?

Yes. Hi, listen, let me just again reiterate how great a leader Robert has been. He's really been passionate with Axalta's great team. I firmly believe along with the Board that there's a great future for this company. And I just want to make sure there's no other hidden messages, period. We're going to be focused on execution. We're going to be focused on delivering. I think I agree the inflection point is going to come. We're going to be very focused on margins and really building great teams and focused on innovation that Robert and the teams have already started. We are starting a comprehensive search for a permanent CEO. I don't want to comment. It's too early and premature to comment on that. But clearly, it's something that's important for the investment community. And I promise to be as transparent as Robert has been with all of you, and you'll hear from me on a very timely basis on that.

Our next question is from David Begleiter with Deutsche Bank. Please proceed.

Thank you. And Robert, again, congrats and best of luck going forward in your future endeavors.

Thank you, David.

Just on the alkyd resins, is that just more of a U.S. issue? Or is it also a European issue? And what are you in allocation for those products? And if so, at what level?

It's predominantly a U.S. issue driven by a recent force majeure. Fortunately, we do have other sources of supply. And we are working rapidly to try and make up for that volume as soon as possible.

Very good. Regarding the Q3 guidance, at the low end, it suggests a decrease quarter-over-quarter. If that low end is reached, what is causing the lower EBIT in Q3 compared to Q2?

Its assumptions around inflation as well as just China rebounding. I covered it in my prepared remarks, but we're somewhat cautious on China. If we were to see a pullback, you could see sort of incremental impacts would bring us down to lower end. I think we're pretty bullish on the Mobility rebound. As far as Refinish and Industrial, I think there's still some question marks on how quickly this rebounds in the third quarter.

Our next question is from Mike Harrison with Seaport Research Partners. Please proceed.

Hi, good morning, and best wishes to Robert. I was wondering if you could talk a little bit about the battery protection wins that you talked about in Industrial. What exactly is this offering, and at this point is it fair to expect that you could get additional commercial traction following the announcement of these wins?

Well, let me start by saying that one of the things we are most excited about at Axalta is our focus on electrification, particularly in battery coatings. This quarter, we secured new wins in the battery protection area, which we believe has significant long-term potential in electric vehicles. We're gaining momentum beyond just electric motor coatings and experiencing growth despite the ongoing chip shortage and the push for product development chips that facilitate more electric vehicles. We have a strong pipeline of powder and eco-friendly products for battery protection across all regions, and we've been increasing resources for product development and testing in our application labs. Recently, we brought on a leader to drive our global electrification initiatives, and we're very eager to see the impact he will have. When we think about electrification, our view is quite broad. While we are a leader in electric motor coatings, our Energy Solutions Coatings, which have received multiple technology awards, are utilized not just in electric motors but also in various industrial applications such as wind turbine generators, transmission towers, electrical conduits, fuel storage containers, battery trays, and covers. We already have a strong position in that market. Additionally, there's potential in sustainability and sustainable energy generation, including areas like transmission, generation, and storage conversion. The opportunities are vast, and we will provide more updates on these topics in the future.

All right. And then I was curious on the Refinish business. When you guys see consolidation within MSO customers, sometimes this can lead to a change in suppliers. I think you've benefited from that, if I went back several years. Are you concerned that there are situations where you could lose some business as the result of a merger? Has that ever happened in the past?

No. On the contrary MSO customers obviously are some of the most sophisticated customers within Refinish, and they tend to run trials. So they'll give each Refinish supplier a certain number of shops and they'll run a test. And when we go head-to-head, and we're looking at productivity and we're looking at cost per labor, per labor paint hour, we rarely, if ever, lose in these types of head-to-head competitions. And so, actually as we see that, we think that will bring even more business our way. So, in terms of some of the recent activity that's transpired within the MSO, and even in the independent space, we're very excited about what those opportunities could bring for Refinish and we expect to gain even more share.

Our next question is from Steve Byrne with Bank of America. Please proceed.

Good morning everyone. It's Matt filling in for Steve. Robert, considering your comments about reducing the cost structure in Light Vehicles and the recent business successes, if we return to the 2019 auto build rates, would Mobility EBIT revert to that mid-130 figure or could it be significantly higher?

I mean, hypothetically, it could be meaningfully higher. I mean, we still have the price cost gap to close, so I think that's the one caveat to what you called out. But Mobility volumes, I mean, that's roughly half of the gap. We say the other half is going to be sort of the price side of the equation.

Yes, that brings me back to my main question. Is the pricing structure in Mobility Coatings different now, or do you still have confidence in recovering from that incorrect asset? Mobility has faced pricing challenges for quite some time, so we're just seeking clarification.

So, yes, to answer your question, I think we're very confident in the business and we've been through the cycle before and we came back to previous levels of profitability. And as we go forward, as we look at the again the cost structure adjustments we've made, the quality of the team we have running that business and the amount of market share, I think we're even more positive on the business and the profitability potential than we were through the last cycle.

Our next question is from Mike Sison with Wells Fargo. Please proceed.

Hey, good morning. And good luck to you, Robert. I assume you just want to move to Cleveland so.

Thanks, Mike.

In the fourth quarter, I know it's challenging to predict anything beyond a single quarter these days. However, we generally see a seasonal decline in the fourth quarter compared to the third. You should expect to see more favorable price trends, and possibly some improvement in Mobility. Considering the challenges from the third quarter to the fourth, what do you think will drive any positive outcomes compared to the third quarter, and what contributes to the usual seasonal decline in the fourth quarter?

Yes. So I guess a couple of things, Mike. I mean the price raw equation is going to continue to improve, and there's going to be a fairly nice step down as far as the gap going from third quarter to fourth quarter. That's probably the biggest call out. You see the IHS industry forecasters gone from 20 million builds up to 22 million builds in the fourth quarter just as supply chain and semiconductor aspects start to get resolved. We continue to see that traction. I think the other aspect is just as COVID stays behind us, we'll have more confidence in China and then more broadly within Refinish just as we continue to see congestion levels pick up. They're really the biggest building blocks. Certainly, the euro is sitting at 102. If currency was to move in our favor, you could also see a nice help there, but they're really the building blocks.

Got it. I have a question for Rakesh. It's great to hear and see you again. Given your extensive auto experience before Sigma-Aldrich, what characteristics do you and the Board consider important for the next CEO?

Yes. Hey Mike, good to hear from you again. Listen, I think we've got a great foundation in the business. It's all about continuing to execute. There is going to be a recovery in our markets. I think Refinish is a great business. As Robert said, we are winning share. Mobility, we're also winning share, but we want to make sure we return to the margin levels and perhaps even enhance the margins from where we were historically. That's going to be an area of great focus. And on the Industrial business, we've got a lot of adjacencies. We're getting into the EV trend. We're going to win new business. So we have lots of pockets of opportunity. We want to make sure that with the strong bench that Robert has created in the company that the CEO is going to continue this journey because, as I said, it's all about execution. We're not changing strategy. We are on point in terms of delivering to the commitments that we and the Board and Robert have made. And that's the singular focus of this business, and it's going to be for the CEO.

Our final question will be from Josh Spector with UBS. Please proceed.

Yes. Hey, thanks for taking my question. I echo thanks to Robert and welcome to Rakesh. Just on the Industrial side, can you provide a little bit more color about what you guys are expecting volume wise in 3Q? And perhaps what changes 2Q versus 3Q, if there was some temporary weakness or where things are worsening? Thanks.

So the second quarter to the third quarter, we are expecting volumes up slightly. But I guess where we're seeing a little bit of slowing is in Europe. We hinted at that in the first quarter. We saw a little bit more of that in the second quarter. And just given where we are through July, we are fully expecting that in the third quarter as well. And then the other aspect is just around China. And I alluded to this just as far as how quickly we're going to rebound from the COVID-19 lockdowns.

And just to add to what Sean said in complement, there's also been supply chain constraints that have hit Industrial a little bit harder than some of the other businesses. But those three elements of the softness in China from lockdown, some of the pressure in architectural coatings in EMEA, and the supply chain constraints, those are three transient elements that we do expect to get better. So essentially, you can think of the Industrial businesses being in a state of under earning currently.

Okay, thanks. And just a quick follow-up. Just in terms of the non-cash adjustment that impacted Refinish, does that recur over the next three quarters? M&A seemed a bit light in the guidance versus what we thought.

It will not reoccur. It was a one-time event. We shouldn't expect anything going forward here.

And that will conclude today's conference. We thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.