Axalta Coating Systems Ltd

NYSE:AXTA

Earnings Call Transcript 2022-Q2

[Operator]

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after today's call should please note that information provided in the recording will not be updated, therefore may be no longer current.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.

[Chris Evans, VP, IR]

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.

[Robert Bryant, CEO]

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 book 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 a 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.

Moving on to Mobility Coatings. In Mobility Coatings, an industry-leader in light vehicle and commercial vehicle exterior OEM coatings, volume growth outpaced relevant industry production rates as we continue to drive share. Specifically, Light Vehicle volumes improved 9% year-over-year, considerably outpacing the flat global auto growth rates. In Commercial Vehicle volume grew 13%, which far exceeded Class 8 truck market production, which declined by approximately 1%.

New Light Vehicle and Commercial Vehicle customer wins are driving above market growth and setting us up with the right customer mix for when global production returns to normalized levels. Automotive OEM customers are increasingly confident about second half production rate improvements given the post lockdown ramp-up of Chinese auto production and improved supply sentiment. We expect sequential market growth through year-end with Q4 production nearly at 22 million builds, 17% above second quarter rates, and an annualized run rate in the high 80 million builds, which was last achieved in 2019.

As we discussed on our Q1 earnings call, we see normalization of Light Vehicle production rate as roughly one-half of the path to recovering the approximate $140 million earnings gap between our trailing 12-month Mobility Coatings adjusted EBIT and our pre-pandemic 2019 profitability levels. The other half of the recovery will be from offsetting significant variable cost inflation, where we are making great progress and will discuss further on the following slide.

It's our intent to fully offset the impact of raw material, energy and logistics inflation on our businesses. In every market we're working with customers to implement the necessary degree of price increases to operate at more attractive levels of profitability.

In Refinish, the team has done a remarkable job increasing price quarter after quarter and has been able to fully neutralize the impact of inflation in real time. Further pricing actions were executed beginning in July in certain regions to address modest sequential inflationary impacts.

In Industrial, second quarter price-mix improved by 15% year-over-year or 20% on a two-year stacked basis, which for the first time in this inflationary period is fully offsetting the impact of inflation. Industrial however, remains behind on price cost given the rapid rise of inflation that began in the third quarter of 2021. As a result, profitability is below target levels, but should improve throughout the year.

In the second quarter, pricing stepped up considerably in both Light Vehicle and commercial vehicle, resulting in 12% higher year-over-year Mobility price-mix. This is a great outcome, but the scale was insufficient to fully offset run rate inflationary impacts and hence the cumulative price cost gap widened in the quarter, but was as we expected when we provided guidance in April. We're optimistic that the highly inflationary environment is finally beginning to stabilize though raw material availability still remains tight and variable costs are likely to continue to rise modestly in the third quarter.

There are pockets of softening in some base chemicals isocyanates as well as plastic and metal packaging, but we continue to face bottlenecks in certain pigments, additives, logistics, and resins following recent force majeures. This will continue to be a dynamic environment. Nonetheless, with the visibility we have today, we believe, we will recover the majority of the cumulative price cost gap by year end.

Now, I will turn the call over to Sean to discuss our financial results beginning with Slide 9.

[Sean Lannon, CFO]

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 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. The adjusted EBIT margin for the segment decreased to 15% from 17% in the prior-year period.

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 OEM's 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 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. Within our third quarter forecast, we further assume raw material inflation in the high teens percent versus the third quarter of 2021.

For Mobility, global auto build rates are expected to be at $80 million to $81 million for the full-year. At these levels, we expect to see annual volume uplift from market growth plus upside from new customer wins. Likewise, heavy duty truck build rates are projected to increase 5% in 2022, ex Asia-Pacific and Eastern Europe, with our Commercial Vehicle volumes expecting to exceed market growth rates given our strong and growing position.

Regarding cost factors, we see stabilization in the raw material environment but still expected 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.

[Rakesh Sachdev, Interim CEO]

Thank you, Sean, and hello, everyone.

On behalf of the Board, I want to first start by thanking Robert for his nearly 10 years of service and contributions to this organization. He has played a huge role in building this great company since joining in 2013 and Axalta has accomplished a great deal over his tenure. In particular, we are very grateful for his leadership and successful navigation during the unprecedented challenges these past few years. With the accomplished leadership team, Robert has put in place, combined with our industry-leading businesses, he leaves the company well-positioned to accelerate the execution of our strategic plan to drive value creation.

Since joining the Board in August 2020, I have gained a full appreciation of the potential of our businesses, and I'm looking forward to stepping in as the Interim CEO to continue the -- to accelerate growth, execute our strategic initiatives and unlock value for our shareholders.

Our senior leadership team is incredibly strong and the Board and I have full confidence that our deep bench of talent will continue to execute while I quickly ramp up in my new role.

With regards to the new CEO search, the entire Board is working with urgency to identify the best possible candidate for the job. And we will let you know as soon as we have made a decision. I'm looking forward to engaging with our global teams, investors, customers, and suppliers, as we work through Robert's transition over the coming weeks.

As I'm sure you can appreciate it will be premature for me to answer many of the questions you may have at this time. But now that I look forward to getting to know many of you over the coming weeks and months, and sharing with you our vision and progress as we harness many of the opportunities that lie in front of us.

With that, operator, please open the lines for Q&A. Thank you.

[Operator]

Thank you. [Operator Instructions].

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

[Christopher Parkinson, Mizuho]

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 -- a little 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.

[Robert Bryant, CEO]

Chris as we expected and communicated on our first quarter call, the price cost gap got bigger, in the second quarter, given the timing of the raw material inflation and the cadence of the new price increases that we've negotiated. We continue to expect market growth and our incremental volumes will continue to drive profitability from this point forward.

If we -- if you step back and you look at it, I think it's important to note that, Light Vehicles really hit the lowest of the lows over the past few years given the pandemic and some of the downstream impacts of the supply chain. And it's important to remember that the global production build from 2020 through the current year are not part of the normal cycle but more so driven by the previously unforeseen conditions within the industry. And we believe a low point of the cycle that global production builds will sit in the high-80s to low-90s production range. But from 2020 to 2022, they've been in the mid-70 to low-80s range, just highlighting how much of an outlier the past few years have been.

[Sean Lannon, CFO]

And, Chris, and 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 see -- should see sequential improvement, although marginal, you should see profitability climb in the third quarter.

[Christopher Parkinson, Mizuho]

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.

[Robert Bryant, CEO]

There are really two items. One is -- one of the things that the team and I made a priority in 2018 was innovation. The company has always been very innovative, but we really stepped up our efforts around innovation. So we've deployed a larger percentage of our R&D technology in innovation budget, to more step change innovations, and not just innovations in products, but innovations in application, in business model, and, frankly, in how we interact with our customers.

And we've got a couple of things that we're working on. One in particular that I think could just fundamentally change the game of one of the -- one of the industries in which we participate, and certainly would have liked to see that to fruition, but I'll watch that from the outside. And I'm really excited about that.

The second area that I think we've begun is, really making people the top priority at the company. People have always been the top priority at the company. But I think in today's world, really focusing on developing talent and capabilities and giving every employee at the company a clear view to their career path and how Axalta can play a role in helping them fully develop in creating an environment where people can make a career, at Axalta is something that that we really strive to do. I think early on, kind of, in that 2013 to 2018 period, we had a lot of potential M&A transactions, and there was a lot of uncertainty, but, kind of, 2018 forward, we really tried to establish a culture in an organization where people could see themselves working at the company for a long time, and getting all of the development and career opportunities that they need here at Axalta.

[Operator]

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

[John McNulty, BMO Capital Markets]

Yes. Thanks for taking my question. And, Robert, good luck in your next endeavors, maybe reach out to us and you've obviously put Axalta on some solid growth trajectory, which is -- which I know is one of the big initiatives. So I appreciate that as well.

[Robert Bryant, CEO]

Thank you.

[John McNulty, BMO Capital Markets]

Wanted to dig into, I guess, two areas, both somewhat related. On the raw material front, on your -- the $114 million of price cost gap that you've got right now, I guess, how much of that you see getting back in the third quarter as part of -- as part of the guide that you put out there, how should we be thinking about that?

[Sean Lannon, CFO]

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.

[John McNulty, BMO Capital Markets]

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?

[Robert Bryant, CEO]

I think overall, I characterize it as we're seeing from an availability perspective we're starting to see things get better. And 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.

[Operator]

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

[Ghansham Panjabi, Baird]

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?

[Sean Lannon, CFO]

Yes. Ghansham, probably the biggest thing is really just the mix of business results. Typically, we just see a seasonality pullback in Refinish in Europe. When you think about sequential volumes in Refinish, we're going to be down about 6%. Year-over-year, we're going to be up about 2%, so we're still growing. But that's really where you're seeing the mix of the businesses impact the bottom line and then offsetting that clearly as Mobility is sticking -- starting to step-up even further off the 18.8 million builds in the second quarter going to roughly 21 million builds. And again, the expectation is we're going to outperform the market on the Mobility side. But the profit margin of Mobility is clearly less than what we get in Refinish.

And then FX, as you know, and there's a marginal impact on operating expenses as we continue to support the volume growth.

[Ghansham Panjabi, Baird]

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.

[Robert Bryant, CEO]

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.

[Sean Lannon, CFO]

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.

[Operator]

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

[Kevin McCarthy, Vertical Research Partners]

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?

[Sean Lannon, CFO]

Yes. Just as far as what's implied in the third quarter guidance, it's mid to high-single-digits coming through in Mobility. But sequentially, you're going to see -- continue to see growth as we progress through the year and certainly the indexing just given what we've seen. On the raw materials side, throughout the first six months, you're going to see part of those start to reset effective July 1.

[Kevin McCarthy, Vertical Research Partners]

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?

[Sean Lannon, CFO]

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, 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.

[Robert Bryant, CEO]

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.

[Kevin McCarthy, Vertical Research Partners]

Okay. Thank -- thank you, both. Robert, it's been a pleasure and I wish you all the best.

[Robert Bryant, CEO]

Thank you, Kevin. Really appreciate it.

[Operator]

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

[PJ Juvekar, Citi]

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 this new contracts, do you expect higher or lower margins on these new contracts because in 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?

[Robert Bryant, CEO]

So I just would reiterate overall that margin recovery is the -- is the highest priority across the company. And in the Mobility business, specifically, we're successfully raising price and we're also growing volumes. And the way that we're -- that we're getting that, PJ, is technology, customer intimacy and relationships, and frankly, our service. But there's another element, and that's also just the quality of execution of our Mobility team, in particular on the Commercial side where they have made greater penetration of China domestics, both in ICE as well as electric vehicles a top priority, and so we've had a bit of a SWAT team working there for the last year. And they've had really, really good results. And that's not only confined to China but that's also reflective of efforts that have been going on in, in North America as well in EMEA.

In terms of the overall profitability of the business, actually the margins of the businesses that we've been winning are at or better than, or I should say better than some of the margins of the historical business because they're being quoted at current pricing levels, therefore, you don't have the lag impact of inflation.

[PJ Juvekar, Citi]

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.

[Robert Bryant, CEO]

So our confidence is really based on two elements. The first is what we're seeing in the data, obviously, from the industry sources in terms of what their projections are for the remainder of the year. The second element is, is what we're seeing in terms of what our customers are telling us.

The other -- you know, the other element is on electrification. It's become such a push by customers and that's really creating additional demand at the consumer level. So I think all those things together are giving our customers more confidence that as we go through the remainder of the year that they will see a step-up in production. Obviously, it's not to the, 95 million-ish builds that we think are eventually going to get back to, but it's certainly moving in the right direction.

[Operator]

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

[Alex Yefremov, KeyBanc]

Thanks. Good morning, all. Robert, first, best of luck with your new project. It was a pleasure working with you. Always appreciated your straightforward style and openness. It seems like we're just in front of those positive inflection in the business later this year. It's like, a lot would agree -- a lot of people would agree with that, but I guess it sort of maybe contradicts with the timing of you stepping down. So can you say anything to reassure people that the trends are as positive as many expect them to be?

[Robert Bryant, CEO]

Well, I think on the first part, in terms of the inflection point, it's difficult because of just 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. And 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 really 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 that will also drop-through.

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.

[Alex Yefremov, KeyBanc]

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?

[Rakesh Sachdev, Interim CEO]

Yes. Hi, listen, let me just again reiterate how great a leader Robert has been. He's really been passionate with Axalta 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, so.

[Operator]

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

[David Begleiter, Deutsche Bank]

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

[Robert Bryant, CEO]

Thank you, David.

[David Begleiter, Deutsche Bank]

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?

[Robert Bryant, CEO]

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.

[David Begleiter, Deutsche Bank]

Very good. And just on the Q3 guidance, at the low end, it would imply -- it is down quarter-over-quarter. If it does occur at that low end, what's driving the sequentially lower EBIT in Q3 versus Q2?

[Sean Lannon, CFO]

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.

[Operator]

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

[Mike Harrison, Seaport Research Partners]

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?

[Robert Bryant, CEO]

Well, first and foremost, let me say that, probably one of the vectors that we're most excited about at Axalta is our effort around electrification, and within that battery coatings. So we booked new wins this quarter in the battery protection space. And that's really where we see, long-term potential within electric vehicles as we gain traction beyond just our current electric motor coatings and we see growth amidst the short -- the chip shortage, the emphasis on product development chips to enable more electric vehicles. And we really have a robust -- a robust pipeline of powder and eco products for battery protection in all regions. And we've been adding resources focused on product development and testing to support these opportunities in our application labs. We've also recently hired a leader to spearhead our electrification effort globally at the company who started this week, and very excited about what he's going to do.

But I think, when we think about electrification, we've got a much broader perspective. Obviously, we're one of the top companies in electric motor coatings, but our Energy Solutions Coatings for which as you already know we've won multiple technology awards, they're not only used on electric motors, but they're used in all kinds of industrial applications, wind turbine generators, transmission towers, electrical conduits, fuel self-storage containers, battery trays, closures and covers. So we're really very strongly positioned in that business already. But there's also an opportunity around sustainability and sustainable energy generation, whether that's transmission and generation, storage conversion, it just goes on and on in terms of the opportunity we have there. So we'll be talking a lot more about these in the future.

[Mike Harrison, Seaport Research Partners]

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?

[Robert Bryant, CEO]

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 this types of head -- heads up 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.

[Operator]

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

[Matt DeYoe, Bank of America]

Good morning everyone. It's Matt on for Steve. Robert, can I -- in light of the comments you made about ripping out, or I should say, lowering the cost structure in Light Vehicles and all these business wins, right, so if we return to 2019 auto build rates, would Mobility EBIT return to that mid-130 number or would it be meaningfully higher?

[Robert Bryant, CEO]

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.

[Matt DeYoe, Bank of America]

Yes. But I mean that kind of gets to the root of my question, right, like is the pricing structure different now in Mobility Coatings or do you still have confidence that this is a business that you can recover off of that wrong [ph] asset. Because I know everybody, look Mobility has been the hardest place for price for a long time. So I think we're just looking for --

[Robert Bryant, CEO]

So, yes, to answer your question, I think we're very confident in the business and we've been through the cycle -- 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.

[Operator]

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

[Mike Sison, Wells Fargo]

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

[Robert Bryant, CEO]

Thanks Mike.

[Mike Sison, Wells Fargo]

In terms of the fourth quarter, and look I understand it's difficult to forecast anything beyond one quarter these days. But it typically seasonally declines in the fourth quarter versus the third. And -- but you are -- you should get to more price raws should turn more favorable and maybe Mobility gets a little bit better. But when you think about the challenges from third to fourth, what do you think the -- what do you think drives upside versus the third? And what drives sort of down the normal seasonal decline in the fourth versus the third?

[Robert Bryant, CEO]

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.

[Mike Sison, Wells Fargo]

Got it. And then I guess one question for Rakesh. Good to hear and see you again. You had a lot of auto experience prior to Sigma-Aldrich. What do you think you and the Board are looking for, for the next sort of -- what characteristics are you looking for the next CEO?

[Rakesh Sachdev, Interim 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, it's -- 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 it's 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.

[Operator]

Our next question is from Mike Leithead with Barclays. Please proceed.

[Mike Leithead, Barclays]

Great. Thanks. Good morning. And Robert, best wishes on your future endeavors. And Rakesh, I look forward to working with you once again. Maybe this question is for Sean. I just wanted to ask on the $25 million hit from a customer recapitalization and some forgiveness there. I guess $25 million feels a bit lumpy. So can you just help us if there's any other similarly sized upfronts in the balance sheet? And have you changed at all how you think about doing some of these upfront investments on the back of this?

[Sean Lannon, CFO]

Yes. This was certainly an outsized investment that we had done with a very large MSO back in 2018. There's nothing similar to the situation that's currently sitting on the balance sheet. This -- I mean certainly, it was a big investment back in 2018, but it has provided really nice returns. And just given the restructuring of their capital structure, I mean, there is a very nice sustainable future here and the partnership is going to bode very well for Axalta.

[Mike Leithead, Barclays]

Got it. And then secondly, Sean, just on leverage, can you give us a sense of where you'd expect net leverage to roughly end the year?

[Sean Lannon, CFO]

Yes, close to 3.5 times, maybe slightly better if we're able to really bring working capital down. Part of that will be dependent on if we see a little bit of deflation in the fourth quarter as far as some benefits from an inventory perspective. But working capital as a percentage of net sales at the end of the second quarter were up around 14%. We expect that to get down closer to 10%, 11% by the end of the year.

[Operator]

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

[Josh Spector, UBS]

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.

[Sean Lannon, CFO]

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.

[Robert Bryant, CEO]

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 underearning currently.

[Josh Spector, UBS]

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.

[Sean Lannon, CFO]

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

[Operator]

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.