Axalta Coating Systems Ltd. (AXTA) Q3 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Axalta Third Quarter 2018 Earnings Conference Call. [Operator Instructions] Today’s call is being recorded, and replay will be available through November 1. Those listening after today’s call should please take note that the information provided in the recording will not be updated, and therefore, may no longer be current. I would now like to turn the call over to Chris Mecray for few introductory remarks. Chris, please go ahead, sir.

Thank you, and good morning. This is Chris Mecray, VP of Investor Relations. We your continued interest in Axalta, and welcome you to our third quarter 2018 financial results conference call. Joining us today are Charlie Shaver, Chairman; Robert Bryant, Interim CEO; as well as Sean Lannon, Interim CFO. This morning we released our quarterly financial results and posted a slide presentation in the Investor Relations section of our website at axalta.com, which we’ll be referencing during this call. Both our prepared remarks and discussion today may contain forward-looking statements reflecting the company’s current view of future events and their potential effect on Axalta’s operating and financial performance. These statements involve uncertainties and risk and actual results may differ materially from those forward-looking statements. Please note that the company is under no obligation to provide updates to these forward-looking statements. This presentation also contains various non-GAAP financial measures. In the appendix, we’ve included a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information regarding forward-looking statements are not GAAP financial measures, please refer to our filings with the SEC. I would now turn the call over to Charlie.

Good morning, everyone. I’d like to begin our call this morning with a few brief comments, and then I’ll turn it over to Robert. Clearly with the announced CEO transition earlier this month and stock market volatility in the coatings group immediately following, it’s understandable that some of you might have questions relating to these topics. I don’t have anything specific to add to what was stated on the October 8th press release regarding Mr. Hahn’s departure from Axalta as you can likely appreciate, but the board took swift action on the matter, and I’m glad it was addressed efficiently, which was in the best interest of Axalta. As we look forward, I’d simply like to say that both the board and I have great confidence in Robert as a leader, and we’re really pleased that he agreed to step into the interim CEO role. Having worked with Robert for the past six years, I’m certain that he has a qualifications, acumen and skill-set to ably take on the role and be very effective leader for Axalta. He clearly has the support of management team, and I know that many of you have also provided a highly supportive feedback, which we all appreciate. Regarding next steps, the board is undertaking appropriate deliberation in accordance with good governance principles to ensure that we make the correct decision regarding a permanent CEO position. We intend to close this process without undue delay, and we thank you for patience in the meantime. With that, I’ll turn the call over to Robert.

Good morning, and thank you for joining us today as we review our third quarter financial and operating performance and provide an update on our 2018 full year outlook. Before we begin, I’d like to note that I’m excited and very proud to take the helm as Axalta’s interim CEO. Having served as Axalta’s CFO for nearly six years and given my background in both financial and operating roles, I feel very well prepared for this job. I’m honored to serve Axalta and our shareholders, and I’m very excited to continue the path of value creation that we pursued since we carved out and stood up this business in 2013. While clearly subject to a board decision on my interim title, I look forward over time to adding focus and energy to initiatives that I believe can accelerate Axalta’s path to value creation. We have a strong strategy in place that guides our operating execution that we have implemented for some time now. That said, I see more to be done, and I anticipate sharing more of this on this topic in our key priorities and future communications, beginning with our 2019 outlook call expected to be held in mid-December. I look forward to our ongoing dialogue and updating you on our progress over time. Regarding Axalta’s third quarter performance, our results reflect solid operating execution and exceeded previously provided guidance. We continue to see broadly steady demand across our businesses, enabling strong progress towards our 2018 financial goals. That said, our business economics continue to be impacted by substantial variable input cost inflation. We remain focused on offsetting this inflation via combination of price increases and productivity initiatives to backstop our margin structure. Broadly speaking, we are pleased with both our quarterly and year-to-date performance. While we face certain challenges common to coating companies, including input cost inflation and foreign exchange headwinds, which we have factored into our outlook and provide guidance, we are largely on track in our core operating performance and making progress where possible to pass through structural price increases. Turning now to Page 3 of our earnings presentation, I will review some quarterly highlights. We grew third quarter net sales by 4.4% year-over-year, which included constant currency organic growth of 6.5%., as we have almost fully lapped all of the 2017 acquisitions. This was driven by volume growth as well as continued acceleration of price and product mix components. We reported substantial volume growth of mid-to high single digits in Refinish, which was fully expected in part due to more favorable comparisons with the prior year as a result of working capital adjustments with certain distributors in North America that we experienced in the second half of 2017. We also generated ongoing volume growth in Industrial Coatings as well as in Transportation Coatings, where we forecasted and realized some light vehicle growth driven by new product launches slated for mid-2018, and saw ongoing solid demand within heavy-duty truck markets. Overall demand across our markets remains generally healthy, but we did experience some pressure from weakening emerging market countries as well as modest volume pressure in Industrial and EMEA due to the impact on our overall focus on margin performance over volume and some trade-offs were made. Finally, we have witnessed some deceleration in automotive markets in China as demand has waned in the last several months. While production in Europe has also been impacted by the worldwide harmonized light vehicle testing procedure or WLTP, transition from gas – from diesel to gas engines, which is expected to be transitory as it speaks more to regulation than underlying demand. Regarding pricing, we saw continued progress and acceleration of weighted average pricing sequentially in the third quarter, particularly within our Performance Coatings segment. On a consolidated basis, average prices and product mix increased nearly 3%. In Performance Coatings, average price and mix increased 5.7%. So while there remains work to be done to recapture inflation impacts in Transportation Coatings, we are doing quite well as a whole, which is reflected in our stable margins as a company this year. Our third quarter margins were up year-over-year and our full year margins are projected to be nearly flat despite an inflation headwind from variable costs of low double digits, relative to adjusted EBITDA. As a whole, I am pleased with our productivity initiatives and overall financial performance given some of the margin challenges we’re seeing with some of our peers. Axalta’s third quarter adjusted EBITDA of $235 million increased 12% from $210 million last year, driven by organic growth and improved average pricing, though offset substantially by variable cost inflation. Foreign exchange negatively impacted adjusted EBITDA by about $5 million in the period versus our previous guidance shared in July. Adjusted EBITDA margins for third quarter increased to 20.6% from 19.2% given positive volume drop-through from Refinish and overall stronger price and mix effects. We are proud of our track record this year and offsetting inflation with both price and productivity to enable this reported margin stability. Briefly reviewing end-market highlights, refinish constant currency net sales growth of 13.9%, was impressive. This growth was driven in almost equal measure by organic volume from all regions and positive price mix. The strongest overall contributor was North America, benefiting from comparisons to last year’s results, which were impacted by distributor working capital adjustments. Business conditions in Refinish markets remains solid. Based on our sales run-rates and indications of ongoing market health from our body shop end-customers. Axalta’s Industrial Coatings end-markets reported another strong growth quarter with 7.2% constant currency net sales increases, led by the Americas and Asia Pacific, though partially offset by a slower EMEA result this quarter, including some of the timing factors unrelated to demand. Price mix continues to show progress here as well, with mid-single digit increases for the period. So Industrial end-markets appear healthy, albeit including some uneven regional volume results, which may also be due in part to more challenging year-over-year comparisons and our preference for price over volume. We remain on track to introduce new products and Industrial Coatings in 2018 at a double-digit rate of growth. Light Vehicle net sales were essentially flat for the quarter. Volumes grew low single digits, led by growth in the Americas, while Europe and China were impacted by broader auto demand trends. Auto production globally remains broadly intact, though we continue to see some impact from slowing demand in China. EMEA continues to see slower production associated with the WLTP engine technology changeover as a temporary factor, but clearly seen in the third quarter data and in demand for Axalta. Global production forecasts have been reduced from 2.1% growth for the year to 0.7% growth since our last update call, reflecting a reduction of just under 1.3 million vehicles, of which a bit less than half of that reduction comes from China. Axalta has tracked broader macro auto demand this year, though we saw some boost in North America from new product launches around the middle of the year. Commercial Vehicle net sales decreased 2.2% on a constant-currency basis in the quarter. Global heavy-duty truck demand remains largely steady, though industry orders from Europe have moderated somewhat, and China is now firmly in a down-trend. As a reminder, we are not a significant share of the China heavy-duty truck market currently. North America and Latin America markets remain very robust, lapping prior year production strength as well. Price mix was essentially flat in the period. Regarding average prices and mix in Transportation Coatings, we continue to dialogue with our key OEM Light Vehicle customers regarding achieving economic offsets to persistent raw material inflation. While we’ve made selected progress in this regard so far this year, we continue to require substantial incremental economic gains to offset the inflation we’ve absorbed in the last two years. In the meantime, we’re also executing additional cost savings in Transportation Coatings, a necessary component in being competitive and maintaining our medium-term margin profile. Touching on our balance sheet and cash flows. Third quarter free cash flow was $90 million compared with $183 million last year. We ended the quarter with net debt to trailing 12-month adjusted EBITDA of 3.5 times versus 3.6 times at June 30 as increased cash balances at higher last 12-month adjusted EBITDA were partially offset by unfavorable currency impacts on our euro debt balances for the period. Regarding capital allocation, we have repurchased a $150 million as of Q3 year-to-date in shares of our common stock, including $50 million in the third quarter. This outlook for excess capital remains opportunistic, and we were also active in October, subsequent to the quarter end. We passed on a few M&A opportunities in Q3 due to valuation expectations and because we had some internal high return investment opportunities with some of our key strategic customers. Next I’d like to add a few additional summary comments on operating highlights. First, our Axalta Way Productivity program continues at pace and we are on track to realize our goal for the year of around $50 million in savings, while laying the foundation for significant incremental savings over the coming years. These savings have been helpful this year as well as in offsetting across – inflation across our businesses. We did record a $10 million severance charge in Q3, which will yield $6 million in annual savings, included in our Axalta Way planning. Second, we finalized plans for the closure of our Mechelen, Belgium, production site, and we are transferring production to other sites using our hub and spoke operating model [indiscernible] substantial economic savings of approximately $30 million annually, which will start to be realized in the back half of 2020 as we execute against our plans. In addition to the $10 million, we also incurred $71 million in severance charges in Q3 related to this closure, the cash for which will go out over the next few years. In terms of innovation investment, we continue to expect to introduce at least 250 new products this year. In the third quarter highlights included the launch of – in Refinish – of a new low VOC basecoat in Canada, the global launch of Corliss portfolio and industrial for iron and steel substrates and in Transportation, the launch of a multilayer product system on two production lines for a major customer in the Americas. In summary, Axalta’s third quarter results met our expectations, including demonstrated growth for Refinish, near record high margins for Performance Coatings, ongoing growth from innovation, and sequential improvement in average realized price, with notable progress within Performance Coatings. While we’ve done well to-date, this outcome has not come without its challenges, including a reversion back to foreign exchange headwinds as well as ongoing significant input and cost inflation running in the low-double digits, including raw materials, freight and packaging. Looking to the balance of the year and into 2019, our end-markets in most cases remained attractive and growing. Still, we’re monitoring global GDP growth, the impact of trade and tariffs, automotive production adjustments in some regions and ongoing cost inflation. Our top strategic focus in 2018 remains offsetting these headwinds through ongoing productivity improvement and updating commercial terms with our customers. For those of you who did not see our earlier Form 8-K, Sean Lannon has been asked by me and the board to step into the Interim CFO position. I’ve been grooming Sean to be my successor over the past five years. Sean joined Axalta in July of 2013 as our Vice President and Global Controller, and has continued to pick up additional responsibilities since then, including financial planning and analysis as well as treasury and risk management. Immediately prior to Axalta, Sean was Vice President and Global Controller at Trinseo. Sean’s broad experience and knowledge of Axalta positions him perfectly to fit into the role and allow the organization to stay focused on meeting our strategic and financial goals without missing a beat. Sean not only possesses great technical skills, but is also a great strategic thought-partner. I could not be more pleased with his appointment. With that, I will now turn the call over to Sean, who will share some further detail on our financial results.

Thank you, Robert, and good morning, everyone. As you can see on Slide 4, third quarter net sales, excluding FX, increased 6.9% year-over-year including 11.1% growth in our Performance Coatings segment and relatively flat net sales comparisons in Transportation Coatings. Acquisition contribution this quarter was also nominal as we have lapped the 12-month anniversaries for most acquisitions posted in 2017. Broader drivers of third quarter top line growth were led by organic volumes, which rose 3.6% in the period as well as continued acceleration of positive price-mix contribution at nearly 3%. Most of the pricing progress to date has continued to be in the Performance Coatings segment across both the Refinish and Industrial end-markets. While price has yet to make substantial contribution in Transportation, we are pleased that the consolidated picture remains very positive. We are doing well at maintaining our overall corporate margins. FX translation shifted to a headwind in the third quarter, as expected and noted in our last update your outlook, given sequential dollar strength versus the euro as well as various emerging market currencies. The 2.5% headwind compared with a 2.4% benefit in Q2 and a 6.3% benefit in Q1. This dramatic reversal during 2018 was expected partially in the last quarter financial guidance update, but the magnitude was greater than our previous outlook, and as such, we have again revised our assumptions here looking forward. Q3 adjusted EBITDA of $235 million increased 12% versus the prior year. Adjusted EBITDA margins increased 140-basis points to 20.6% in the third quarter. The third quarter results reflect the strong contribution of volume and price mix in the quarter, offset impactfully by higher variable costs, including raw material, freight and packaging cost inflation as well as by notable FX headwinds. Margins increased 10-basis points sequentially from the second quarter, primarily reflecting improved business mix and sequential continued improvement in average consolidated pricing. Turning to Slide 5. Performance Coatings’ Q3 net sales increased 11.1% year-over-year, excluding a FX headwind of 2.2%. Constant currency growth was driven primarily by 5.7% higher average selling prices and mix benefits and organic volume growth of 4.8% for the segment. For Refinish, 30.9% to x FX net sales growth reflected both underlying market growth as well as the comparison against Q3 last year, which included the distributor working capital adjustment impact in North America. Volumes from North America Refinish were what we consider normalized this year, and we continue to gain global market share in Refinish as measured by end-customer body shop count. Refinish volumes increased in all regions, and by nearly double digits in North America as expected given the less challenging comparison there. Average pricing in all four regions was also strong, with overall reported price mix up mid-single digits globally for the period. Product mix also contributed positively in North America. Industrial net sales increased 7.2% year-over-year, excluding the 1.8% FX headwinds and including very modest acquisition contribution. Organic net sales growth for Industrial continues led by a positive pricing contribution from all regions and mid-single digit overall price mix tailwinds for the quarter. Robert already noted that volumes were impacted somewhat by weaker performance for Europe in the quarter, which was driven primarily by certain volume trade-offs as we continue to focus on getting certain customers back to appropriate margins to account for raw material inflation. Performance Coatings delivered Q3 adjusted EBITDA of $176 million, a 31% year-over-year increase, with strong price mix benefits and solid volume drop, though offset substantially by variable cost inflation and modest headwinds from FX. Q3 adjusted EBITDA margins of 23.4% were up 390-basis points year-over-year, representing the second sequential quarterly improvement from the low of 19.7% in Q1. This is despite net sales being down sequentially from the second quarter. This result reflects our success in performance in offsetting raw material inflation to date, with price increases as required, coupled with incremental productivity from our Axalta Way initiatives. Turning to Slide 6. Transportation Coatings net sales decreased slightly year-over-year in third quarter, excluding the currency headwind of 3.1%. Segment volumes increased 1.5%, which were slightly more than offset by ongoing unfavorable price-mix impacts. The price component continued to show sequential reduced impact, while mix impact was greater due to increased volume in Light Vehicle from certain new launches. Light Vehicle Q3 net sales were essentially flat, excluding a 3.5% FX headwind. Volumes increased low single digits, with growth in the Americas partially offset by lower volume from Europe and Asia Pacific. Average price of mix were down low-single digits in the period. Q3 Commercial Vehicle net sales decreased 2.2%, excluding a negative FX impact of 1.8%. This moderate reduction reflects ongoing strength of broad commercial markets as well as non-truck commercial vehicles, but we did see moderation of demand impacting net sales in both Europe and China in the quarter. Forecasts for Commercial Vehicle appear largely stable for the remainder of the year led by ongoing growth in the Americas, albeit with some moderation in demand seen in Europe and Asia Pacific. Transportation Coatings generated Q3 adjusted EBITDA of $58 million versus $74 million last year, with associated margins of 15.2% and 18.7%, respectively. The lower-margin comparison was driven by headwinds from unfavorable price-mix and raw material inflation, partially offset by positive benefit from volume drop-through. Turning to Slide 7. Cash and cash equivalents totaled $588 million at September end. Total reported debt was $3.9 billion, resulting in net debt balance of $3.3 billion versus $3.1 billion at year-end, and flat sequentially at the second quarter of 2018. Our net leverage ratio was 3.5 times at quarter end versus 3.6 times at June 30. The slight decrease was driven by stronger operating results and a slightly higher cash position, which was somewhat offset by a weaker dollar-euro exchange rate at period end. Q3 free cash flow, defined as cash flow from operations less CapEx, totaled $90 million compared to $183 million in the same quarter a year ago. The year-over-year decline is primarily related to investment working capital, which was largely timing-related as well as the raw material inflation impact from inventory and certain customer-specific arrangements, which were detrimental to third quarter operating free cash flow. During third quarter, we took the opportunity to lock-in attractive long-term sales commitments in certain commercial terms with several Performance Coatings customers, which impacted third quarter and will impact the full year cash flows given cash investments made in amounts exceeding our budgeted targets. These investments are expected to yield very attractive returns comparable to many of our historical M&A transactions, which we have noted tend to target at least high-teen on leveraged returns. Our working capital to latest 12 months net sales ratio at quarter end was 12.6% compared with 12.4% a year ago, and down from 13.4% in second quarter. This includes the effect of normal seasonal working capital fluctuations. We expect overall working capital levels for the year 2018 to improve in the fourth quarter, following a similar pattern to that of 2017. Turning to Slide 8. We have updated our financial guidance for 2018. For net sales, we see growth of around 7% excluding FX. Based on consensus, currency forecast, we see a 1% tailwind from FX for the year, down from 3% forecasted in April and 2% in our July update. As-reported growth, therefore, is expected to be around 8%. This continues to incorporate 3% growth from acquisitions completed in the last year. Regarding end-market conditions, our updated guidance incorporates some moderation in economic forecasts, including automotive production expectations for the balance of the year referenced earlier. We continue to believe we’re on track to meet our expectations in Refinish for the year, and Industrial end-markets we serve appear to remain consistent and healthy based on broader macro-level data. For adjusted EBITDA, we’re expecting to finish the year moderately below the low-end of our previous guidance range at approximately $935 million or $959 million, whereas we had indicated the lower half of the previous range in our July update call. Impacts to adjusted EBITDA since our last update come primarily from foreign exchange impacts amounting to approximately $50 million incremental, negative driver between our July and October full-year outlook. We also note somewhat lower net sales and margins from Light Vehicle, most notably in China, but also including revisions in EMEA. Guidance for interest expense remains at $165 million. Regarding taxes, we’re revising our adjusted effective income tax rate slightly to 18% to 20% for the full year, which represents the adjusted tax rate corresponding to adjusted net income and reflects some additional benefit associated with excess tax benefits related to stock-based compensation. Our free cash flow guidance has been revised to $330 million to $350 million. This includes some impacts from reduced operating results and the cash outflow associated with the Performance Coatings customer business incentive payments I referenced a moment ago. Our CapEx, depreciation and amortization and share count guidance all remains unchanged. This concludes our prepared remarks. We would now be pleased to answer any questions. Operator, please open the lines for Q&A.

Thank you. [Operator Instructions] Our first question today is coming from Duffy Fischer from Barclays. Your line is live.

Yes and good morning. I was wondering could you flush a little bit more the program that’s going to take some of the cash in Performance Coatings. It sounds like maybe you’re making a large investment working capital, a $100 million-ish or so. If you kind of think about the high-teens you talked about that should be an incremental $50 million plus of EBIT next year, but can you just kind of talk through what that is? And how that’s going to work out?

Good morning Duffy. This is Robert. Regarding those investments, we’re not going to comment specifically on the individual investments, but we do evaluate all customer investments from a value-creation standpoint, and enter into only those agreements that we view as having attractive financial and strategic returns. The agreements we entered into in the third quarter were very attractive from that perspective. That makes up the majority of the variance that you mentioned. And then the other part, is just related to the timing of some working capital accounts.

Okay. And then the market share that you guys are gaining in the body shops, two questions there, geographically how is that broken out? And then two, in general, when you pick up new body shops, the per body shop number, is that accretive or decretive to the kind of the overall business?

In the Refinish business globally, we’re gaining shops in all geographies around the world. And as it pertains to each individual shop and the accretion of those, it really depends on the market and the size of the body shop. But the body shops that we add are accretive.

Great, thank you guys.

Thank you. And the next question today is coming Ghansham Panjabi from Baird. Your line is now live.

Hi, everyone good morning. I guess, just following up Duffy’s question on auto refinish, can you just maybe take that one step further and just characterize for us, what you’re seeing in this market on a global basis adjusting from your – for your comparison from a year ago. Do you see any shift in end-markets across North America and Europe, just given the lower collision rates, et cetera, so far in 2018?

No. I think overall, we see very stable market conditions in each one of the individual geographies. As we expected in North America, given the commercial changes that we made last year, we expected to see a strong rebound in the third quarter in terms of the year-over-year comparison. And that’s exactly what happened.

Okay, thanks Robert. And just one more in terms of your low-double digit cost inflation for 2018, realizing it’s early, how should we sort of think about cost inflation for 2019 at this point? Are there any pockets of deflation that you are you starting to see on a global basis. Looks like TiO2 for example, has weakened a bit in certain geographies. Just trying to get some level setting from your end as it relates to 2019? Thanks so much.

Yes, I think if we see oil prices stay at the levels that they are at today, essentially as we look forward into 2019 – and we’re not yet providing guidance for 2019 – but as we look forward to next year, the rollover, the carryover effect of the inflation that we’ve seen this year would translate roughly into a low single digit inflation number for raw materials. And at this point, in general, we’re not seeing much relief in any of the categories – in each one of the categories of raw materials that we purchased, we do continue to see inflation.

Thank you, Robert. And good luck in your new role too thank you.

Thank Ghansham.

Thank you. The next question today is coming from Arun Viswanathan from RBC Capital Markets. Your line is now live.

Great thanks good morning and congrats on the new role Robert.

Thank you Arun.

Just a question here on. And welcome Sean as well. So on Light Vehicle, I guess, understanding that you do have some new assumptions in place for Q4. Are you also seeing potentially some moderation in your outlook for 2019 from IHS builds forecast perspective? Does that likely to come down as well?

So yes. I mean, I think if you look at the IHS data for 2019, you do see that starts to pull off a little bit. And the primary driver of that, of course, is China. We saw China, I believe in July, builds come down about 0.6%. And then in August, I think, they came down something around 7.7%, and then in September, 7.6%. So we got a couple of months here of China really pulling back from a bill perspective. So I think, we’ll have to see if that’s just a momentary blip or if that’s an overall trend. That’s probably the biggest driver. We do see a little bit of a slowdown in EMEA from a production perspective as well. But at this point, overall, for the market, I think we’re not projecting outside of that any type of cyclical downturn.

Okay, great. And then just as a follow-up on the price cost side. Given some of the productivity gains for the $50 million this year and potential for similar amount next year and your price increases, when do you expect that pricing should fully offset cost, including some of the challenges you faced in Light Vehicle? Thanks.

So overall, within Performance, I think, we’ve done a nice job as far as offsetting that raw material inflation both between getting price as well as getting the productivity on Transportation. As you can clearly can see we’re little still a little behind as it relates to 2019. We will be giving more guidance on that when we give our December update as far as 2019 outlook goes.

Thanks.

Thank you. Our next question is coming from David Begleiter from Deutsche Bank. Your line is now live.

Thank you good morning. Robert, in performance in Refinish were the customer arrangements you signed related to the market share gains you referenced as well in Refinish?

No. They were not. These type of customer arrangements into which we entered are long-term contracts with strategic large customers in Performance Coatings. So we would see the benefit of that as we move forward over the next several years. They wouldn’t have had any impact at all on third quarter.

So these new customers to Axalta?

These are existing customers to Axalta who are growing quite nicely.

Very good. And lastly, on OEM pricing – I know it’s been difficult challenging any pricing – any movement by your large German or Japanese competitors in perhaps raising OEM pricing?

Probably shouldn’t get that specific in terms of pricing trends that we’re seeing in the market place. I think overall as a market, that market continues to be somewhat challenged from a profitability perspective for all the players in the coatings market. I think we all continue to work with all of our customers in order to explain and highlight the amount of cost inflation, not only on the raw material side, but also on the freight, logistics and packaging side, and then now the new element of tariffs. And I think we’re all working together with our customers to highlight the impact that, that’s had to our profitability. Additionally, though, our customers always expect us to continue to work on our cost structure and to become as efficient as we can and we’re also doing the same thing.

Thank you.

Your next question is coming from Robert Koort from Goldman Sachs. Your line is now live.

This is Chris Evans on for Bob. In North America Refinish, just curious if you were to exclude the benefit from comping against the prior year issue, what might you estimate the volume growth would have been in the third quarter? And then also U.S. vehicle miles driven is finally stalling out after several years of steady growth. How correlated is this metric to Axalta Refinish sales in the U.S.? And curious if you have any insight into trends in other significant regions?

Chris, I let Chris Mecray comment on the second part of your question. On the first part of your question, if we take the sales and profitability drop that we saw in the third quarter of last year related to some of the changes that we made, the increase in sales and profitability that we’ve seen this year more than offsets that drop. So that gives us a general indication that not only did we recuperate what we saw in the third quarter of last year, but given some of the market share gains, specifically that we made in North America Refinish, that we’ve also had some growth.

Yes, I think that it’s unfortunate and we wish there were one, but to-date we’ve been unable to find any publicly available source data that really properly correlates to our business that we can use as a direct indicator. So while we have snippets of the market from insurance companies, from other industry observers, nothing that really correlates directly to Refinish sales either North America or our global business.

And then a question just regarding the rationale behind the recent consent solicitations you put about a week or so ago. In that release, you cited this as being an enabling factor, potentially permitting the company to effect certain corporate transactions. Can you provide more color here on what terms are restrictive and the underlying need for this change?

Yes. This is really just a technical amendment. Our parent company, the registrant was not a guarantor under the debt structures. So we’re adding that as part of the consent and it will allow for additional flexibility. Just as far as internally when we had restructuring – and really going forward, this just allows us in a quickly changing regulatory environment to move our legal entities around and have that flexibility.

Perfect thank you.

Your next question is coming from Kevin McCarthy from Vertical Research Partners. Your line is now live.

Would you comment on the impact of the implementation of WLTP in Europe on your auto OEM coatings volumes in 3Q? And whether or not you would anticipate any impact in the current quarter?

Basically for Q3 and Q4, we’ve seen Western Europe light vehicle builds decrease approximately year-on-year by about 400,000units. And we can’t directly attribute that to the impact of WLTP, but we believe it’s safe to say that this would be the primary driver of that reduction when looking at an industry level data.

Okay. And then a second question, if I may, on capital deployment. I think you mentioned in the prepared remarks that you passed on a few opportunities recently. Obviously, public market equity prices are shifting rapidly. How would you – how your thinking involved with regard to repurchases versus ongoing acquisitions and industrial and perhaps other areas?

Kevin, on that one, we had – as I said, we had a couple of internal high IRR of customer investment opportunities. And so we did, in terms of looking at some M&A deals that we had in the pipeline. Now we did take that into consideration in terms of our thinking. And in terms of our capital allocation moving forward, we have, as we commented before, we have a $675 million share repurchase plan in the market, we purchased a little over $200 million against that plan. And our stock repurchase plan will continue to be opportunistic in nature. And then the only variable there is really the amount that we would buy back in any given quarter as a function of what we see in terms of those international investment opportunities as well as M& A opportunities. And there is basically just a risk-reward trade-off decision.

Thanks very much.

Our next question is coming from Donald Carson from Susquehanna Financial. Your line is now live.

I want to go back to Refinish and two specific questions. First one is related to the underlying end-market growth. Back at your Capital Markets Day in March, you said you thought the market would grow 3% to 4%. Is that still the case because I know a competitor of yours is saying that the market’s actually declining by that amount in the EU and the Americas?

I think, overall, if we look at the global refinish market, we continue to see favorable market trends. Certainly in North America, even stripping out what we think the estimated effect was of the change in commercial terms that we made last year, we feel that we made good progress in the third quarter. In terms of Europe, some of the overall economic conditions have slowed slightly, but we continue to have a franchise business in that region. And I would point out, as we mentioned before at Capital Markets days and other conversations, we are over-weighted in some countries, but under-weighted in other countries within the Europe, Middle East and Africa region. And so we’re really focusing on some of those countries where we are under-weighted for growth. And we are making progress there.

And a follow-up on the mix benefit in Refinish. I know over time you said that you’re transitioning to more higher percentage of value product lines in your Refinish business, which I would think would be negative from a price standpoint. But you had a positive contribution for mix. Is this because the year-ago comparisons where you had the destocking and most of that destocking was in your premium product lines?

That’s correct. And at this point, the mainstream end-product lines that we have around the world, it’s a growing area for us, but in terms of absolute contribution, it’s not large enough yet to really have a material impact on the overall profitability of the business. Now in mainstream, we have not only mainstream water-borne, but mainstream solvent-borne products. In the mainstream solvent-borne products, that product line, as you know, utilizes much more paint than our water-borne solution, which is much more efficient. So, although you may see from a percentage basis some margin impact, you do see greater volume. And that’s where a lot of the volume growth is globally, is in the mainstream part of the market.

Thank you.

Our next question is coming from P.J. Juvekar from Citigroup. Your line is now live.

I had a question on your Light Vehicle sales, the OEM business, Europe and China were clearly down. Can you talk about where dealer inventories are there in those regions? And was there de-stocking going on, meaning that was the result at the end of the quarter were far worse than the beginning of the quarter?

PJ, in terms of dealer inventories in those markets, there’s not really a lot of updated terribly accurate data in that regard. We really haven’t seen dealer inventories necessarily build in those particular markets. We’ve just seen lower build rates, in particular, in China. And then as it relates to Europe, that really has more to do with our customer mix in Europe compared to the market more than anything else.

Okay. And then a question on M&A. You talked about valuation expectations are still high. So strategically, does the industry need consolidation to get pricing with larger customers?

I think we’ll stay away from commenting directly on anything related to pricing. What I would say regarding industry structure is that our belief continues to be that we will continue to see consolidation in the coatings industry, given some of the strategic as well as operational benefits from doing so.

I just had a quick question on TiO2 surcharge that you had. As TiO2 prices go down, do you have to give anything back? Thank you.

Great question, PJ. I think most of our customers with the surcharge just in terms of implementing that surcharge in their billing and information systems have actually said – just rolled it into the price increase. We have some customers that – where we have separated it out, but as we actually implemented that, many of our customers said that it’s just easier from a systems and accounting perspective to just roll it into the price increase, which we did in many cases. If we were to see a significant pullback in the price of TiO2, we would, of course, evaluate that and what that means in terms of our value proposition.

Thank you.

Our next question is coming from Christopher Parkinson from Credit Suisse. Your line is now live.

Can you just give us some preliminary thoughts on how you’re thinking about the incremental non-raw material cost increments as we head into 2019? I know you’ve had a few facility closures and you discussed it a little in your prepared remarks, and Dan has also been working on a few different efficiency initiatives. Just can you give us any general sense on how strong your – the fight is here?

So on the results that we’ve seen year-to-date for Axalta Way, our Axalta Way program and our overall restructuring initiatives that have been in addition to the Axalta Way program, year-to-date, we’ve had very good results. And as we move into the planning phase of many of those activities for next year, the pipeline for Axalta Way looks strong. And the one area that we are excited about is optimizing our manufacturing operations and supply chain footprint, not so much from a cost perspective, but really to be as efficient and effective as we can in servicing our customers.

Just add on as far as the Belgium comment. Most of those benefits really start to come in the latter part of 2020, and towards the end of 2021 will be our full run rate savings of the $30 million. So that’s essentially two years out from today given the announcement.

Okay. And just on the broader M&A opportunities, can you just give us any update or brief insights on strategic rationale, geographic focusing. And on the former, are these still mostly industrial/technology-focused initiatives. Just any broad insight would be appreciated. Thank you.

Chris, as we’ve said before, our M&A strategy is just reflective of our overall corporate strategy, which is to continue to strengthen our franchise in our Refinish business globally. Certainly, an area of focus for us is mainstream, and that is a keen area of focus within our M&A pipeline. And then on our industrial business, continuing to build out the verticals in which we participate as well as the verticals in which we’ve made acquisitions, making acquisitions in those verticals in other areas of the world to continue to grow those businesses. So our M&A strategy remains very focused, and I think we remain valuation disciplined. We haven’t found that valuation has been an impediment to actually – just given the value proposition that we bring to the table when we sit down and speak with potential companies. It just happened that in the second and third quarter here, we just had even more attractive internal investment opportunities. And that’s why you saw more capital deployed in that area.

That’s helpful, thank you.

Thank you. Our next question is coming from Michael Sison from KeyBanc Capital Markets. Your line is now live.

Hi, guys. Hey, Robert. Can you hear me? Sorry.

Yes, we can hear you.

So I guess, when you think about 2019, and I know it’s a little bit too early to give specific guidance, but qualitatively, where do you think we should see some growth next year and how do you sort of gauge some of the headwinds that could pop up next year that somehow surprisingly pops up in any given year?

From a big picture structural perspective, I think we see opportunity for continued growth in our Refinish business, continued growth in our industrial business and in pockets of our transportation business as well, particularly in Commercial Vehicle. The big question is really going to be to see how car production evolves over the next quarter, and what impact there is, if any, in particular, of some of the tariff and trade discussions that are going on between the U.S. and many other countries in terms of what the outlook for that market is. As always, FX is a variable that’s difficult to project. But hopefully, we will get some greater insight at least into what U.S. monetary policy is going to be, which will be probably one of the [indiscernible] of the U.S. dollar, which, of course, is our functional currency reporting. So we’ll go from there.

Okay, great. And then when you think about where you’re at the beginning of the year in terms of your outlook for EBITDA and where you’re at now, it’s about a $20 million, $25 million impact. When you think about the delta, can you maybe talk about – is that all inflation, some of it that – is some of it kind of just weak demand? And then how much of that do you think you can make up as you head into next year?

Yes, if you look at the – sort of guide down from the midpoint of our guidance at the beginning of the year to the midpoint of our guidance this year, essentially you would say that the majority of that is due to unfavorable FX. Unfortunately, that’s not something that we can control, but we do our best to offset that. And then the other portion would be lower bills and certain challenges from a commercial perspective in our Light Vehicle business. Those would be the two primary drivers.

All right, and congrats on your new role.

Our next question is coming from Jeffrey Zekauskas of JPMorgan. Your line is now live.

Thanks very much. Of your $82.5 million charge, how much of that is cash? How much of that is, we take cash terms this year? How much next year? How much is Axalta Way? How much is other stuff?

So Jeff, the $82 million will all be cash. I guess, from a sequencing perspective, it’ll probably be around $10 million that gets spent next year, with the difference going out in 2020. And this is all Axalta Way related. So $70 million relates specifically to the Belgian closure. And the incremental $10 million, which is another global initiative we did as far as Axalta Way, which we fully expect second half of next year of 2019 will start to be at the run-rate savings of around $6 million in that $10 million charge.

Okay. So this year you’ve described your free cash flow as $340 million. Last year it was $415 million, and your EBITDA is going to grow roughly $60 million. So if you add the $60 million to the 2017 free cash flow, you would be at about $475 million instead of $340 million. So given these payments that you’ve made on – or maybe receivable terms that you’ve given to your customers, is that a onetime item? And all things being equal, should your free next flow next year, assuming that business is flat or roughly flat, should your free cash flow be $475 million next year, roughly?

So Jeff, we’ll give further upgrades on 2019, back when we get to December, but as it relates

On the logical standpoint, I’m not asking you to forecast your business, is that a onetime outlay and it all comes back next year or these outlays just keep going.

So maybe the comment on 2018 on your first part of your question. So these incentives, they are certainly up versus prior year. There’ll essentially be double what they were in 2017. So it’s onetime from that perspective. We are not necessarily expecting this to be the run rate. The other nuance in 2018 compared to 2017 is the raw material headwinds. We are seeing a roughly $25 million in headwinds in inventory. So those really are the two big pieces. And we go back to the other comment on accounts receivable, we have not extended any sort of terms with our customers as part of these incentive programs.

I think your – are your inventories roughly flat?

Inventories are up slightly year-over-year. But there’s about $25 million of raw material inflation in those numbers. And there is also, just to add to what Sean said, there is also some inventory build related to the Mechelen plant closure and the stand-up of some of our spokes sites as part of our manufacturing strategy.

Okay. Great, thank you so much.

Thank you. Our next question is coming from John Roberts from UBS. Your line is now live.

Thank you. PPG appears to be going through a Refinish channel issue. It looks kind of similar to what you experienced earlier. Should we just expect these sort of episodic channel shifts to occur because of the difficulty in tracking channel inventory in the fragmentation of the channel?

It’s difficult for us to compare and contrast with PPG because we don’t know the nature of their comments around third quarter Refinish. I think as we commented last year, in terms of the change that we needed to make just given the changes in the market dynamics with distribution as well as end- customers, I think in our case, that was a onetime change that we intended to make. We would not expect to see moving forward those same type of – or that same type of variability in Refinish volumes. Distribution, of course, can always from one quarter to another vary some, and we can’t control that. But it certainly, I think in terms of factors within Axalta’s control, we just don’t foresee those type of changes moving forward.

Thank you.

Thank you. Our next question is coming from Laurent Favre from Exane. Your line is now live.

Yes, good morning everyone. My question is going back to Jeff’s point on cash conversion. And I guess, there was about a $50 million swing in prepaid expenses. I assume this is where we’ve got those growth investments, those high returns growth investments. So I guess, first question is, am I right? And are we looking at about $50 million of those investments? And I guess, the second question is should we assume further investments in Q4? Or would you say that the change in your free cash flow guidance for the year was related to Q3 investments? Thank you.

So these investments actually run through other assets within long-term assets. What you’re seeing in the prepay change is an impact as it relates to the revenue recognition and option that we did back in January of 2018. There was roughly a $40 million impact on that adoption. You should see a continued outflow as far as the other assets go when we get into Q4. And that’s why we’re revising the full year impact from a cash flow perspective.

Got it. Thank you.

We’ve reach the end of our question-and-answer session. I’d like to turn the floor back to Robert for any further or closing comments.

Great. Thank you. I just want to make sure that in the overall picture of what’s going on from a macroeconomic perspective, obviously, as well as some of the activity in the industry that we put things in a proper perspective. We delivered really one heck of a quarter. We had 6.5% top line growth, excluding FX and acquisitions. Our EBITDA grew 12%. Our Refinish third quarter sales and profits were strong, exactly as we said they would be. Industrial was over 6% growth x FX. And we are now lapped the acquisition contribution. And we had a strong contribution from our Axalta Way initiatives. So as a company, I think we delivered one heck of a third quarter, and we’re executing quite well. So we look forward to updating everybody in our December outlook call for 2019. And thank you all for joining today.

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.