Avient Corp (AVNT) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the PolyOne Corporation Third Quarter 2017 Conference Call. My name is James, and I will be your operator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

At this time, I'd like to turn the call over to Eric Swanson, Director of Investor Relations. Please proceed.

Thank you, James. Good morning, and welcome to everyone joining us on the call today. Before beginning, we would like to remind you that statements made during this conference call may be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements will give current expectations or forecasts of future events and are not guarantees of future performance. They're based on management's expectation and involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statement. Some of these risks and uncertainties can be found in the company's filings with the Securities and Exchange Commission as well as in today's press release.

During the discussion today, the company will use both GAAP and non-GAAP financial measures. Please refer to the earnings release posted on the PolyOne website, where the company describes the non-GAAP measures and provides a reconciliation from the most comparable GAAP financial measures.

Operating results referenced during today's call will be comparing the third quarter of 2017 to the third quarter of 2016, unless otherwise stated.

Joining me today on the call is our Chairman, President and Chief Executive Officer, Bob Patterson; and Executive Vice President and Chief Financial Officer, Brad Richardson.

Now I will turn the call over to Bob.

Well, thanks, Eric, and good morning to everyone. I am pleased to report record third quarter adjusted earnings per share of $0.58, an increase from $0.55 per share reported last year. Operationally, our Color, Additives and Inks segment led our growth with a 20% increase in sales and a 16% year-over-year improvement in operating income. Color reported its highest ever third quarter sales and operating income with notable gains in packaging and high-end wire-and-cable colorants for the oil and gas industry. Overall, we grew sales by 10% this quarter to $818 million with 5% organic growth, a 4% contribution from our recent acquisitions and favorable FX adding 1%.

For those of you who know us well, you know that we have been investing heavily in additional commercial resources, and they are paying off. We're growing in our focused end markets, leveraging our key technologies and converting sales opportunities at a higher rate than ever before. Our innovation pipeline is brimming with unique solutions, and our acquisitions are integrating very well.

Over the last 6 months, we've also taken numerous steps to strengthen our portfolio. We divested the underperforming DSS segment, and we reinvested those proceeds to fund the acquisitions of Rutland and Mesa. Our cash flow generation, financial profile and earnings potential have never been stronger. And we have tremendous confidence in our ability to deliver our eighth consecutive year of EPS growth in 2017 and return to double-digit EPS growth in 2018. This was a precursor to announcing a 30% increase to our dividend in a plan whereby we will raise our dividend by 60% or more cumulatively over the next 3 years. We're very pleased with our recent performance. However, like many companies, we have been focused on the safety and welfare of employees, families and communities impacted by hurricanes Harvey and Irma. While our facilities were undamaged and all of our employees are safe, others were not as fortunate. Like many companies, we are experiencing raw material supply disruptions and incurring additional expenses as a result of Hurricane Harvey. Brad will outline them for you in a few moments, but understand that, most importantly, we remain focused on assisting local communities and residents where needed in serving our customers. And I believe we are doing just that, thanks to the great work of our associates in the Houston area, who first did an outstanding job keeping our employees safe and are now focused on providing exemplary service to our customers.

A lot more to be said on what's to come, and I'll do that in a moment, but first let me turn the call over to Brad to review our third quarter performance in more detail.

Well, thank you, Bob, and good morning, everyone.

I'm starting with our GAAP results. In the third quarter, we reported earnings of $0.49 per share. Adjusting for special items, EPS from continuing operations for the quarter was $0.58, a 5% year-over-year increase from $0.55 in the third quarter of 2016. Record-setting operating income in our Color, Additives and Inks segments and top line growth drove that success, but it required a company-wide effort to overcome several challenges in the quarter, including Hurricane Harvey and raw material costs that continue to be substantially higher than last year.

As Bob already mentioned regarding Hurricane Harvey, I'm very thankful that all of our employees in the region are safe. We have 2 manufacturing facilities and a distribution center in the Houston area, all 3 of which reported no structural damage and are returning to normal operation. The impact of Harvey on PolyOne can be divided into 3 buckets: logistics, supply and raw material cost.

Beginning with logistics, we are incurring higher shipping costs as suppliers deal with route disruptions. Although the rail system is back online, we are still facing some difficulties with truck shipments.

On the supply side, we had several suppliers put customers on allocation, but we have not. Issues like this remind us of the importance of inventory and supply chain management. I'm pleased to report that PolyOne's operations and sourcing teams were proactive, which helped us prepare for and mitigate supply disruptions and related challenges. Unfortunately, we have seen the majority of our input cost increase sequentially in September and October, and a basket of base resin cost we purchased remained 15% to 20% higher than last year. In total, we expect to incur $3 million to $4 million of expenses in the fourth quarter related to the storms, but we are confident this is short term in nature and should be behind us by the time we begin 2018.

We also managed Hurricane Harvey due to the strong and collaborative relationships we forged with our suppliers. It's in that spirit we again held our global supplier symposium last quarter. Our suppliers from across the world joined with our team to discuss efficiency, innovation opportunities, customer service and to better understand each other's business objectives. It was a great meeting. It always is and it's an important factor in strengthening our supply chain. But PolyOne has never been a company to dwell on the macroeconomic environment. We are a company that focuses on strategy and more importantly, our execution of it to ensure success regardless of market conditions. And Color is once again exemplifying all that we strive for.

Color delivered record third quarter sales and operating income of $235 million and $36 million, respectively. That represents 20% sales growth comprised of 5% organic improvement and a 13% growth from acquisitions as well as the slight benefit from foreign exchange. Our recent Color portfolio additions of Rutland and Mesa are making an impactful contributions, while our existing businesses are exceeding expectations. From a regional standpoint, our Asia and Europe Color teams performed exceptionally well in the quarter, increasing operating income 52% and 12%, respectively.

Moving on from Color. Our Engineered Materials segment produced solid sales growth, continue to be hampered from a bottom line perspective by higher raw material cost, most notably due to dyeing, polycarbonate and nylon pricing were all up 15% to 20% year-over-year, which eroded margins and resulted in lower operating income for the quarter.

Shifting gears, Performance Products and Solutions was the business most negatively impacted by Hurricane Harvey, incurring approximately $2 million of additional third quarter expenses with $3 million to $4 million of cost expected in the fourth quarter. As I just discussed before, logistical issues and pricing challenges took a toll, but I'm pleased the team was still able to deliver 3% sales growth and nearly flat operating income from the prior year.

PVC costs remained up year-over-year. While we are working hard to offset the rising price, it has led to slight margin compression. Despite this quarter's difficulties, our vinyl business remains world class and is having an exceptional year.

We'll finish this segment review with Distribution, which once again proved why it's best in the industry. Our team increased revenue 6% on a 4% volume improvement. In addition to Distribution being a great PolyOne touch point for nearly 7,000 customers, it continues to generate substantial cash flow, which allows us to return value to our shareholders and reinvest in all of our businesses, thus propelling innovation and growth.

Looking at our results by geography. We expanded sales across all regions and grew operating income in Europe, Asia and Latin America. Our team in Asia delivered record operating income this quarter, representing a 23% increase over last year while driving a 20% sales growth. I'm especially proud of our Color Asia team, which grew sales 17% year-over-year and expanded operating income by an impressive 52%. We have seen great success the last 2 years in Asia, and we have plans to build on that. As I met with our leadership team in Asia last quarter, I was inspired by their focus on delivering in the near term yet also staying forward-looking. And as the Chinese government focuses its attention and resources on connecting China to the west with what they call the One Belt One Road initiatives, we are developing plans for additional commercial and manufacturing investments in the next 5 years to capitalize on this major expansion. And that's a consistent theme we are striving for in every region we do business, continue to invest in and execute our strategy so that we grow now and in the future.

In terms of our balance sheet and cash flow, we are forecasting between $180 million and $2 million -- $200 million in free cash flow this year. That's a fantastic and often underappreciated aspect of PolyOne. And I'm also pleased that we again refinanced our term loan this past quarter, reducing the interest rate by 25 basis points. That will translate to $1.5 million in annual savings.

We have also made great progress over the last couple of years structurally lowering our tax rate, all of which contributes to cash, which we can reinvest in our business and/or return to shareholders. One way we continue to do that is through our share buyback program. In this quarter, we repurchased 1 million shares for a cash cost of $36 million. And as Bob mentioned earlier in the call, we also recently significantly increased our annual dividend and laid out a 3-year plan to increase our dividend cumulatively by 60%.

I'll now turn the call back to Bob.

Well, thanks, Brad. It has been an important transformative year for PolyOne thus far. We've grown sales. We've streamlined our portfolio, and we have acquired new businesses with complementary and new technologies. All those steps have given us great confidence in our future earnings potential. For the last couple of years, we have stressed the importance of increased investments in commercial resources to drive growth. And here are some of the biggest reasons why. Our portfolio has become more specialized with a higher degree of engineered complexity. Sellers and technology support spend more time with existing accounts on current applications, which is great, but it reduces the amount of time we have to prospect for new business, either within those customers or for new accounts altogether. Thus, we needed to add more sales resources to expand our reach. And we also needed to add more technology associates who support them. Their impact has been unquestionable, and the strategy has worked to grow the top line, as our organic sales growth is the highest it's been since we first came out of the recession.

Investors often ask us for metrics and data to help articulate how this has worked. So consider the following: Over the last 3 years, we've increased our sales force by 19%. Sales calls to both existing customers and prospects have increased 28% since 2014. And over that same time period, our sales funnel is up over 50%. More calls equal more opportunities, which our talented and technical sales teams have translated to more business. You know we had just over 600 sellers in the company and just as many in research and development and technology support, which is almost a 1:1 ratio, which is required for these specialty sales. Our recent hires are gaining momentum. Our sellers are increasingly focused on prospecting with new customers while our existing sales force has expanded our relationships with our existing customers. Our technology teams are not only focused on new innovations to move through our pipeline, but also on very important customization work, which drives so much of our new products. And finally, we're losing less business to normal and customary turnover such as what we see in Distribution. We're doing this with consistent and exemplary service that differentiates us from the competition and is such a vital element of our value proposition. Our sales force effectiveness metrics reinforce the fact that it's not just market growth driving our results, it's PolyOne growth. Whether we are adding personnel, training existing employees, expanding regionally or simply investing in the systems that drive our sales force, our investments are working. And our businesses are outpacing market growth. We've given our team the tools to win, and they are doing just that. And for PolyOne, that's not just about selling existing products, it's about finding new solutions for our customers, solution that drive value for them and for us, and that's why we're always focused on innovating for the future.

I'd like to highlight a few new product launches from this quarter that capture the spirit of that innovation, and these have been specifically developed for the health care market. Starting with Color, the team came through with a fantastic win. After 2 years in development, we closed an additive solution for prefilled syringe barrels. This particular medication or the particular medication contained in these syringes is extremely sensitive to light, but an opaque or colored barrel was not an option because medical professionals needed to maintain visibility into their syringe at all times. We were able to formulate a specialty UV-blocking additive solution that blocked a harmful wavelength of light, while maintaining the clarity required to monitor medication levels.

In Asia, we prospected and identified an opportunity for a medical device manufacturer. Not only did our Engineered Materials team successfully formulate a UL-certified TPU to replace other existing materials used in the medical scanner, but our global manufacturing footprint and technical resources achieved the local supply and service that they required.

And lastly, another great win in the health care space was our development of a slip agent additive solution that allowed a major lab or OEM to achieve the right amount of torque between closure and vial for its sample containers. As a result, the OEM was able to resolve concerns from their customers over the difficulty of opening closures and accessing samples in this container. Innovation has made these successes possible. And as we look to the future there are 4 technology platforms that we continue to focus on: composites, barrier additives, fiber colorants, and flame retardant polymers. Some innovations we develop internally, some we gained through acquisition. And in terms of our 3 most recent acquisitions: Rutland, Mesa and SilCoTec, the integrations of each are going very smoothly. They're meshing very well with our portfolio, and we are growing the seeds for their expansion.

Looking specifically at Rutland. Our customers have responded very well into our early integration work. We now offer the most comprehensive screenprinting ink portfolio in the market, including plastisol silicone and water-based ink offerings. At Mesa and Rutland, we are realizing manufacturing and sourcing synergies, improving operations through safety LSS collaboration and consolidation of our research and development efforts and all the regularly scheduled conference call with our integration leaders assigned to each of the businesses, and I'm confident we're providing the right level involvement at the right pace to use our invest-to-grow approach to these integrations.

Our advanced composite team is a great example. We're building important cohesion and collaboration as a means to grow this business. The team has taken a truly One PolyOne approach in their plans for growth, several worked in other businesses and functions, and they're using that knowledge to broadly evaluate the unlimited potential use for composites. In one end market, you've heard me discuss in the past that has tremendous upside for us is in outdoor high performance. Composites tout high strength, lightweight and optimal performance characteristics. Whether it's hiking equipment, outdoor sports, ATVs, composites make for a perfect material for consumers who demand the best. And the collaboration between our Advanced Composites and outdoor teams was one of several great discussions we've had as part of our annual strategic planning process, and this won't surprise anyone who has followed PolyOne, but this latest strategic plan in essence has reconfirmed that our 4-pillar strategy is the right one for us: globalization, commercial excellence, operational excellence and specialization. These 4 pillars continue to provide for us the foundation for our transformation and moving forward. And innovation is the lifeblood of any specialty company. Leading up to our Investor Day that we plan to host early next year, we're going to be sharing more of the innovative work we're doing to help our customers. We'll do this in stages as each month we unveil a new innovation and our progress we are making commercializing technologies. Ultimately, these innovations will allow us to not only grow revenue but also expand margins. And this -- with this renewed confidence that earlier this month, we declared a quarterly cash dividend of $0.175 raising that dividend on an annual basis by $0.30 -- 30% to $0.70. And that's a big jump and one we're very pleased to do. It represents our seventh consecutive year of dividend increases, and it was a step into a plan that we have to increase our dividend by 60% or more cumulatively over the next 3 years. We are confident in our future, and we believe shareholders should be too. Top line growth and margin expansion, that's the goal. And it's the one that will allow us to deliver double-digit adjusted EPS growth in 2018 and beyond.

Thank you for listening so far. We will now open the discussion for questions.

(Operator Instructions) Our first question comes from Frank Mitsch with Wells Fargo.

You did -- you talked a lot about some of the specialization and the fact that your one-for-one in sales to tech and doing more in advanced materials. And -- but one of the things I noticed is that, that would normally suggest that you might get pricing and mix up, and it was up 2% last quarter. This quarter, it went back down to 0. Was there anything specific that happened this quarter? And what would your expectation be in terms of the pricing side of things?

Well, I'm pretty sure price and mix was actually up 2% for this quarter as well. Maybe we can go through that when it -- the number should be out in the Q as well by segment. But on a consolidated basis, price and mix should be up. But look, with respect to those initiatives and down driving price and mix, I absolutely expect that to be the case as we go forward. Certainly, what we experienced in the third quarter and you see this most notably in Engineered Materials has been the rising impact of raw material costs, which continued into the third quarter. So as I look at margins year-over-year, that had the most significant impact on our results.

Frank, I'll just add to Bob's point, again, we had overall organic revenue growth of 5%. That was 3% volume and 2% price.

I see. Okay. We had thought that was all on the volume side of things, so our bad here. But in terms of -- you mentioned that on the raw side, Brad that it was -- resins were up 15% to 20% year-over-year. And you highlighted some of that in the Engineered Materials side of things, but my expectation is that a lot of that would might have also played out in POD. And how are you -- what is the timing in terms of being able to mitigate the higher raws in that more commodity sort of business? What's the time frame we're looking at before you can fully capture pricing to offset the higher raws in the POD side of things?

On POD, for the most part, if you see prices moving in an upward direction for a short period of time that can actually at times be a margin good guy if you're selling slightly lower cost inventory into a higher price environment. Of course, it goes the other way when prices come back down. So from a POD perspective, I think they've been doing a pretty good job of staying ahead of that. So I'm not sure that there is much more of a lag to get past. The bigger lag that we really have to get past is in EM, Frank, and that's where I'd say we probably still have another 3 to 6 months to go with respect to pricing offsetting or getting back to and lapping the cost increases we've seen in that segment.

All right. So by the early part of next year, that should be all taken care of.

Right.

Our next question comes from Mike Sison with KeyBanc.

Bob, when you think about the squeeze from raw materials, how big is that going to be in total in '17? And then I would imagine as that stabilizes, hopefully that, that would be an earnings maybe plus next year as you get pricing?

Yes, I think towards the second half of the year next year, it should be a plus, certainly, as we lap the impact this year. My estimate would be that we saw a lot of press as well as indice increases going up in the first quarter of '17, but really didn't experience much in the way of higher costs in our P&L until the second quarter. And the second and the third and then by far and away the most challenging to the tune of probably $3 million each. And when I net pricing and et cetera and everything against that, a lot of that falling into EM. So I think that helps maybe give you some sense of how much the impact will be on an annual basis. We should get a little bit better in the fourth quarter here, but I still expect it to be a year-over-year negative for us.

Okay. And then when you think about 2018, given you've suggested double-digit EPS growth. Can you give us sort of a frame what type of volume you hope to see next year? Is there some stock buyback there, acquisitions? And then maybe, which of the segments do you think will really lead the charge in terms of earnings growth?

Yes. I mean, look, first of all, I would just point out as we kind of calibrate next year's expectations versus where we are right now. When I look at the third quarter results, I think everybody is aware of this, if you went back one year, that's really when DSS, I think, swung to a loss, that significantly impacted incentives for the company overall. And so if you look at -- we didn't reverse any incentives in the third quarter last year, we just recorded less, it's the easiest way to understand that. But now that we've returned to closer to target pay out this year, we actually had -- we incurred $10 million more of incentive expense across all the businesses in the company as a whole in Q3 this year than we did last year. So I mean that's close to $0.075 something to just think about, all right? There's probably another $6 million of GAAP coming in the fourth quarter, which we'll overcome and deliver EPS growth, but just to set the stage for that. So one thing to just consider is that we've gotten back to target level performance. And as you think about the gross margin expansion that we have already seen in our businesses this year, I expect that to continue into '18 without the same level of SG&A burden. So there is EPS growth that comes from that. When I think about the segment performances, I mean Color has outstanding momentum right now, and I expect them to lead 2018, some of which is coming from acquisitions. As you know, we've just done Rutland and Mesa. Both of them will help, and I expect that to be the case in '18. As you know, with respect to share repurchases, we remain opportunistic (inaudible) through the balance of this year, but we always like to try to put that cash to use first in the business and M&A. And if those opportunities present themselves, that's where we'll go with it. Lastly, I'd say, look, Brad and his team have done an outstanding job of lowering our overall effective tax rate over the last few years. It's really been kind of a 3-year journey, and that's another reason why I have confidence in the EPS expectations for next year. So a little bit of a long-winded response to your question there, but I guess a lot of things kind of go into that view for next year.

Our next question comes from Mike Harrison with Seaport Global.

Bob, just looking at the PP&S business and the gross margin decline sequentially, we also saw that last year. I know you mentioned that there was some hurricane impact in there, but it's just -- this just really how the raws are hitting you in both years? Or is there some seasonal issue there? And then maybe if I can do another one on PP&S, just wondering how potential improvement in the housing market could impact your margins going forward. Is it a positive because it helps improve fixed cost absorption? Or could that be a negative because that's lower margin business?

I'm sorry the first question was around year-over-year margins for EM?

PP&S, sequential last year, sequential this year.

Right. So yes, as you look forward, if the question is sort of going towards what to expect for the fourth quarter, I mean, typically, as you know, that's our weakest quarter of the year seasonally in that business, and so margins come down some from that. What you see in Q3 versus Q2, this year versus, excuse me, Q3, Q2 this year really looks pretty similar to what it did last year, so nothing new there in my opinion. However, had it not been for Harvey, I think we actually would have been better than last year. I mean, that's probably the best way to think about that. And Brad in his comments talked about probably $2 million of expenses in PP&S. And so you could probably add that to Q3 and get a better sense of where margins would have been, absent Harvey. So hopefully, I answered the margin questions. And then the second -- why don't you repeat your second question for me on PP&S to make sure I don't miss that.

Yes. And the second question, the vinyl business historically was very sensitive to the housing market, both construction as well as appliances. There are a lot of indicators out there suggesting that new housing starts could be growing. And just wondering, at this point with kind of the new CP&S, how much impact do we see on margins as housing improves? Is that a positive to margin because it helps fixed cost absorption? Or does it drag because of those products being lower-margin products versus some of the higher-end stuff you're selling now?

Right, and look, I think growth in single-family construction is a good guy for us and would help margins. I think, as you know, from an application standpoint, our positioning in the single-family home side is much bigger than it is on multifamily. So as you look at how housing starts have recovered since the recession, we -- our growth really hasn't followed it as closely as the overall starts because we're most connected to single family. So if that starts to pick up steam and move faster than multifamily, I think it's a good guy for us on sales and margins.

Got it. And then specific to the Color segment, I guess I was really surprised to hear the strength in Europe. It sounds like both on the sales and the operating income side. Can you talk a little bit about what's driving that strength in terms of end markets or your own internal efforts?

Yes, let me say a couple things. The first I'd say is that recall from prior years, and this is probably going back to '16 and '15 where we would have talked about how the oil and gas industry was impacting us. And one of the things we would have referenced then was we sell some very high-end colors that are used for wire and cable applications that find their way into high-heat applications like those being used for oil and gas. And so that business is (inaudible). In fact, they had a very strong quarter and is a big part of the explanation for us for what we're seeing in Europe because it's primarily coming out of Europe. That's where that business is. So I'd say that was very end market specific with respect to being driven by energy, less than being driven by a European economic recovery of some kind. But Europe has been getting better. We have actually seen some upside from transportation as well. North American auto was down, but European auto was up, and those are the 2 reasons why I would cite improving performance in Europe, Mike.

Our next question comes from Bob Koort with Goldman Sachs.

Couple of quick ones here. One on the pretty sizable dividend hike. I'm just curious if you could talk about the various factors that went into your thinking of that the basis for such an increase, what the target was? How you came to that conclusion in that particular level of dividend?

Yes. Really, there were 2 things, Bob, that played into that. The first was related to the portfolio changes that we've made this year. As I said, divesting DSS and then reinvesting in Rutland and Mesa. But part of that really is just associated with improvement in cash flow generation. So by not having to further invest in restructuring actions or other things that we believe would have been required to grow and improve DSS, we have a structural improvement in our cash flow and that was a big driver in the 30% increase this year, which was taking a portion of that and really just permanently putting that back into what we pay out to shareholders as a dividend. As you look at the future increases, it's much more closely tied to an expectation that we're going to return to double-digit EPS growth. And so we could do even better than that as our earnings improve. But when you look at our yield, we're not trying to get to be a retirement yield type company stock, but we do see room for growth in our yield when we look at where others are in our space. And so accelerating the growth to get there, as I say, really driven by those 3 things.

Then secondly, you mentioned, I think partially in response to an earlier question, some hurricane impact in the third quarter results. Did you quantify in aggregate what the hit was relative to that 3 to 4 you expect next quarter?

Yes, Bob, I mean, we basically said the impact on the third quarter was $2 million, again primarily in PP&S and another $3 million to $4 million on its way here in the fourth quarter.

Got it. Okay. I missed that. And then lastly, Bob, you've been on a program here for a couple of years now to strengthen the sales force. Obviously, new product development a key part of your offering. Have you got enough data yet? Any predictive analytics that you can refine and give some sense of what that sell-through is going to be, maybe if the time to traction -- profitable traction for those new hires, if it increased or decreased? Or just some metrics around that so we can get a sense for what might be coming down the pike?

Yes. It's not -- it's not perfect yet with respect to when you add a seller you get X results in Y period of time. But what I was trying to do with my earlier remarks today was, say that, we know we've increased the sales force 19%. Calls are up 28%. The funnel is increasing 50%, and we know that organic sales growth this year is up 6% or 7%. So what that tells you, of course, is that not every call results in a sale. I mean, obviously, everyone knows that, but 7% sales growth is very good. Now as you go through, and ultimately, you'd like to see that sales growth get closer and closer to the number of people you've added. However, we know that we're spending more and more time on applications with our customers, and so every sales call is longer, and the work that we're doing at specification is longer. So it's not perfect yet but our data is showing us that typically when you bring somebody in who's brand-new and let's say, they're right out of school and may never have sold professionally, they probably have an 18-month to 2-year type run time really before they're paying for themselves, and we're seeing that now whereas an experienced hire can come in, hit the ground running and have more of an impact. So it's not perfect yet, Bob, but that's directionally what we know about the investments we've made.

Our next question comes from Tyler Frank with Robert Baird.

Can you just discuss your 2020 Platinum Vision? How confident you are that you'll be able to hit those numbers in each segment? And how we should think about margins ramping, I guess, through Q4 and into 2018?

Yes. I mean, look, we've got really 3 primary financial measures in the 2020 Platinum Vision: The return on invested capital, double-digit EPS growth and segment margin targets. I'm very confident in getting to the return on invested capital and double-digit EPS growth. And when you look at segment profitability, that really is a means to an end, right? That's part of how we drive ROIC and EPS growth. One of the things that we have observed in this last year or 2 since we set the goals has been that the acquisitions that we have been doing are all very good acquisitions but they've been dilutive to our existing segment margins. So they still make all the sense in the world from an ROIC standpoint and will ultimately have better margins in the future, but when I think about how M&A impacts the margins, and I'm really referring to Color and EM now when I say this, I think that it takes the expectation down some. The additional thing that we just need to factor in is the investment that we're making in Composites, for example. And we know what we spent to acquire Gordon and Polystrand last year. We continue to invest at a higher rate. And so while that's going to drive future growth, I think in the near term that dilutes margins a little bit. So as I look at all of the, again, targets we have for 2020, feel very good about ROIC, EPS growth. PP&S Distribution are really already there with some upside to come, and it really comes down to Color and EM. I think it's one of the things that at our Investor Day earlier next year, we'll revisit in a little more detail to try to outline for everyone just how much M&A is impacting things? How much the investment in composites is impacting margins? But look, most importantly, we're improving ROIC and we're getting back to double-digit EPS growth.

And then a quick follow-up, how should we think about acquisitions going forward? Are you going to continue to look at smaller tuck-in acquisitions or could we see a potentially larger acquisition on the horizon? And does your increase in the dividend make that less likely?

No, the change in the dividend doesn't change our outlook or perspective or ability to do acquisitions going forward at all. And as I mentioned, part of this really was a return of cash that we're saving from no longer investing in some of these restructuring activities we had in the past. So dividend doesn't change that at all. And really, when I think about what's in the pipeline now is more of what we have seen over the last couple of years, which has been smaller bolt-on acquisitions. I don't want anyone to get the impression that we wouldn't do a larger deal, but many of the ones that we know about like aren't for sale and that just is what it is. So but we're not running out there to do a bigger deal just for the sake of doing one. At present, we've been really happy with the smaller deals we've done and got more of those I think in the future.

Our next question comes from Colin Rusch with Oppenheimer.

Can you talk about the opportunities for cross selling, leveraging the Color success that you've had in Asia, particularly given the big push towards electric vehicles option in China? And what we assume is the need for some incremental light-weighting?

Yes, I mean, I think that's one of the things that we have really gotten better at, and cross-selling has been something we've been talking about for I'm sure 7 or 8 years now. You really do see it coming together around application opportunities like that, for example, in light-weighting. I would highlight the work that our key accounts team does with customers like Tesla is probably some of our best examples where you have a point person in key accounts coordinating all of the solutions that we have and provide not only supporting them in a mega trend toward light-weighting and electrification. But candidly, they also want this thing to look good, right? And that's what Color is all about as well as protecting the materials. So I think that we've done a really good job of improving collaboration within the company, and that's a really good example I can provide you.

Okay. And then could you talk just a little bit more specifically about the cadence for operating leverage. I appreciate all the color on the sales force metrics, but how should we see that translating into improved operating margin as we go through the balance of this year and into next year?

Yes. I mean, look, first of all, just to remind everybody that the fourth quarter is always our seasonally weakest of the year, and oftentimes, the most difficult to predict just because of how difficult December is to predict. So in the near term, no doubt you'll see margins sequentially go down from where they are in Q3 just due to the seasonality. But I think that with respect to -- with the exception of Engineered Materials, I think we can start to see some positive progress in margins and excluding the impact of Harvey, I think you did see a positive impact in PP&S as well. But maybe looking a little bit longer term and thinking about '18, I do expect to see margin expansion across the board with the exception of how raw materials are really impacting EM and I expect that to be a bad guy here through the first half of next year.

Our next question comes from Laurence Alexander with Jefferies.

It's Dan on for Laurence. You mentioned some of the examples of new products, particularly in health care, that are helping, I mean, support growth. I was just wondering if with each individual product if you can quantify how much that means in terms of revenue, I don't know, per year.

Yes. I mean, for the most part, when we have wins like that, there's somewhere in the order of magnitude of $100,000 to $150,000, sometimes $250,000 in terms of order of magnitude. It's one of the things that when people ask questions about PolyOne and they understand what we do, sometimes they're surprised that how small individual wins with specific customers are, but that's the nature of what we do. The power really is in the ability to translate that across markets into different applications. So when I look at specifically what we've done in those markets for those particular customers, that's probably the right order of magnitude.

And then you mentioned in the past Vitality Index. I'm just wondering what your thoughts are on that, where it is and what's your outlook going forward?

Actually, the Vitality Index is ending -- at the third quarter, it is between 38% and 39%. So we have always said that anything above 35% is world class, so we're happy where we are. Still have a very good mixture, I think, of customization work as well as innovation work that goes through our pipeline.

Our next question comes from Dmitry Silversteyn with Longbow Research.

A lot of my questions have been answered. I just want to follow up, make sure I heard this correctly. The $3 million to $4 million in impact that you're going to see in the fourth quarter from the hurricane and ancillary transportation and logistics issue, that's all going to be in PP&S? Is that the way to think about it? And why is it so focused in that division versus your other divisions?

No, there could be a little bit of that, that shows up in EM. But really, I think most of that's going to be in PP&S. And largely, it's around -- Brad talked about different buckets of cost, but shipping is about material that's coming out of the Houston area. But when you look at what's going on with raw materials and inflation there, that is going to impact the EM business. So there is a portion of that, that goes to EM as well.

Okay, but not so much Color or the Distribution business?

No. And as I said, I think Distribution is doing a good job of staying ahead of that. Look, as prices go up, typically in the Distribution side, the suppliers are setting those prices, and they are what they are. And for us, that's -- sometimes there's a plus or a minus based on on-hand inventory, but nothing to really, I think, report or expect for Q4.

Got you. And then just a follow-up, a question on the gross margins. It's kind of hard to compare sort of annual numbers year-over-year or quarterly numbers year-over-year because of the absence of the design systems or solutions and structures business. But it does look like your margins are up mainly on mix on the gross margin line despite a pretty significant raw material impact. That's all basically the absence of DSS, right? I mean there is not much that you're doing there in terms of kind of mix within the existing businesses? So how should we think about, I guess, at your gross margin resilience given the raw material pressures, primarily for 2018, if we have a thesis that in the back end of the year you may see flattening if not a rollover of raw material costs, and it does sound like there can be a pretty good lift in margins at the back end of next year?

With DSS in the numbers for last year, margins have improved from there. You're right in pointing out that the absence of DSS is driving that because when you look at things really on a continuing operations basis, this year, we've had really good margin results in PP&S and Distribution. But you know, in EM, we've had the most challenge of raw materials. And year-over-year, EM probably has lower margins by about 1% just due to the composites investment we've been making. So if I look at things on a continuing operations basis, it's down a little bit from where it was last year.

Okay. But again, my point is that given the 20% increase in raw material costs, the decline is just not that dramatic as you would expect typically. Is that just a function of how specialty your portfolio has become where there is such a disconnect between raw material costs and the selling price that even a 20% move in raw materials doesn't kill your margin?

I mean I appreciate you coming at it from that angle. From ours, we seem to always dwell on where the opportunities exist to get better. But yes, there is no doubt, I mean look, we're doing everything that we can from a pricing standpoint and I probably have said this before in other quarters. But it's been a really unique year in a sense that -- been very challenging to get price in this environment with how fast things spiked up in the first part of the year and then people thought they were going to come down and really haven't. So but to answer your question, yes, I think we've been mitigating much of that with our own pricing. I think that you probably see that a little better in Color than you do in EM. But directionally you're correct.

Our next question comes from Kevin Hocevar with Northcoast Research.

Back to the dividend, if I'm hearing what you're saying correctly, it seems like the increase in the dividend is really a function of your expectations for better cash flow as opposed to cannibalizing share repurchases or M&A or anything like that. So wondering what your expectations are for a free cash conversion going forward. I think, Brad, you mentioned earlier in the call, you expect $180 million to $200 million of free cash this year, if I heard you right, and I think that's 100% plus of your net income so 100% plus free cash conversion. So wondering if you have any metrics we should think about in terms of free cash conversion going forward.

I think that is a good metric, $180 million to $200 million of free cash flow. Again, Bob mentioned really the portfolio changes that we've made. And I would also point out related to the portfolio changes, I mean you look at our overall capital expenditures. When we had DSS, we were putting $90 million to $95 million a year back into the business, which included $20 million for DSS. That's now gone. And so our capital next year will be in the $70 million to $75 million range. So again that's just lower restructuring expenditures for DSS but also significantly lower capital investment required for our core business. So I mean, those are examples of how we're improving the free cash flow generation of the company.

Got you. Okay. And then Bob, you seem pretty confident in the ability to grow EPS double digits in 2018. Obviously, that's a pretty big range. So wondering if you're ready to narrow that down at this point or are we going to have to wait for the fourth quarter call?

No further guidance at this time. I think when we get to the end of the year, we'll have more we can say about that. And also, we're still kind of honing in on the date for an Investor Day to hold next year, at which time, I'm sure we'll have more to say not only about next year but beyond that.

Okay, no problem. And then just last question, I think you expected to drive down some of the stranded costs from the DS&S business, not all of them I know. You said some of those -- that money would be reinvested in the business, but expectation to drive down a couple of million dollars in stranded costs. So wondering how that's going and if that's progressing as expected?

Yes, I think that's going fine. We're really probably right on pace with where we thought we would be, which was not a whole lot could come out in the third quarter here, but we'll see more in the fourth quarter and next year.

Our next question comes from Jason Freuchtel with SunTrust.

I guess just to follow up on the free cash flow commentary that Brad just provided. In terms of looking at the kind of the $180 million to $200 million in free cash flow and bridging into next year beyond earnings improvement and, I guess, lower normalized CapEx. Are there any other kind of puts and takes that we should think about?

No, I mean, I think those are the drivers. I mean, clearly, as we look at next year, I mean, as we grow the business, we'll be putting additional working capital to work in support of that growth. But overall, I gave the puts and takes.

Okay. And interest expense, I guess, maybe stay around the same level?

Yes, same. Roughly the same level. That's correct.

So thank you very much for everyone who joined us on the call today. We appreciate your time and support. We look forward to giving you an update on our next call at the conclusion of the fourth quarter. Goodbye for now.

Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.