Axalta Coating Systems Ltd (AXTA) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Axalta Coating Systems Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Today's call is being recorded, and replays will be available through November 10. 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 a few introductory remarks. Please go ahead, sir.

Thank you, and good morning. This is Chris Mecray, Axalta's VP of Investor Relations. We appreciate your continued interest in Axalta, and welcome you to our third quarter 2017 financial results conference call. Joining us today are Charlie Shaver, Chairman and CEO; and Robert Bryant, EVP and CFO. This morning, we released our quarterly financial results and posted a slide presentation to the Investor Relations section of our website at axaltacs.com, which we'll be referencing during this call.

Both the prepared remarks and discussion today may contain forward-looking statements reflecting the company's current view of future events and their potential effect on Axalta's operating and financial performance. These statements involve uncertainties and risks, and actual results may differ materially from those forward-looking statements. Please note that the company is under no obligation to provide updates to these forward-looking statements.

This presentation also contains various non-GAAP financial measures. In the appendix, we've included reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information regarding forward-looking statements and non-GAAP financial measures, please refer to our filings with the SEC.

I'll now turn the call over to Charlie.

Good morning, and thank you for joining our call today. We look forward to providing color on our most recent performance as well as offering a few thoughts on how we see the balance of 2017 shaping up. I hope you've had a chance to review our press release, and also noted from our release on October 9, when we previewed today's results and some of the key drivers for our quarter.

While the third quarter 2017 included significant business impacts and operating adjustments, we believe the business remains on solid footing and some of the transitory elements that took and will continue to impact 2017 results, may actually translate to better outcomes as we look forward to 2018, which I'll review.

Our markets remain fundamentally stable, supportive, and we believe we're on the right course for the coming year to deliver improved underlying results. If you would turn to Slide 3 of our presentation, I'll review some of our third quarter highlights. Taking a look at our financial results, we grew net sales year-over-year by 7%, which included a 9.7% contribution from recent acquisitions. We commented in our October 9 press release on the drivers of lower organic volume in the third quarter, which included distribution working capital adjustments in North America Performance Coatings, the ongoing effect of raw material cost price headwinds and the impact of the hurricanes and the earthquake in North America.

These elements collectively had a significant impact on our net sales, masking otherwise healthy and stable demand trends in the end markets that we serve. We believe most of these drivers are transitory in nature, and we see our core markets as largely unchanged in the period. Stripping out the impact of the Refinish adjustments in North America and the 5% year-over-year net sales headwind from Venezuela, which was similar to second quarter, but the last such headwind quarter. Axalta's overall global Refinish demand and performance remains solid. This reflects the underlying business drivers, which tend not to shift meaningfully period-to-period.

Overall, Refinish growth in Q3 excluded the impacts we noted, was in the mid-single digits, though held back somewhat by ongoing subdued growth in Asia Pacific and slightly lower-than-expected growth rates from EMEA in the period. Further, the significant impact of the Performance Coating distributor working capital adjustments, this past quarter, also represents an opportunity to more closely align our sales volumes to in-market demand pull from The Body Shop channel, which should reduce sales and production volatility over time and provide associated benefits. On balance, we believe we’ve got greater visibility into and flexibility around managing our Performance Coatings business going forward. We're also pleased to see ongoing solid industrial market demand. We grew our total industrial volumes by 60%, bought by acquisitions and coupled with organic volumes and increased double digits this past quarter, with positive contributions from all segment -- regions. Key net sales growth contributors included general industrial demand through our Global Powder business, strong electrical motor demand through our Voltatex product line and other submarkets including machinery.

Light Vehicle net sales declined mid-single digits, held back by a combination of lower North America volumes and ongoing impact from previous Light Vehicle price concessions that were given to select OEMs. Overall, we're pleased to see core demand in the segment holding up year-to-date, though we were impacted somewhat by certain customer exposures, including plant-specific volume interruptions in the third quarter. Commercial Vehicle posted mid-single-digit net sales growth, propelled by solid volume performance for most regions, offset by a slightly negative price mix effect. We continue to benefit from broader strength in both truck demand and improving machinery demand globally. We reported an adjusted EBITDA of $210 million compared with $230 million in the prior-year quarter, with associated margins down 3.4% to 19.2%. Our adjusted EBITDA results included the impact of the lower volumes in the quarter as well as cost pressure from higher raw material expense. Axalta's overall results were clearly not what we projected earlier in the year or last quarter. Since most of the third quarter impacts are expected to be transitory, we continue to focus on corrective actions that we initiated last quarter and doubled down on in recent weeks. We remain fully committed to executing on our productivity goals, and we're now taking actions on the cost side to generate incremental savings. We expect these savings to drop through more directly to adjusted EBITDA in 2018. And we'll update you on this in more detail in our outlook call for 2018, which we expect to be held in mid-December.

Based on expectation for headcount reduction's been revisited, and we expect to increase targeted outcomes from all of our regions. In general, given moderating expenditures to support planned growth, we expect that 2018 will see more net drop through of any productivity and cost savings that we achieve in that period. Indeed, perhaps the most direct net benefit for cost actions that we've seen since our IPO. As we've made significant offsetting investments in the business over the last 3 years that will not repeat.

As we continue to focus on measures to offset increased raw material cost pressure, our previously announced TiO2 surcharge has been effective largely in Performance Coatings as expected. Further, we're in ongoing discussions with Transportation segment customers to address these persistent cost pressures and begin to make headway on this front. Free cash flow in the third quarter saw material sequential improvement, where working capital and sale metrics there affected by lower Q3 volumes as well as recent acquisitions. Given only partial year net sales contribution versus full balance sheet weighting. For this reason, we expect further progress at year-end on working capital ratios, assuming our revised full year operating targets are achieved. Regarding capital deployment and M&A, highlights for the quarter include the acquisition of Plascoat Systems based in the U.K. Plascoat is a global provider of industrial thermoplastic powder coatings with a wide range of product technology and highly complementary customer base. Although Plascoat is a tuck-in transaction, it's a good example of expected value creation with multiple levers that could increase return potentials from our baseline assumptions. We see this as a strong use of Axalta's capital and expect baseline returns commensurate with other deals that we closed on in the last several years.

Regarding the integration of the Wood Coatings deal closed in June, we're very pleased with the progress that's been made towards our goal of largely competing -- completing this carve out by the year end. And we're also pleased with the Wood business' operating performance since our close. Finally, we also stepped up our share repurchase activities in the quarter, taking advantage of the elevated share price volatility to buy back $50 million of Axalta stock during the period.

Looking at operating highlights across the business. Our focus on operating cost discipline remains. We've achieved key milestones for the quarter in our Axalta Way program, which remains on track for full year savings goals. Our complexity reduction initiative is also moving ahead at a solid clip as a key driver Axalta Way savings, including meaningful savings this year and further acceleration looking into next year. We finished the reorganization of our new America's management structure, consolidating North America and Latin America leadership under this structure, and taking a large step forward in realizing those synergies. We also appointed Joe McDougall, as Global Head of our Refinish end market, adding this previously unfilled role to certain of his other existing responsibilities. In terms of innovation highlights, we had numerous successful new product launches in the third quarter. In our Industrial segment, we introduced significant new products within the Alesta Powder Coating lines as well as to our Tough Coat and Nap-Guard product families. In Refinish, we already launched our new Syrox product line in China, following the initial launch of this line in the EMEA region last year. We remain on track to introduce roughly 250 new products this year, which will be key contributors to organic growth in 2018 and beyond.

In summary, our third quarter results were clearly challenged relative to our previously communicated financial objectives. Still the drivers of this outcome include the transitory impacts, though while disappointing, should not impact our ability to deliver our medium-term growth objectives.

Within market health, essentially unchanged, enhanced over flexibility and our operating model, we do look forward with a degree of increased confidence backed by greater visibility in certain areas of the business.

With that, Robert will now share some of the further details on our results.

Thank you, and good morning. Turning to Slide 4, constant currency net sales in the quarter increased 5.1% year-over-year, including 10.4% growth in Performance Coatings, offset by a 2.8% decline in Transportation Coatings. Overall, growth in the third quarter was driven by a 9.7% acquisition contribution, offset by lower organic volume and slightly lower average pricing in the period.

Foreign currency translation benefited net sales by 1.9% in the quarter. The first positive effect in several years and a change from the 1.5% negative effect seen in the second quarter. We certainly welcome this inflection point. The largest contributor to the shift was the euro-dollar appreciation versus the same period last year.

Axalta's lower organic volume in the third quarter was driven largely by lower Refinish volumes in North America and Latin America, partially offset by solid growth in industrial and commercial vehicle end markets. Consolidated price/mix realization was a decrement of 0.7% in the quarter, primarily coming from the transportation segment, while Refinish pricing was positive in all regions.

Adjusted EBITDA in the third quarter was $210 million, decreasing 9.1% from last year's $230 million. The adjusted EBITDA margin for the quarter of 19.2% compared with 22.6% in the year-ago quarter. This decrease was driven primarily by the impact of lower volumes, increased variable cost pressure and ongoing reduced average pricing. These drivers were offset in part by higher acquisition contribution, particularly, from the Wood Coatings transaction completed in June as well as Spencer Coatings.

Turning to Slide 5. Performance Coatings net sales in the third quarter increased 12.5% year-over-year, including an FX benefit of 2.1%, driven by 16.1% growth from acquisition contribution and 0.9% higher average selling prices, again, offset by a 6.6% pull back in organic volumes. Third quarter Refinish net sales decreased by 8.4%, including a currency tailwind of 2.2%, driven by lower organic volumes in North America and Latin America, particularly from Venezuela, which we deconsolidated this past April and which amounted to a $19 million year-over-year headwind in sales.

The North America volume loss from our previously communicated distributor working capital adjustments in the period. As was the case in the second quarter, underlying body shop demand at our markets remained steady. And we continue to believe that the impact in the middle of this year is temporary. To be clear, it does not represent any change in the competitive dynamics in the Refinish market. We continue to gain Refinish share on a global basis, including in North America as reflected in the number of and associated paint volumes in the body shops we serve.

Industrial net sales increased 61.4% year-over-year as reported, largely driven by substantial acquisition contribution and including 1.9% FX benefit. Second quarter industrial organic volumes also increased at a double digit rate, with growth coming from all regions, though offset slightly by lower average price/mix and the aggregate similar to the second quarter.

Performance Coatings generated a Q3 adjusted EBITDA of $135 million, a 7.3% decrease versus $146 million in the year-ago quarter. This result was driven largely by the effect of lower volume from North America and Latin America Refinish, coupled with higher variable cost pressure and offset to a significant degree by acquisition contribution. Lower operating expenses to support growth, the benefit of slightly improved price/mix and a modest FX tailwind.

Adjusted EBITDA margins for Q3 of 19.5% compared with 23.6% last year, driven by the factors just mentioned. The notable additional headwind in the quarter from the year-over-year comparison in our Venezuela operations was $12 million in adjusted EBITDA. After the third quarter, there will be no material ongoing headwind.

Switching now to Slide 6, third quarter Transportation Coatings net sales declined 1.4% year-over-year, including a currency benefit of 1.4%, with growth in Commercial Vehicle net sales offset by a decline in Light Vehicle. Segment volumes were stable in the quarter with the 3.0% drop in average pricing, offset partially by the FX benefit.

Light Vehicle net sales in the quarter decreased 3.6%, including a foreign currency benefit of 1.3%. Volumes declined at a low single-digit rate and were behind the market somewhat in the quarter due to Axalta's specific customer exposures in both North America and EMEA. Much of this impact came from specific plant adjustments as opposed to lower demand, and therefore may not be representative of core market demand for our products looking forward. Average pricing in Light Vehicle was down low single-digits as moderate impact from price concessions to select customers continued to flow through the business, albeit, at rates not as impactful as in the second quarter.

Commercial Vehicle net sales increased 6.7%, including an FX benefit of 1.5% as production volumes continued at a healthy pace year-to-date for truck markets in North America as well as solid demand in other markets. Truck production forecast in North America have been upwardly revised several times this year with a consensus for Class A production now around 250,000 units versus closer to 250,000 units entering the year.

Order rates for non-truck customers remain healthy as well, with solid progress seen in bus and other non-truck customers.

Transportation Coatings generated third quarter adjusted EBITDA of $74 million versus $85 million last year, while adjusted EBITDA margins of 18.7% compared with 21% in Q3 2016. This decline was driven by lower average pricing, offset in part by reduced operating expense and productivity actions.

Turning to Slide 7, cash and cash equivalents totaled $589 million at September 30, an increase of $102 million from last quarter. Total reported debt was $3.9 billion, resulting in a net debt balance of $3.3 billion versus $3.4 billion at June 30. Our net leverage ratio remained at 3.8x at quarter end, reflecting higher cash balances with stronger cash flow performance, essentially offset by a stronger euro on our euro debt and lower 12-month adjusted EBITDA denominator due to the impact of lower operating results in the quarter. The calculation also does not yet incorporate the full benefit of adjusted EBITDA associated with the recently completed acquisitions, which penalize the ratio several tenths in the short term, in particular, since we finished the Industrial Wood acquisition.

Free cash flow for the third quarter, defined as cash flow from operations less capital expenditures, was $183 million compared to $115 million in the same quarter a year ago. Cash flow was notably better sequentially as well, given the normalization of working capital outcomes after somewhat subdued free cash flow production in the second quarter. Regarding our leverage in overall capital allocation, we remain focused on a combination of tuck-in M&A, opportunistic share buybacks and building cash for future M&A transactions. During the quarter, we repurchased approximately $50 million of Axalta stock at an average price of approximately $29.

Turning to Slide 8, we have detailed our updated financial guidance for 2017.

Net sales growth and revised adjusted EBITDA guidance was provided in our press release on October 9, and remains unchanged from that release. Other metrics are largely unchanged from our last quarterly call in August, with the exception of cash flow, which is directly influenced by the revision in adjusted EBITDA. For net sales, we expect as-reported growth of 6% to 7% and no meaningful impact for the full year from FX, which shifted from a headwind to a tailwind in the second half of this year. Essentially, all of the projected growth was driven by the acquisitions completed in the last 12 months as the third quarter reduction in volume offsets core growth in many areas of the business through the year. Regarding end market health, Charlie has noted that there has been little discernible change in the last quarter in terms of key indicators broadly, which we take as an encouraging sign for the outcome this year. Our adjusted EBITDA outlook remains at $870 million to $900 million since our downwardly revised guidance set on October 9. This implies fourth quarter EBITDA of $230 million to $260 million with improvement sequentially, driven by more normalized volumes across the business. The elimination of the impact from the natural disasters in North America and by certain seasonal and business-specific assumptions around volume as well as pricing to generate a somewhat better fourth quarter outcome.

As noted on our August call, we do assume somewhat increased headwinds to our results from higher raw material costs, offset in part by the expected progress in net pricing, which have shown some encouraging signs at recent months. We have maintained our guidance for interest expense, our adjusted effective income tax rate, capital expenditures and depreciation and amortization. Our free cash flow guidance is now $360 million to $400 million for the year, with the revision coming from the lowered profit expectation versus last quarter.

This concludes our prepared remarks. And we will be pleased to answer any of your questions. Operator, please open up the lines for Q&A.

(Operator Instructions) Our first question is from Arun Viswanathan with RBC Capital Markets.

Just wanted to ask a couple of questions on the guidance. For Q4, it looks like the implied range is about a $30 million sequential improvement. What do you think is going to drive that? Is that the accelerated cost reductions? Some price cost recovery FX? Maybe you can just help us size some of those buckets?

Arun, good morning. To answer your question, there are really 3 variables in that. The first one is volume. We will have volume recuperation in the fourth quarter compared to the one-time third quarter events that we've highlighted. The second aspect is acquisition contribution. We'll have a full 3 months of all of the acquisitions contributing. And then we also have the impact of cost reductions, which as we put -- as we talked about on previous calls is not linear through the year. It picks up and accelerates a little bit more in the back half of the year, given the timing of when some of those decisions were implemented in the fourth quarter and first -- of last year and the first quarter of this year.

Okay. That's helpful. And then on 2018, you also have a comment in your release expecting double-digit growth. And I understand that's partly due to the lower base, but maybe you can give us a similar kind of outlook as far as what you think is going to drive that double-digit growth. I imagine that it's -- the acquisitions, some volume as you said? And do you expect any moderation in either the distributor working capital adjustments or the OEM price givebacks?

So we'll provide more information on our guidance call that we'll have in early December, where we'll preview our outlook for 2018. But if you look at stating that will be double-digit growth in EBITDA. Again, that's not a heroic effort actually. When you pull out the one-time effects that we've seen here in the third quarter related to the hurricanes, the earthquake and then also the distributor working capital adjustments that we have seen in our North America Performance Coatings segment. We would not expect that those circumstances to repeat themselves in 2018.

And lastly, is there a range for the Venezuela deconsolidation impact that you would give as far as a 2018 uplift?

So in the fourth quarter, as we highlighted in our prepared remarks, the year-over-year headwind will totally dissipate. And the actual amount of EBITDA contribution from Venezuela in 2017 was immaterial or essentially close to 0. In sorry -- in 2017 it was close to 0. Therefore, year-over-year versus 2018, that it will not be an impact in Q4, nor would it be an impact in 2018.

Our next question is from Bob Koort with Goldman Sachs.

This is Chris Evans on for Bob. I was wondering in Light Vehicle, you mentioned there is targeted Light Vehicle customers that you're seeing lower selling pressures. That seems in the second quarter you focused really on a single customer that was pushing back on price. So is there any change or additional OEMs that are coming and looking for pricing concessions? Or is this just a change in communication to us?

Yes, this is Charlie. There's no change. In fact, at this point in time, largely a lot of the price downs occurred over the past year. We don't see anything new there. Clearly, there's always business up for renewal over the coming periods, but there's nothing new there.

Chris, there was a lot of focus last quarter on one customer in particular. But we commented several times that the effect of price in the second quarter, and indeed, in the first quarter and the fourth quarter of last year was cumulative than inclusive of a broader trend among the OEMs.

And then maybe just broadly on your variable cost pressures. Could you quantify how much raws may have impacted the third quarter? Which raw specifically might have been most impactful? And then maybe your expectation into the fourth?

Chris, in the second quarter, just to give you some sequential perspective and that, actually going back to the first quarter of this year, raws were actually a slight -- slightly neutral for us. We did see low single-digit pressure in the second quarter. That's increased now to mid-single-digit pressure on our raw material basket. And as we look into the fourth quarter, we expect to see raw materials in the high single-digits as a headwind year-over-year. And as it turns that the outlook for 2018, we expect that to continue into, at least the Q -- first quarter of 2018 based on purchases that we've already made of raw materials. That being said, obviously we have 2 keen areas of focus: One is on cost reduction; and then the other is on where appropriate passing along price increases to our customers. The specific areas where we're seeing raw material inflation really are in several categories. We're seeing inflation in solvents, in monomers, in resins both polyester and epoxy, isocyanates. And then, although, we have seen a slight decrease in some of the high pigments, we continue to see significant raw material price increases in TiO2.

Our next question is from Christopher Parkinson with Crédit Suisse. Our next question would be David Begleiter with Deutsche Bank.

Charlie and Robert, first on the Q4 guide, it's still a pretty wide range of $30 million. You're 1/3 through the quarter. Any further insight, is the upper half more likely at this point in time? And any further help would be appreciated there?

David, I think with -- as we think about the third quarter, obviously, there are variables that could move around in the fourth quarter in terms of light vehicle production, in terms of price increase execution as well as other macro factors. I think we've done a pretty good job of trying to understand the impact of the natural disasters. But that has impacts both on the cost side as well as the revenue side. So given the variability in some of those elements, we felt that a range of that nature was appropriate.

And Rob, you mentioned on the key -- on the 2018 guide that double digits was not heroic, which I agree with. Any further -- is mid-teens plus a more realistic guide. I know it's early before your December earnings or guidance call, but any help there also would be appreciated and what double-digits plus means?

David on that, we're in the middle of going through our annual budgeting process. And as I said, that process is still ongoing. We need to get through that process with each one of our businesses and each one of our regions to really be able to answer that question. And as I said, we'll be able to provide a little bit more insight into that in our preview at the beginning of December or middle of December.

And David, I think the point we were making in that release was that, clearly, we don't view 2017 as a new baseline, if you will. We didn't want to try to communicate that. We'd be comfortable or satisfied with a normal rate of growth off of 2017, given the severity of the one-time impacts that we highlighted. So we wanted to make that point, and note that 2018 observationally today should be a more normal year, and therefore, substantially better than a 2017 outlook.

Our next question is from Christopher Parkinson with Crédit Suisse.

Can you guys hear me?

Coming through loud and clear, Chris.

So probably correlative of the raw material question, but when you guys take a step back and you look at your various price initiatives and surcharges throughout the year. What do you believe could be done differently? Or would you do anything differently in '18 and '19? And then also in the year, do you have a view in terms of percent of magnitude of the spike in raws that were resulting from various force majeures and from some of your suppliers in Europe and Asia. Just any views on that would be helpful.

Yes, Chris, I'll take the first one. I'll let Robert take the second one. The -- as far as we've gone through the year, I think we knew -- our general view, when we looked at oil prices, hydrocarbon prices moving through the year. I don't think we could have done anything different on pricing. I think, it's okay, so you have to wait until that raw material goes up before you can go sit down with a customer and talk about a price increase. When you look at the pigments, as Robert mentioned, with TiO2, as TiO2 started up, we started having discussions, as many people know, we even went to a surcharge recognizing that when all the China production went offline, that was kind of unprecedented and we had to deal with it. And the last piece of that is just roughly 1/3 of our raw material increases this year have come from tight supply demand conditions that either were a result of one-time issues. We had technical force majeure early in the year. So you can't really always -- you just kind of have to wait, so when those things happen and you have to go deal with them. So I think now as we go through the year, I think we've taken the actions, wouldn't we saw the increases coming and (inaudible) to our customers. Now I think as we look in 2018, 2019, I would just say my general view is, and again, I think it's appropriate not to be trying to get exactly what the numbers will be. I think what you have to look for now is a couple of questions. One, will there be an abatement in TiO2 as we go into '18? Will some of that capacity come on? And I think we'll wait to see how that gets answered. I think we're covered because the way we've addressed the surcharges. But I think in general, if we believe oil today is $52 a barrel, WTI $58 with Brent. We have a general view we think they'll continue to be a slight upward bias on oil. So as we go into '18, as we think about pricing, we think raw materials clearly could go up another 3%, 4%, 5% mid-single-digits on average. Again, we haven't planned, we haven't laid all that out yet with everyone. But certainly, recovering that price, we’ll try to be in front of that as much as we can as the oil complex continues to recover. Now should it pull back, then I think we'd take a different view. But right now, I think with a positive bias on oil, my general view is the coatings industry and certainly Axalta, we'll be dealing with these increases for some period of time to come, and try to stay out and in front of them as much as we can.

Great. And just could you just give us a little more color on your doubling down comments on costs? And just in terms of the potential magnitude and cadence of any new initiatives in particular? And then also, Robert, if you could just comment on your long-term working capital initiatives? And how you expect that cash flow to evolve in '18 and '19? Just any preliminary thoughts there would be helpful.

On the cost initiative, we are -- have undertaken a new initiative related to costs. We'll provide more detail about that in terms of magnitude as well as one-time cost on our call in December. Again, I think it's important to know to keep that cost program in the appropriate context. In other words, the results were negatively impacted in Q3 and somewhat in Q2, by really a lot of one-time items. So if we look at our volumes, excluding one-time items in the third quarter, our volumes would have been up 1%. So the important thing here is not to overreact to several of these things that we see as one time. And further, with regard to Refinish, excluding the one-time events in Refinish, our revenue would have been up mid-single-digits. So we're at a number on a volume side consistent with what our peers are seeing in our Refinish end market, I would say, outperforming the overall market globally. So I think as we think about an appropriate reaction to some of the margin pressure. The margin pressure from raw materials is something that is driving the desire to have an additional cost program. It's not driven by these temporary factors. And we just thought that, that was something that was very important to highlight. In terms of working capital, we have made a lot of acquisitions. As you know, those acquisitions bring with them obviously increased accounts receivable, but we also have the impact of the decrease in sales offsetting some of that as well as a lot of collection efforts. So you'll see our AR performance in Q3 was notably better than it was in Q2, and that was a focused effort. On the inventory side, we haven’t seen the increase in inventory due to the acquisitions as well as due to the lower sales levels that we experienced in Q3, but we expect to bring those down in Q4. And regarding our working capital, I think we're -- we feel confident that we'll end up at the end of the year what our expectations were that we set out at the beginning of the year. And as you could see, we saw very good cash flow progress even adjusting for the debt extinguishment charge that we took in third quarter of last year, very strong cash flow, and we still see opportunities in inventory in AR as we go into 2018.

Our next question is from Duffy Fischer with Barclays.

First question is just around the margin effect from the volume issues around the inventory. What was the decremental margin on kind of that raws volume? And then should that come back roughly to the same magnitude as we normalize the volumes going forward?

Duffy, with regard to the margin in Performance Coatings and the decrement that we saw in Q3 from that, the decremental margin in Q3 from the decrease in volume was very high. And it was high due to 2 reasons. #1, the mix, particular product mix that was not purchased in Q3 was a very rich product mix, so the drop-through on the volume is quite high. The secondary and much, much smaller effect is Venezuela, which is a market where we did enjoy very good margins. So as we experienced 0 sales in the third quarter of this year compared to about $20 million in sales last year and the associated EBITDA contribution from that, that was also another region with a very rich mix. Moving forward, we would not expect to see a decremental margin to the extent that volumes were lower anywhere near that magnitude. And I think our expectation now is that volumes will continue to back-to-normal levels as we go into Q3 and Q1 of next year.

Okay. And then can you quantify on an EBITDA level. FX turned positive for the first time in a long time, how much of a benefit was that going from Q2 to Q3? And then if you just flat-line FX for the rest of this quarter, what does that do Q3 to Q4 to the business?

So Duffy, I'll have to get back to you on the exact number of the Q2 to Q3. Obviously, acquisitions, I'm sorry, FX was a big help on the top line in Q3, it's was about $19 million or 1.9%. What it does do is change our FX assumptions for the full year. As you remember, at the beginning of the year when we provided guidance, it was expected to be a slight headwind as we came into Q2 and then now Q3, it's been a quarter, it's been a slight tailwind. And depending upon what the euro does, which is obviously the most important variable for us, it could end up being a slight tailwind for us on a full year basis.

Yes, the euro assumed at around a $1.18 in the fourth quarter, that should translate to somewhat over 3% tailwind for FX in the fourth quarter, leading to a full year FX effect that's relatively neutral, slightly positive given the decrement of FX in the first half of the year.

Our next question is from P.J. Juvekar with Citigroup.

Just a quick question on light vehicles. With lower pricing, you mentioned that it was just 1 or 2 sites where you had to give this pricing concessions. How long does it take to get pricing back in auto? Is it typical 2 to 3 quarters, or could it be faster because it was just a couple of sites?

P.J. yes, on that question, it depends on -- frankly on the cycle of new business and how much new business is up for bid. I mean, I think the important thing that we've highlighted before is that some of those price concessions that were given in earlier quarters this year and end of last year were really reflective of price sharing that occurred, or you could say should have occurred in the quarters prior to those quarters. It's just that -- it's kind of come all at once. Now we'll lap some of these price downs as we go into the middle quarters of next year. But we have a number of elements that allow us to continue to increase price in Transportation segment. First and foremost, of course, is introducing new colors, introducing new products, any type of an engineering change gives us an opportunity to reset everything to current raw material pricing. That's one element. Another element is reformulation. And that's another area where we spend time in terms of the actual formulation of the paint, are there tweaks that we can do to lower the cost basis of that. So that the impact of the higher raw materials is not so -- is not to such a degree. We also have index pricing implemented at some customers. And then, of course, it goes without saying that the first tool in the toolbox against that is overall cost management and cost reduction at the company.

Okay. And second question is on use of cash. Stock buyback versus M&A. You purchased $50 million worth of shares. Should we expect more buybacks in the future on an ongoing basis? Or M&A is still a top priority?

Yes, P.J. this is Charlie. I think that you'll continue to see us to do strategic M&A as we go through, if you look at our strategic plan over the next couple of years. Things we have lined up, things we like. At the same time, when we look at the total free cash flow of the company, we certainly have the opportunity to do that and from time-to-time going to the market. So I think you'll see us from time-to-time continue to go into the market and buy shares at points where we believe they can be value creating. Obviously, we liked with the price where it was here in the third quarter, and that was an opportunity to use some of that free cash flow. So I think you'll continue to see M&A a priority, but from time-to-time, we'll exercise on our stock repurchase plan.

Our next question is from Laurence Alexander with Jefferies.

Just 2 quick ones. First, on the OEM side, can you characterize what you're seeing in terms of year-end shutdowns if your customers have given you any indications yet? And secondly, there was a quick allusion to how being closer to the body shops would have associated benefits? And that's probably something negligible but just want to be -- would you mind clarifying if that's anything that we should be -- that would be relevant?

Yes. This is Charlie. On the first question around light vehicle production in fourth quarter, if you look at what we saw in third quarter, which was actually consistent with our plan was in North America you saw a pretty big pullback in production. In August, some of the producers took shutdowns and managed to keeping their inventories constant in August and September. Although sales picked up pretty significantly in September. And my guess is, we'll see some hurricane effect here in fourth quarter on vehicle sales that might be a little stronger than normal. Right now, we haven't seen any of our customers or any of our production plants in fourth quarter for light vehicle change from previously communicated plans either North America, Europe or China. So I think we see continued demand being off a little bit versus first half of the year, but pretty much consistent with the plan and probably the numbers that a lot of you get from IHS and others I think is what we see. Again, we might see a little stronger production out of a couple of OEMs here in North America as they replace some volumes of the million-or-so cars that were affected in the hurricane, but again those are very specific models that in some cases we're on and in some cases we're not.

Laurence, it's Chris. On your second part of your question on associated benefits from being closer to body shop demand. What we're really referring to there is the expectation that volumes and sales from the Refinish channel should more closely align to end market demand going forward. The benefit that we have from that is simply the ability to smooth the operating flow in our business. And theoretically, to have a more consistent and stable operating profile, which has benefit to our cost structure.

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

Wanted to come back to pricing in Transportation Coatings. Do you have meaningful price increases on the table today? And then as I look at the sequence of price contributions over the last 3 or 4 quarters, it looks like your price comparisons get easier in the fourth quarter of 2017. And so in that context, would you expect price to neutralize or turn positive over the next few quarters?

Kevin, so in terms of providing specific commentary about pricing that we might or might not have on the table right now with our light vehicle customers, that's something that we have to be a little bit careful about discussing. I would say, just in the normal course of operating the business, as I commented from my earlier comment, there are ways that we attempt to continue to go out and get price. And as new business comes up for bid, there has not been a lot of business that's come up to bid, say over the last quarter or 2. There will be some coming up here in the back end of the year and first quarter of next year, when we'll have a little bit more insight in terms of how price is behaving in the market. But at this point, I think it's a little bit too early to say.

Very good. Understood. Second question, if I may, on performance, Robert, I think you made a comment here on the call that excluding one-time events, the Refinish business would have been up mid-single-digits. Perhaps you could provide a little bit more color on what were those one-time events or perhaps the magnitude associated with the various events that you're including in there so that we can kind of bridge to that positive mid-single level?

Sure. So there were 3 events. One would be the distributor reduction in their capital levels in Performance Coatings in North America. That would be one element. The other element is the year-over-year comparison in Venezuela. And then the third element is the impact of the 2 hurricanes and the earthquake on our Refinish and our industrial business in the third quarter. So those are 3 events that we see largely as one-time, and would expect demand and volume levels to come back to normal levels beginning in the fourth quarter and moving into the first quarter.

Our next question is from John Roberts with UBS.

Operator, let's move on and we can try and pickup John on the way back.

Steve Byrne from Bank of America Merrill Lynch.

Charlie, you mentioned 250 new products you're expecting this year. Can you just describe the nature of these new products? Is there any new technology in there that could help drive price and/or market share or anything on the horizon you can comment on in terms of new technology that could give you an edge?

Yes, I mean, I think a couple of examples there. As we look across all of our segments. For example, in the Refinish business this past year, we've launched what we call our Syrox brand. This is a mainstream Refinish product that's at a very competitive price point in the market for folks who aren't looking for a premium type of product but are looking for a nice good color match at a good value price, we've launched that globally. And right now is actually ahead of our expectations. We're now measuring its acceptance in thousands of body shops, not hundreds. So very pleased with that. I think an example, on the industrial business across the board, we're introducing products that, in most cases, are -- give higher protective value. Give that at a nominal price but also extend the product range. I listed a couple there in my comments either in our Powder Coatings line like Tough Coat, Nap-Guard product families. But I think, overall, we're really focused in these segments where we can either shift to a low VOC. I would say that the theme in many cases is lower VOC, waterborne products. In the Powder Coatings business, more protective products and more differentiation of color. In the OEM segment, across the board, we're working on productivity with the OEMs, where we can either go to lower flash temperatures where they can use lower oven temperatures, faster drying and also waterborne products that have -- that meet some of the specs they're looking for on corrosion protection. So I think across the board, when you look at the fact that we spent roughly almost $200 million this year in R&D over -- well in excess of 4% of our sales. That's pretty equal across all 3 of our major segments. The 2 segments in Performance and then in Transportation both Light Vehicle and Commercial Vehicle. So I think you'll see us continue to introduce products that have increased protective properties, a good value proposition from a cost price standpoint and then ones that move lower VOC and more into waterborne around the world. As we see waterborne becoming more and more an accepted product, not just in premium markets but in more mainstream markets. Clearly, in places like China, you see more and more government regulation around that. And but also not just on environmental but also productivity, where people are looking for those waterborne products to be even more productive than they have been in the past.

And another technology question for you. As autos increasingly employ more sensors in their body panels to detect other vehicles and so forth. Is the repair of those body panels more challenging from a Refinish coating perspective? Or is this trend more of a headwind for you?

It's actually an interesting question and one that, as you know, those trends are evolving both, excuse me, electric vehicles but then also more active driving technology, ultimately, autonomous vehicles are out there. So we do -- we kind of think about it in 2 ways. One is, we already currently work with the OEMs and a lot of the Tier 1 plastic parts suppliers on not only coating those the first time, but also ultimately how you teach the Refinish shops how to repair a lot of those parts. I think more -- just as important, we're actually starting to work with some other external plating companies on long-term, where you get into some of these other compounds on cars and on trucks. How do you not only coat them right the first time with increasing tighter specs on corrosion and scratch-resistant smart coatings, but also how you repair those. So it is an increasing effort for us. I would say, all that is just a trend. There is not any one single technology or one single person that has or one single company that has the monopoly on that. You’re really having to work across a range of manufactures, not only in the OEM side but also on the Refinish side. It's absolutely, as an industry leader, we view it's important that we're leading a lot of those efforts. But we're also finding you got to work closer with other companies, other plating companies, other coatings companies, not necessarily direct competitors, but other coatings companies on technologies that are going to help not only the OEMs but the Refinish market. So I think we feel pretty good about it. Those are all macro trends that you got to stay in front of absolutely.

Our next question is from John Roberts with UBS.

Did you say how the Wood Coatings business performed versus your expectations? And what was it up versus a year ago? And should we expect any seasonality here as we go through the next few quarters?

John, this is Robert. On that point, I would say that, we haven't provided granular detail at that low of business level. But what I would say is that we had an investment case, which we made the decision to purchase that business and associated projections that are our budget for this year. And the business is spot on budget. So it's performing quite well. And we've been very happy with the performance of the business. And of course, there is the seasonal effect and that you would expect to see in Q4 and Q1, given the weather patterns.

And then could you remind us again how concentrated or fragmented the North American Refinish distribution channel is? And maybe compare and contrast that with international distribution for your Refinish business?

North America Refinish we have approximately 400 distributors in total. We have a few distributors that make up a pretty sizable amount of the total volume in North America. As you look at distribution in Europe, it's much more of a local country-based model and it's highly, highly fragmented. The same thing in Asia from a distribution perspective as well as Latin America.

Our next question is from Jeff Zekauskas with JPMorgan.

In the domestic Refinish market where some customers lowered their inventories. Was it one or two customers? Is that where all of the volume weakness comes from exclusive of the hurricane?

Jeff, in terms of the volume impact that we saw a little bit in the second quarter and then strongly in the third quarter, just to make sure from a nomenclature perspective, that we're being clear. We did not see any decrease in customer demand. The dynamics with the end customer, in other words, the body shop, those remain quite healthy. Miles driven are up about 2%. Accident rates, the rate itself is holding relatively steady and the car parc, it's -- is up about 1.6%. Where we saw the decrease in volume was at the distributor level that sits in between the manufacturer and the end customer. And that is what we expect to be much more of a one-time nature.

Right, but at distributor level, is this a couple of larger customers, and that your competitors don't describe the business similarly to the way you describe it?

Yes. So in that case, correct. If you -- our distribution model, it's a little bit more heavily weighted towards large national distributors compared to some of our competitors that have a distribution system that's a little bit more distributed, and not quite as concentrated.

And in light vehicle pricing, if you exclude the effects of one customer that you had issues with. Can you talk about light vehicle pricing in general in the quarter? And why wasn't there more progress in pricing in Industrial coatings. You've been trying to raise prices there for a long time. What were there, pockets of weakness and pockets of strength in Industrial?

Jeff, I think when you think about light vehicle pricing, it is not just one customer. I think it's not fair to try to pin it on any one customer. I think over the last year, the 2016 round of negotiations with OEMs involved a broad-based ask on their part to share some of the saving that we'd experienced in lower raw materials over a multiyear time frame. So it would be a misrepresentation to think that you could strip out one customer and that pricing is therefore positive in light vehicle. The fact is it's been somewhat of a sharing during that 2016 round. And I think as you look forward, obviously there is an opportunity, given structural increases in cost over recent quarters to shift the tone of that discussion, but that's a process.

And regarding Industrial, Jeff, we have been pushing to increase price. Obviously, there are particularly in Powder Coatings, the impact of TiO2 is quite substantial. So similar to other players in the industry, in particular in Industrial, we've seen a pretty dramatic raw material impact in Asia Pacific that started early. And in previous calls when we've talked about trying to increase price in the Industrial business to offset that raw material inflation. It has been in Asia Pacific in particular. Our efforts to increase price and then also with the TiO2 surcharge that we have implemented. We've had some success with those 2 efforts. Obviously, there's a lot more to do just given how much raw materials have gone up. But I think it is important to highlight that Industrial is up as an end market year-over-year in all regions. So from a top line perspective, is actually performing quite well. The challenge is really at the cost level from a raw material perspective.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back over to management for closing remarks.

Yes, thanks, operator. And appreciate everyone's questions this morning. I think we -- as we noted in our press release and our call, pretty challenging quarter. I think when you would lay out 2 hurricanes, an earthquake and some supply-chain adjustments, having all of that happen in one quarter, certainly disappointing for us. However, again the transitory nature, I think that Robert talks to, we feel good our markets remain fundamentally sound. In some cases, better than we would have guessed in low organic growth period. I think that we, like most of our industry at this point in time feel pretty good about the markets being fundamentally sound. In fact, I'm probably more optimistic on the industrial markets than I would have thought I would be at this point. So as we go in 2018, we feel pretty good about overall underling demand. I think the challenge for all of us will continue to be looking at these raw materials, looking at the increases, which ones are transitory in nature, which ones are more fundamental i.e., around oil prices around the world. I think we have a good insight into that. And are really just focused on recovering that price, recovering our margins and moving forward as we go into 2018. So I appreciate the questions this morning. And we look forward to a good solid fourth quarter and look forward to visiting with you in December when we do our 2018 outlook. So thanks, everyone. And have a good day.

This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.