Axalta Coating Systems Ltd.

Good morning. This is Chris McRae, Vice President of Investor Relations. Thank you for joining the call today to review our third quarter 2019 financial results and for your interest in Exalta. Joining me today are Robert Bryant, CEO, and Sean Landon, CFO. We released our financial results this morning and posted a slide presentation to the Investor Relations section of the website at exalta.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 Exalta'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 Robert.

Good morning and thank you for joining us. Exalta delivered a strong third quarter with adjusted EBIT, adjusted EBITDA, adjusted EPS, and free cash flow well ahead of expectations. We overcame important macroeconomic, political, and currency headwinds, as well as the distraction caused by a strategic review process, which underscores the resiliency of our business model, our multiple value levers, and the commitment of our employees. Though net sales were impacted by volume headwinds across global markets where Exalta participates, Exalta's sales were still positive in the aggregate before FX and divestiture related impacts. Operating profit and earnings per share both showcased solid execution and the benefit of continued margin recovery from pricing actions across most businesses and end markets. and year-over-year operating cost reduction driven by our continual focus on Exalta Way. Free cash flow also improved notably from the prior year quarter. Exalta's review of strategic alternatives, initiated in late June, is also progressing. We do not have any incremental news to share with you today, but we will provide updates to the market as circumstances warrant. Turning to slide three, let's review a few operating highlights for the quarter. Consolidated organic and constant currency net sales were stable in Q3, in fact, increasing 0.4%. This growth outcome included ongoing favorable price mix effects of 3.8% this quarter, which included some of the best improvements we have seen in any quarter as a public company. Performance coatings net sales increased 0.7% before foreign currency and M&A-related impacts. Transportation coatings net sales were flat XFX, reflecting lower light vehicle production volumes offset by volume growth in our commercial vehicle and market. Price mix in light vehicle continued to show positive gains with an increase of 2.8% as we made ongoing progress with multiple OEM customers to offset persistent and ongoing raw material inflation impacting the business since 2017. This is now our fourth consecutive quarter with positive price mix including an acceleration in the last two quarters. We reported third quarter consolidated adjusted EBIT of $191 million, a 17% increase from last year's third quarter, driven principally by strong price-mix earnings drop-through, as well as from improved productivity and lower stock-based compensation expense. Volume headwinds, FX impacts, and modest variable cost inflation were partial offsets to the quarterly profit growth. Notably, our adjusted EBIT margin of 17.3% was a full 300 basis points higher year over year, and Exalta's margins broadly are approaching all-time highs since we have been an independent company, largely due to our success in recapturing lost pricing from 2017 to 2018. Exalta's consolidated fixed operating expense, excluding FX impacts, was also 14% lower in the third quarter of 2018. Our adjusted EBITDA margin of 22.5% has materially improved, now approaching the all-time high of 23.5% achieved in 2016, despite margins in light vehicles still lagging due to volume pressure, pricing headwinds from 2017, and uncaptured raw material inflation to date. Adjusted earnings per share for the quarter was 52 cents per share, which compared with 40 cents per share in the prior year quarter, with drivers consistent with those mentioned at the operating level. Looking at our end markets briefly, Exalt has refinished net sales increased 2.5% XFX in the quarter. We grew net sales XFX solidly across North America and EMEA, while Latin America and Asia Pacific were impacted by weaker macroeconomic conditions. Our refinish team continues to effectively offset variable cost inflation with appropriate price management to sustain the broader margins of this business. In volume terms, we continue to see moderate pressure globally, driven by a combination of distributor inventory management, continued structural volume reduction from the conversion to waterborne products, increasing body shop productivity and efficiency, which we drive with our customers every day, and by an element of broader economic weakness. Despite this, the business has seen continued share gains in many regions exhibited in our increase in total net customer shop count. In North America, we're seeing significant growth in our mainstream refinish markets as we've rolled out multiple product systems in recent years with great success. Our industrial end market net sales declined about 1% in the quarter, XFX, and before negative M&A-related impacts from the China joint venture sale. Drivers of this pullback include global volume weakness, with volumes down mid-single digits, largely offset by improved average price mix. The contraction, as with last quarter, correlates with global industrial production indicators, which remain pressured in many key countries and nearly all regions. Our overall execution remains solid, though, and we continue to drive for share gain via new product introductions and innovation, which may also help explain our lower rate of decline relative to many underlying macro-industrial indicators. Light vehicle net sales declined 0.8% XFX for the third quarter, reflecting lower global automotive production rates, most notably in China, though year-over-year comparisons have eased since China's market contraction began over a year ago. Lower net sales were also influenced by strike impacts in North America for the last half of September. IHS production forecasts for 2019 have been further reduced, now 14 months in a row for the global picture and now calling for a 5.8% global production decline for 2019 versus a 3.7% lower assumption as of July end. The updated global production guidance now includes a 5.8% reduction from EMEA, a 4.5% decline in North America, and a 6.5% decrease for Asia Pacific, including an 8.8% decrease in China. Despite this fundamental backdrop, we continue to execute well in our business, and we're working on multiple significant business opportunities for the 2020 to 2021 period. Additionally, line service revenues continue to grow, offering some offset to production volume pressure. Commercial vehicle net sales increased 2.9% XFX in Q3, including ongoing strong overall vehicle production rates in the Americas and solid demand for non-truck customers in most regions. Price mix, consistent with last quarter, was slightly down in the period, due largely to mixed effects this quarter. Regarding our balance sheet and cash flows, third quarter free cash flow was strong, and we're reconfirming our full year free cash flow targets of $430 to $470 million. We finished the quarter at 3.2 times net leverage, a significant improvement versus the 3.5 times at June 30th, as we continue to target lower overall leverage over time with a 2.5 times longer-term goal. In terms of innovation and investment highlights, in Refinish, we continue to launch several new Refinish products in North America, including Nason XL and the Challenger mainstream brands to support new distributor channels. Also, we will launch our new Speed Hacker sealer technology this month that will provide a VOC-friendly sealer to use with our premium waterborne base coats. In Industrial, we launched our new high thermal conductivity impregnating resin for energy solutions that lowers electric motor operating temperatures by 10 to 30%. We also continue to globalize key quill technologies, expanding the introduction of Durapon into the Asia Pacific marketplace. In transportation, we mark the third quarter of the Lumira Clearcoats global rollout. These 1K and 2K products represent Exalta's newest product line of high-performance clearcoats for the OEM market. and leverage our latest resin technology for improved appearance and enhanced scratch resistance while reducing cost and use. In terms of operating highlights, we completed the acquisition of UA-based Capital Paints in the quarter, which gives us a strong entrée into the Middle East in the powder business. Overall, we're pleased to continue to produce well-executed quarters year-to-date in 2019. We've seen persistent volume pressure across global coatings markets, along with some acceleration in FX headwinds this past quarter, which we have incorporated into our revised guidance. That said, much of the impact has been mitigated by ongoing productivity efforts, as well as by somewhat moderating variable cost inflation. Raw material headwinds have been abating in recent months, and in fact, we saw a modest year-over-year tailwind in the month of September, which also bodes well for coming quarters, given the mark on current commodity prices. We're very pleased that in the third quarter, we fully closed out the price-cost gap that developed since 2017 at the total company level. While an important achievement, we also acknowledge that light vehicle and certain industrial submarkets still have more to do in terms of gap closure, and we continue to discuss this important need with our customers in these end markets. In addition to focus on needing pricing adjustments, we also continue to work hard to improve our cost structure and productivity. Accordingly, we took another charge this quarter, totaling $29 million, which will help us reach our ExaltaWay cost savings goals, and we continue to make real-time adjustments to our cost structure and transportation codings to meet our broader financial objectives despite near-term cyclical pressures. I'll now turn the call over to Sean to review our financial results.

Thanks, Robert, and good morning. Turning to slide four, consolidated constant currency net sales decreased 1.4% year-over-year, including a 2% decrease in performance codings and a flat result in transportation codings. Excluding net negative divestiture-related impacts, consolidated net sales increased 0.4%, with performance codings posting a 0.7% increase. The top line result consistent with last quarter reflected robust positive price mix contribution, offset by volume pressure across all regions. Price mix was notably strong in performance coatings, including a component of mixed benefit and refinish, along with solid underlying price recapture. Transportation coatings price mix was also positive, including ongoing recapture in light vehicle for the fourth sequential quarter, offset slightly by weaker mix within commercial vehicle. FX translation was a 2% year-over-year net sales headwind for the period. The impact of FX translation at the profit level remains largely aligned with the overall corporate margins. Key sources of pressure included the euro, the renminbi, Argentinian peso, and pounds. Q3 adjusted EBIT of $191 million was a 17% increase from the prior year, and margins improved 300 basis points to 17.3%. driven by a combination of the price next drop-through benefit, as well as lower overall operating costs from continued productivity savings and lower stock-based compensation expense in the quarter. Partial offsets to these drivers included volume headwinds across most end markets, accelerating negative FX impact, and modest raw material inflation for the quarter. Turning to slide five, performance coding's third quarter net sales decreased 2% year-over-year, excluding a 2.3% negative FX impact and increased 0.7% excluding FX and net negative M&A related impacts. Drivers of this 0.7 organic constant currency growth included a 5% increase in average price mix, partially offset by a 4.3% buying decrease. Exalta's refinish end market produced Q3 constant currency net sales growth of 2.5% year over year, including improved price mix contribution in the mid single digits. Net sales growth XFX was led by North America and EMEA, while Latin America and Asia Pacific were more subdued in the period consistent with the second quarter. Volume decreased in the period globally, including distributor-level inventory adjustments, ongoing conversion to waterborne products, as well as macroeconomic weakness in some regions. Industrial and market net sales XFX decreased 8.4% year-over-year in the third quarter. but decreased only 0.9% excluding the China JV sale impact. This modest decline was driven by volume pressure in all regions, which aligns with global industrial production weakness, offset by solid gains and average price mix from all regions. Performance Coding's third quarter adjusted EBIT of $125 million increased 20% year-over-year with strong price mix contribution, the realization of productivity benefits as well as lower year-over-year stock-based compensation. partially offset by negative volume drop-through, FX impacts, and modest variable cost inflation effects. Adjusted EBIT margins of 17.3% increased 350 basis points year-over-year, reflecting price mix benefits and lower operating costs versus the prior year quarter. Turning to slide six, third quarter transportation coatings net sales were flat year-over-year before FX headwinds of 1.7%. Segment volumes decreased 1.5% offset in equal amount by price mix benefit despite moderate negative product mix impacts from commercial vehicle. Light vehicle third quarter net sales decreased 0.8% excluding a 1.8% FX headwind. Volumes decreased low to mid single digits overall driven by lower automotive production rates globally, but most notably in China, as well as by the two-week impact in September from strikes in North America which have continued into October. Average price mix remains positive, up 2.8%, reflecting ongoing price recapture associated with persistent raw material inflation over the previous two years. Commercial vehicle third quarter net sales increased 2.9% before FX headwinds of 1.2%, driven by solid overall vehicle demand globally, excluding China. Forecast updates for truck production have begun to moderate in recent months given ongoing order rate weakness in North America, which continues to reduce backlog and lead times in the region. Transportation Coatings Q3 adjusted EBIT of $37 million increased 45% versus $26 million in the prior year quarter. And associated margins of 9.7% increased over 300 basis points versus 6.6% in Q3 2018 as the benefits of improved price mix and lower operating expense were partially offset by volume declines and modest ongoing input cost inflation. Turning to slide seven, third quarter free cash flow totaled $198 million versus $96 million in Q3 2018. The notable increase was driven by stronger operating results and improved overall working capital outcomes. Lower CapEx also contributed about $8 million of the improvement. We ended the quarter with cash and cash equivalents of $767 million and a net debt balance of $3 billion versus $3.3 billion at June 30th end. Our net leverage ratio was 3.2 times versus 3.5 times at June 30th, primarily reflecting the stronger cash balance coupled with improved the latest 12 months adjusted EBITDA. Turning to slide eight, we've updated our financial guidance for 2019. For net sales, XFX, we now assume a decline of approximately 1% versus a flat expectation from our previous assumption, which incorporates slightly lower volume assumptions across most end markets, including a reduction in light vehicle build forecast, as well as ongoing global industrial demand slowness. Our new assumptions also reflect the North America OEM strikes, which are not fully expected to be made up in 2019. The net sales forecast continues to incorporate an approximate 1% negative impact from the China JV interest sale in May, and hence organic net sales before FX impact would essentially be flat. For as reported net sales, we expect to be around 4% lower year over year, including an approximate 3% FX headwinds versus approximately 2% in our prior assumption, and including the other impacts just noted. For adjusted EBIT and adjusted EPS, we have maintained our previous guidance, as well as seen offsetting benefits to net sales pressure with lower stock-based compensation expense. For adjusted EBITDA, we now expect to generate 940 to 960 million for the full year. This incorporates the drop-through effect of the top-line adjustments just mentioned, offset partly by accelerated cost reduction and moderately better input inflation outcomes versus our budget. DNA is also assumed to be $5 million lower principally due to FX translation impacts. We have maintained the range for income tax rates as adjusted, but we appear to be trending in the lower half of the range for the full year. For free cash flow, we do assume CapEx for the full year to come in around $130 million, which is $30 million lower than the previously contemplated amounts due largely to timing. We have also incorporated cash impacts for employee retention awards and costs associated with the strategic review of approximately $25 to $30 million. This concludes our prepared remarks. We would now be pleased to answer any questions. Operator, please open the lines for Q&A.

Thank you. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from the line of Laurent Fabre with Exane BNP Power Abuse. Please proceed with your questions.

Good morning, guys. I've got a couple of questions on the commercial side, please. So the first one, when we think about the weaker orders, I'm just wondering when do you think you will start to see lower volumes? Is that already in Q4, or do you think it's more for 2020? And then could you give us a bit more color on price mix in both the U.S., where it seems that it's still positive, and in Europe, where it seems that you have a bit of an issue there, and what is that issue? Thank you.

Yeah, Laurent, it's Chris. Thank you for the question. You know, I assume you're referring to commercial truck orders in your first question. And in that respect, you know, orders have been weak for some months now. Production volumes are expected to begin to moderate in the relative near term in that market.

And just to add on, as far as 2020, looking at class four through eight, you know, we're expecting approximately an 8% decline, at least where the the current forecasts are for 2020.

Thank you. And on the price mix?

So that was largely a mixed issue. We did see strong volumes in CV in the third quarter, opposite Q3 2018. We did have a slight mixed impact as far as lower average selling price. It wasn't that we were giving any sort of, you know, pricing back. It was more of a mixed issue for the quarter.

Thank you.

Your next question comes from the line of Gansham Punjabi with Baird. Please proceed with your question.

Hey, guys. Good morning. I guess first off on auto refinish and, you know, your call out on volume weakness there had a reference point on the impact from the economy slowing. Can you just give us a little bit more color on that? Which regions and where was the inventory optimization in that segment most pronounced, do you think?

Yeah, Gansham, overall in the refinished business, the overall business continues to perform quite well. As we highlighted, we did see global volumes down roughly low single digits due to some distributor inventory management. That would be predominantly in North America. And then as we've highlighted before, the structural volume reduction from the solvent to waterborne conversion, and given that MSOs buy more – waterborne, that also is a continual natural impact on on volume. And in terms of the demand due to the economic conditions, we saw that perhaps, you know, somewhat in each market, but perhaps more acutely in Europe.

That's helpful, Robert. And then just for my second question on, you know, 2020 parameters, I mean, obviously, there's a lot of variability on volumes, but How should we think about the flow-through effect of pricing, you know, from what you've already accomplished? And then also, how should we think about gross and net productivity realization in 2020?

Well, I think overall, if we look at 2020, we'll be providing in our December outlook call more clarity on 2020. But I think overall, as we look at the year, We see a pretty strong setup for a better year in terms of core volumes across our businesses. We continue to expect to outperform the market next year in each one of our end markets. The key driver of that is really the expectation that global auto builds will be stable. And we've started to see some signs of that, that the China market has already begun to stabilize. And with ongoing innovation-driven product introductions, and ongoing share capture in core refinish market, we see 2020 as a year of positive volume development. On the pricing side, we do expect to continue to achieve price, positive price mix next year that would drop to the bottom line. Thank you, Robert.

Your next question comes from the line of Christopher Parkinson with Please proceed with your question.

Good morning, guys. This is Harris Fine. I'm for Chris. Thanks for taking my question. When we think about industrial markets, can you just give us a walkthrough in terms of which verticals outperform the segment average versus where you're facing some challenges and which areas would you say you're the most bullish on moving forward?

So if we look at the industrial overall, we saw that sales decreased in the quarter about 1% XFX and excluding the impact of our former China powder joint venture. We did see volume pressure, as you know, from slower industrial markets, but we had strong price capture. And really for us, what's driving our outperformance relative to the market are our new product additions and also new customer acquisitions. If we look at the individual markets themselves, in oil, we are seeing volume down slightly, but we are achieving pretty attractive price mix in that market. Overall, in general industrial, we did see volume down somewhat in the mid to high single digits, but we also saw price up by the same amount in that market. Part of that is OEM-related in that some of those products, whether it's e-coat or whether it's metal coating systems, go into the different tiers there. In energy solutions, we did see volume down in that market, but price mix also up in that market. There, somewhat the demand was impacted by conditions in Europe as well as in China. And then in powder, We saw volume down in most regions, but again, with our price increases, price mix-up compensating for that, and we did see somewhat of slower conditions in Europe, in particular in powder. Wood, we saw volume down, low single digits, but price mix-up by a commensurate amount, and there really what we're seeing is that a lot of the new business gains that we're getting there and the higher selling prices are offsetting some of the core business volume challenges that are really a result of housing starts and remodel being a little bit soft. So, you know, overall, I think if we'll talk about that market, you know, our team is performing extremely well from a new customer acquisition and a new product introduction, which is allowing us to perform better than the overall market.

And you also mentioned before that you closed the price cost gap at the full company level. Just given the raw material environment, can you just help us think about how your pricing strategy may change moving forward? And do you have any non-raw material cost buckets that are still maybe creating some pressure?

Well, I think as we think about overall price mix, I mean, we're constantly developing new technologies. We're constantly launching new products. We're constantly launching new colors. And all of those have an upward impact on price, and we would expect that to continue as we move forward in the business. And in terms of the raw environment for next year, it's probably a little bit too early to call it, but I think we see it, you know, a fairly stable raw material pricing environment, at least at this stage. Thank you.

Your next question comes from the line of David Begleiter with Deutsche Bank. Please proceed with your question.

Hi, this is David Huang here for David. I guess first, just on refinish volume, what's your expectation for Q4 volume, and do you expect any additional inventory destocking in Q4?

Yeah, we're not expecting any material destocking. Q4 of a Q4 volume. currently out looking essentially a flat volume. So no declines heading into Q4.

And then I guess another question on your transportation segment. I guess what's your expectation for all production Q4 in 20 and what's your target organic growth rate?

So I think you're going to see similar trends Q3 to Q4. The Q4 comp becomes a little bit easier as we start to see, you know, production builds down in Q4 of 2018. But by and large, you know, we're currently following IHS guidance, which is now down 5.8% for the year.

Thank you.

Your next question comes from the line of PJ Juviker with Citi Group. Please proceed with your question.

Good morning. This is Eric Petrion for PJ. Longer term, what's your refinished volume growth outlook as MSOs convert to waterborne technology and you've seen lower collisions?

We look at our refinish business and as we said before, in the medium and in long term, you know, it's a business where we expect overall net sales to grow over time. We work with our customers every single day to help them be more efficient and to help them be more productive. Obviously, that requires a pretty significant technology investment and technology support on our side. And we are recognized for that value in pricing. So as you look at the market and you think about over a period of time in terms of market growth, with MSOs, we are, you know, extremely well positioned with MSOs. Expect that sales channel for us to continue to grow. And we'll continue to support that channel as well as continuing to support independent and small body shops as well. So longer term, I think we expect net sales to continue to increase in the refinish market.

Thank you. And secondly, you noted a modest tailwind in September from raw materials, and that's expected to help offset the lower light vehicle production. So I was just wondering, of the basket of raw materials, where did you see the greatest tailwind? Was it resins, solvents, TiO2, or could you elaborate on that?

Sure. So we saw solvents, monomers, resins as flat or ever so slightly down. And then we continued to see price inflation in isocyanates and in pigments. So again, that did give us, you know, some confidence that we might be potentially at an inflection point. However, uncertainty around the Chinese tariffs are also very relevant to what the outlook is going to be for next year.

One clarification point on the ROLs. So for the quarter as a whole, we actually had a headwind. What we saw in September specifically is that inflection point that Robert just commented on.

Thank you.

Your next question comes from with RBC Capital Markets. Please proceed with your question.

Great. Thanks. Good morning. I'm just kind of thinking about 2020. Maybe you can just reiterate kind of some of the drivers that you see unfolding there. You know, any improvement that you'd expect in China? And then I guess as far as OEM, have you been, you know, given the progress, are you fully caught up on price cost there? Thanks.

I think as we look at OEM for next year, as we talked about, you know, we are seeing signs that the China market is beginning to stabilize. We don't believe that China will experience a prolonged cyclical downturn like we may have seen in other markets historically. So I think we're fairly optimistic on the China market, you know, overall as we go forward.

I was just going to answer the other question in regards to transportation. So when you look specifically at light vehicle, Robert did comment in his opening remarks, you know, we're largely caught up at the total company level. We're still trailing when you look at that price-cost equation within light vehicle.

And then next, just wondering on the cost reduction front, do you still see that as kind of an ongoing $50 million opportunity, or is there any upside or downside on that front? Thanks.

Yeah, so we're sticking with our original Exaltaway 2, $50 million a year. You know, if we were to see an uptick in inflationary pressure, you know, we may expedite some of those initiatives, but that's something we're working on thoroughly right now as we head into 2020. And we'll be providing more guidance once we get into December as far as the guidance update.

Great. Thanks.

Your next question comes from the line of Vincent Andrews with Morgan Stanley. Please proceed with your question.

Hi, guys. This is Steve Haynes on for Vincent. Maybe in regard to customer inventories outside of the refinished business, could you talk about where you see those levels and, you know, if there's any anticipation of kind of a restock maybe in 2020 if they are on the lighter side of things? Thank you.

Outside of refinish, in our transportation markets and light vehicle and commercial vehicle, our customers carry a relatively small amount of inventory. So there's not really a risk there. And then from an industrial perspective, some of those sales are direct and some of those sales are through distribution. But in general, folks in industrial distribution tend not to carry overly high levels of inventory. So we wouldn't expect to see or have any major concerns in those other markets.

Okay. Thank you.

Your next question comes from Josh Spector with UBS. Please proceed with your question.

Yeah. Hey, guys. So just a question, as your cash continues to grow and you're in the midst of this strategic review process, do you have any plans for any cash allocation kind of over the next few months here, or is that just going to build until you get to some resolution?

Yeah, certainly there'll be some decisions coming out of the strategic review process as far as capital deployment, but, you know, we continue to focus on, you know, what we've previously communicated, you know, that being M&A, organic growth opportunities, and looking at opportunistic share buyback, followed by potentially paying down debt. Debt today is sitting below 3.6% as far as weighted average cost. So that is an extremely attractive at the moment, but the other priorities remain the same.

Okay. And I mean, I know you're not going to comment on anything with the strategic process itself, but if the result of that is do nothing, how are you thinking about what the Exalta itself strategy is over the next couple of years? Does anything kind of change in your mind or anything you consider doing differently?

I think our strategy is very well defined in terms of what we're trying to achieve overall as a company and each one of our end markets wouldn't expect any major changes in strategic direction coming out of the strategic review process itself.

Okay, thanks.

Your next question comes from Mike Sison with Wells Fargo. Please proceed with your question.

Hey guys, nice quarter. When you think about 2020 and volumes do recover, which it's been quite some time since we had volume growth for anybody, but can you maybe walk us through the leverage needs of the segments? Maybe it should be stronger than it's been in the past. You've got pricing. You've got cost savings. And just maybe give us a feel for that as we head into 2020.

Mike, can you clarify a little bit? You said what are the leverage needs?

If you get volume growth, you know, what is the earnings leverage from volume growth going forward as you head into 2020?

Yeah, Mike, so we provide annual guidance. And the reason for that is that each annual guide period is going to incorporate the drop through of volume and incremental margin that we'd expect to see from that, as well as any one-off investments or period unique cost elements that would fall in the period. So generally, we have commented that a business like ours can see very strong drop-through of volume naturally given the high gross margin business that we have. But more specifically, our annual guidance is meant to capture, you know, all elements in the period. But, you know, as most people understand, the coding business is a strong business from the standpoint of incremental margin potential.

Okay, and then just a quick follow-up and refinish. It's been a while since that market seems to have grown. What do you think needs to happen? I know you're coming out with a lot of good new products and such. What are you looking for in terms of the market to show some growth going forward?

Well, I think overall at an absolute value level, we've seen attractive growth in refinish, and we achieved attractive growth in the third quarter. We expect that to continue. We also continue our focus on building out our mainstream business and also in penetrating countries around the world where our market share in those individual countries might be lower than our global and our regional share. So I think we're pretty optimistic about the top-line growth opportunities in that business.

Great. Thank you.

Your next question comes from the line of Steve Byrne with Bank of America, Maryland. Please proceed with your question.

Hi. This is Luke Washer on for Steve. I wanted to talk about the volume slowdown in your refinish business. With the slowdown, did you see any kind of lower collision activity during the quarter or was that mostly the stocking and the other factors you said?

Yeah, it was largely the other factors. You know, collision rates within the quarter, you know, weren't a major driver. It was really the continued conversion of solvent to water as well as, you know, some destocking. And again, you know, Robert commented, but we did see, you know, more of a macro impact in the European region.

Great. Thanks. And just one more on the variable cost inflation. Could you remind us how much of your variable costs are raw materials versus, say, labor and distribution? And how would you characterize kind of the labor and distribution costs year over year this quarter?

Labor and distribution, you know, relatively flat. At the COGS level, variable COGS is about 60%, just for perspective.

Great. Thank you.

Your next question comes from the line of Bob Court with Goldman Sachs. Please proceed with your question.

Hi, guys. It's Anthony Walker on for Bob. In light of the macro headwinds, your volume performance in light vehicle I thought was pretty impressive. Can you talk about how impactful the strikes you referenced were during the quarter and then how much share did you guys gain and how much of that contributes to quarterly performance? Thanks.

Yeah, so we're not going to get down to the granular level as far as quantifying the impacts on the strikes. I would give you some incremental. As far as the impacts we saw in Q3, we're expecting similar impacts in Q4. Although the strikes are essentially doubled in time, we are expecting to make up some of that difference in the back half of the quarter.

Great. And then just if you could comment on your ability to take share within the light vehicle segment leading to some, I think, outgrowth relative to what the bill forecast was and what you guys set up.

I think, you know, it continues to be, you know, we have very good competitors in that market with good technologies. We have a very strong product portfolio. Our line service and technical support in And I think as we continue to compete in that end market, we will continue to leverage both our product technology as well as our service and support.

Your next question comes from the line of Jeff Zekowskis with J.P. Morgan. Please proceed with your question.

Good morning. It's Silke Kukla, Jeff. How are you?

Hey, good morning, Silke.

Hi. I was wondering whether I could follow on to, like, the variable cost question that was asked previously. You said, like, 60% of your cogs are variable costs, and even if those were up 5% this quarter, you know, if that's like a raw material headwind, if you really have that much, you know, that's only maybe, you know, $20 million, right? but your prices were up 3.8%. And so that's really an incremental 44 million on your sales base. And so it does look like whatever the price cost realization is, like it's definitely much better, right, because you've had these really nice gross margin expansions.

I think Sophia, Sean mentioned, you know, although we did see, You know, some flattening or some attenuating of raw material inflation in September overall for the quarter, it was still a headwind for us. But you are correct, you know, from an actual variable contribution margin perspective, the strong performance that we had in price mix dropped very well to the bottom line.

And, Silke, I would add that you're somewhat overstating prospective variable cost headwinds in the quarter. It was not to the magnitude that you suggest, but certainly the magnitude of price-cost is meaningful and certainly overcomes the variable cost headwind.

So when you look at your gross margin expansion, do you think half of it comes from productivity improvements and maybe half of it from whatever the... raw material versus price realizations are?

Yeah, I would say it's probably heavier weighted for its price mix when you look at the quarter in particular. The variable cost, headwinds in the quarter, the way to think about it, it's probably low single digits at the EBIT level to give some context. So it was really a price mix story at the gross margin level.

That's helpful. And my second question is when I look at your transportation coatings results. The overall volumes were down 1.5%. And maybe the transit, like the light vehicle volumes being down, I don't know, maybe like 3% to 4%, something like that, which is much better performance than what your competitors reported. Do you think all of that is due to market share gains or some of it is due to a different geographic split? Is there like any insight that you have into that?

We did perform relatively better in the quarter. I think, in fairness, it's largely a function of the particular regional mix, the customer mix, and then the actual product platforms that we were on for the quarter.

Do you think it has more to do with the regional mix and less to do with market share gains?

Yeah, it was more of a regional mix. You know, North America was actually, you know, fairly flat year over year. You know, had it not been for the strikes, you know, we actually would have had a positive volume story. So it's more on the regional side than specific customer wins.

Okay, that's helpful. Thanks very much.

Your next question comes from the line of John McNulty with BMO Capital Markets. Please proceed with your question.

Hi guys, this is Colton being on for John McNulty. Thanks for taking my question. Just a follow up on light vehicle volumes. I was wondering, have you seen any impact there from the switch over in emission standards from China 5 to China 6? Or do you expect to see any impact in 4Q? I know it had been a bit of a headwind in some businesses in the first half of the year.

Yeah, that's a fair observation. We are seeing, as you know, the China 6 regulations being pulled about a year ahead to, you know, we're pulled about a year ahead to July 2019 in several cities. But if you look at it, most of the international OEM production is nearly 100% compliant. That's really giving those players an edge over the China domestics while they still catch up. Okay, thank you. So to the extent that someone is more heavily weighted to the international players as opposed to the domestics, you are seeing a benefit.

Okay, so it would have been a slight benefit in the quarter then?

Relative to those other, well, we're talking about light vehicle and customers, but those light vehicle and customers that are non-domestic are seeing a benefit because they've met those standards sooner.

Okay, great. Thank you.

Your next question comes from the line of Lawrence Alexander with Jefferies. Please proceed with your question.

Hi. Good morning, everyone. You mentioned, I think, that higher price and product mix contributed 3.8% to sales. I was wondering, is there any way to quantify how much of this 3.8% was driven by price versus mix?

So when you look across the end markets within performance, it's more towards a 50-50 split. Light vehicles certainly, you know, much heavier weighted towards price compared to mix. And CVA, as I stated, that was a negative mix story and not so much to do with actual price.

Okay, great. And then my second question was with margins reaching all-time highs, I was wondering where kind of do we go from here in terms of cost-cutting and productivity gains?

Well, just to clarify, I think all-time high margins were in the middle of 2016 at 23.5% EBITDA margins. We achieved 22.5% EBITDA margins in this quarter. I think as we look forward on the transportation side, there's much more of the price gap that we still would like to close as we go forward. And as we talked about in terms of offsetting cost inflation each year with Exaltaway initiatives, as well as additional Exaltaway initiatives to go beyond that and reduce our structural base costs, those continue to be an area of keen focus.

Okay. Thanks a lot.

Your final question comes from Paritosh Misra with Barenberg. Please proceed with your question.

Thanks. Thanks for taking my question. So given where we are in the light vehicle business with volumes under pressure, is there any color you could provide on margins in that business versus your industrial business? In other words, if light vehicle is still a higher margin subsegment versus industrial, of course it would be great if you could give us a range.

Yeah, we do not provide information about the profitability of our end markets. At a segment level, however, our performance coatings segment margins are higher than our transportation coating segment margins.

Got it. And then the last one, on the CAPEX, and I apologize if I missed that, CAPEX forecast went down because of timing issues. So which project was that?

We actually haven't stated all the projects. There's just been, you know, a general delay in some of the spending. The original guidance was at 160, and that's what you're saying, bring it down to 130. Some of those project delays will just slip into 2020. I wouldn't necessarily expect a huge ramp up in CapEx next year. It's something we're working towards, and we'll provide incremental guidance for 2020 once we get into December.

Fair enough. Thanks, guys.

Ladies and gentlemen, we have reached the end of the question and answer session. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.