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Edited Transcript of AXTA earnings conference call or presentation 24-Oct-19 12:00pm GMT

Q3 2019 Axalta Coating Systems Ltd Earnings Call

Philadelpia Oct 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Axalta Coating Systems Ltd earnings conference call or presentation Thursday, October 24, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher H. Mecray

Axalta Coating Systems Ltd. - VP of IR, Treasury & Strategy

* Robert W. Bryant

Axalta Coating Systems Ltd. - CEO & Director

* Sean M. Lannon

Axalta Coating Systems Ltd. - Senior VP & CFO

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Conference Call Participants

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* Anthony Walker

Goldman Sachs Group Inc., Research Division - Research Analyst

* Arun Shankar Viswanathan

RBC Capital Markets, LLC, Research Division - Analyst

* Colton Anderson Bina

BMO Capital Markets Equity Research - Associate

* Eric B Petrie

Citigroup Inc, Research Division - Senior Associate

* Ghansham Panjabi

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Harris J. Fein

Crédit Suisse AG, Research Division - Research Associate

* Joshua David Spector

UBS Investment Bank, Research Division - Equity Research Associate - Chemicals

* Laurence Alexander

Jefferies LLC

* Laurent Guy Favre

Exane BNP Paribas, Research Division - Research Analyst

* Luke Emerson Washer

BofA Merrill Lynch, Research Division - Research Analyst

* Michael Joseph Sison

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Paretosh Misra

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Silke Kueck-Valdes

JP Morgan Chase & Co, Research Division - VP

* Steven Kyle Haynes

Morgan Stanley, Research Division - Research Associate

* Yifei Huang

Deutsche Bank AG, Research Division - Research Associate

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to Axalta's Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Today's call is being recorded and replays will be available through October 30. Those listening after today's call should please note that the information provided in the recording will not be updated and therefore may no longer be current.

I will now turn the call over to Chris Mecray. Please go ahead, sir.

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Christopher H. Mecray, Axalta Coating Systems Ltd. - VP of IR, Treasury & Strategy [2]

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Good morning. This is Chris Mecray, 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 Axalta.

Joining me today are Robert Bryant, CEO; and Sean Lannon, CFO.

We released our financial results this morning and posted a slide presentation to the Investor Relations section of the website at axalta.com, which we'll be referencing during this call.

Both our prepared remarks and discussion today may contain forward-looking statements reflecting the company's current view of future events and a 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.

The 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.

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [3]

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Good morning, and thank you for joining us. Axalta 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 Axalta participates, Axalta'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 Axalta Way.

Free cash flow also improved notably from the prior year quarter. Axalta'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 3. 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 ex FX, reflecting lower Light Vehicle production volumes, offset by volume growth in our Commercial Vehicle end 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 2 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 Axalta'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.

Axalta'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 Vehicle 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 $0.52 per share, which compared with $0.40 per share in the prior year quarter, with drivers consistent with those mentioned at the operating level.

Looking at our end markets briefly. Axalta's Refinish net sales increased 2.5% ex FX in the quarter. We grew net sales ex FX 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 rolled out multiple product systems in recent years with great success.

Our Industrial end market net sales declined about 1% in the quarter ex FX 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 in 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% ex FX 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 on 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% ex FX in Q3, including ongoing strong overall vehicle production rates in the Americas and solid demand for nontruck customers in most regions. Price mix, consistent with last quarter, was slightly down in the period, due largely to mix 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 million to $470 million. We finished the quarter at 3.2x net leverage, a significant improvement versus the 3.5x at June 30, as we continue to target lower overall leverage over time, with a 2.5x longer-term goal.

In terms of innovation and investment highlights, in Refinish, we continue to launch several new Refinish products in North America, including NasonXL and the Challenger mainstream brands to support new distributor channels. Also, we will launch our new

Spies Hecker sealer technology this month that will provide a VOC-friendly sealer to use with our premium waterborne basecoats.

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 continued to globalize key coil technologies, expanding the introduction of Durapon into the Asia Pacific marketplace.

In Transportation, we marked the third quarter of the Lumeera clearcoats global rollout. These 1K and 2K products represent Axalta'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 in use.

In terms of operating highlights, we completed the acquisition of UAE-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 headwind this past quarter, which we've 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 continued 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 Axalta Way cost savings goals, and we continue to make real-time adjustments to our cost structure in Transportation Coatings 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.

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [4]

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Thanks, Robert, and good morning.

Turning to Slide 4. Consolidated constant currency net sales decreased 1.4% year-over-year, including a 2% decrease in Performance Coatings and a flat result in Transportation Coatings. Excluding net negative divestiture-related impacts, consolidated net sales increased 0.4%, with Performance Coatings 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 mix benefit in 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 at 2% year-over-year net sales headwinds 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 pound.

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 mix drop-through benefit as well as lower overall operating cost 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 5. Performance Coatings third quarter net sales decreased 2% year-over-year excluding a 2.3% negative FX impacts, 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% volume decrease. Axalta'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 ex FX 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 end-market net sales ex FX 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 in average price mix from all regions.

Performance Coatings 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 6. Third quarter Transportation Coatings net sales were flat year-over-year before FX headwinds of 1.7%. Segment volumes decreased 1.5%, offset an 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 2-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 materials inflation over the previous 2 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 7. 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 30 end. Our net leverage ratio was 3.2x versus 3.5x at June 30, primarily reflecting a stronger cash balance, coupled with improved latest 12 months adjusted EBITDA.

Turning to Slide 8. We have updated our financial guidance for 2019. For net sales ex FX, we now assume a decline of approximately 1% versus the flat expectation from our previous assumption, which incorporates slightly lower volume assumptions across most end markets including a reduction in Light Vehicle build forecasts 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 headwind 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 we've seen offsetting benefits to net sales pressure with lower stock-based compensation expense. For adjusted EBITDA, we now expect to generate $940 million to $960 million for the full year. This incorporates the drop-through effects of the top line adjustments just mentioned, offset partly by accelerated cost reduction and moderately better input inflation outcomes versus our budget. D&A 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 the 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 from employee retention awards and costs associated with the strategic review of approximately $25 million to $30 million.

This concludes our prepared remarks. We will now be pleased to answer any questions. Operator, please open the lines for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Laurent Favre with Exane BNP Paribas.

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Laurent Guy Favre, Exane BNP Paribas, Research Division - Research Analyst [2]

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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 you have a bit of an issue there. And what is that issue?

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Christopher H. Mecray, Axalta Coating Systems Ltd. - VP of IR, Treasury & Strategy [3]

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

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [4]

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And just to add on, as far as 2020, looking at Class 4 through 8, we're expecting approximately an 8% decline, at least where the current forecasts are for 2020.

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Laurent Guy Favre, Exane BNP Paribas, Research Division - Research Analyst [5]

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And on the price mix?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [6]

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

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Operator [7]

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The next question comes from the line of Ghansham Panjabi with Baird.

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Ghansham Panjabi, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [8]

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I guess first off on auto Refinish and your callout on volume weakness there. It 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?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [9]

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Yes, Ghansham. Overall, in the Refinish 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 was a continual natural impact on volume. And in terms of the demand due to the economic conditions, we saw that perhaps somewhat in each market, but perhaps more acutely in Europe.

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Ghansham Panjabi, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [10]

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That's helpful, Robert. And then just for my second question on 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 on -- from what you've already accomplished? And then also how should we think about gross and net productivity realization in 2020?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [11]

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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 as -- 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 that is really the expectation that global auto builds will be stable. And we've started to see some signs of that, but 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.

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Operator [12]

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Your next question comes from the line of Christopher Parkinson with Crédit Suisse.

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Harris J. Fein, Crédit Suisse AG, Research Division - Research Associate [13]

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This is Harris Fein on for Chris. When we think about industrial end markets, can you just give us a walk-through in terms of which verticals outperformed the segment average versus where you're facing some challenges? And which areas would you say you're the most bullish on moving forward?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [14]

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So if we look at the industrial overall, we saw that sales decreased in the quarter about 1% ex FX and excluding our -- the impact of our former China product 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 coil, 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 repair and remodel being a little bit soft. So overall, I think if we talk about that market, 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.

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Harris J. Fein, Crédit Suisse AG, Research Division - Research Associate [15]

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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 if they are -- and do you have any non-raw material cost buckets that are still maybe creating some pressure?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [16]

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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 a fairly stable raw material pricing environment at least at this stage.

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Operator [17]

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

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Yifei Huang, Deutsche Bank AG, Research Division - Research Associate [18]

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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?

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [19]

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Yes. We're not expecting any material destocking Q4-over-Q4. We're currently outlooking essentially a flat volume. So no declines heading into Q4.

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Yifei Huang, Deutsche Bank AG, Research Division - Research Associate [20]

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

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [21]

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

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Operator [22]

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Your next question comes from the line of P.J. Juvekar with Citigroup.

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Eric B Petrie, Citigroup Inc, Research Division - Senior Associate [23]

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This is Eric Petrie on for P.J. Longer term, what's your Refinish volume growth outlook as MSOs convert to waterborne technology and you're seeing lower collisions?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [24]

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We look at our Refinish business in -- as we said before, in the medium and long term, 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 recognize 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 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.

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Eric B Petrie, Citigroup Inc, Research Division - Senior Associate [25]

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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 out of the basket of raw materials, where did you see the greatest tailwind? Was it resins, solvents, PiO2? Or could you elaborate on that?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [26]

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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 pigments. So again, that did give us 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.

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [27]

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

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Operator [28]

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Your next question comes from the line of Arun Viswanathan with RBC Capital Markets.

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Arun Shankar Viswanathan, RBC Capital Markets, LLC, Research Division - Analyst [29]

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I'm just kind of thinking about 2020. Maybe you can just reiterate kind of some of the drivers that you see unfolding there. Any improvement that you would expect in China? And then I guess as far as OEM, have you been -- given the progress, are you fully caught up on price-cost gap?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [30]

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Yes. I think as we look at OEM for next year, as we talked about, we are seeing signs of the China market as 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 are fairly optimistic on the China market overall as we go forward.

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Arun Shankar Viswanathan, RBC Capital Markets, LLC, Research Division - Analyst [31]

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And...

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [32]

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And just to add to this...

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Arun Shankar Viswanathan, RBC Capital Markets, LLC, Research Division - Analyst [33]

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Yes. Price.

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [34]

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I was 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, 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.

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Arun Shankar Viswanathan, RBC Capital Markets, LLC, Research Division - Analyst [35]

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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?

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [36]

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Yes. So we're sticking with our original Axalta Way II, $50 million a year. If we were to see an uptick on inflationary pressure, we may expedite some of those initiatives. But that's something we are working on thoroughly right now as we head into 2020. And we'll be providing more guidance once we go into December as far as the guidance update.

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Operator [37]

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

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Steven Kyle Haynes, Morgan Stanley, Research Division - Research Associate [38]

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

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [39]

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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.

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Operator [40]

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The next question comes from the line of Josh Spector with UBS.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [41]

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So just a question, as your cash continues to grow in your -- in the midst of the 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?

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [42]

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Yes. Certainly, there will be some decisions coming out of the strategic review process as far as capital deployment. But we continue to focus on what we previously communicated, that being M&A, organic growth opportunities, I mean looking at opportunistic share buyback, followed by potentially paying down debt. Debt today, it's sitting below 3.6% as far as weighted average cost, so that isn't extremely attractive at the moment, but the other priorities remain the same.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [43]

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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 Axalta itself strategy is over the next couple of years? Does anything kind of change in your mind? Or anything you consider doing differently?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [44]

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

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Operator [45]

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The next question comes from the line of Mike Sison with Wells Fargo.

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Michael Joseph Sison, Wells Fargo Securities, LLC, Research Division - Senior Analyst [46]

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Nice quarter. When you think about 2020 and volumes do recover, which has been quite some time since we had volume growth for anybody. But can you maybe walk us through the leverage needs of the segment, if 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.

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Christopher H. Mecray, Axalta Coating Systems Ltd. - VP of IR, Treasury & Strategy [47]

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

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Michael Joseph Sison, Wells Fargo Securities, LLC, Research Division - Senior Analyst [48]

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

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Christopher H. Mecray, Axalta Coating Systems Ltd. - VP of IR, Treasury & Strategy [49]

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Yes, 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 all elements in the period, but as most people understand the coatings business is a strong business from the standpoint of incremental margin potential.

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Michael Joseph Sison, Wells Fargo Securities, LLC, Research Division - Senior Analyst [50]

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Okay. And then just a quick follow-up on 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 new good products and such -- what are you -- where are you looking for in terms of the market to show some growth going forward?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [51]

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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.

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Operator [52]

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Your next question comes from line of Steve Byrne with Bank of America Merrill Lynch.

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Luke Emerson Washer, BofA Merrill Lynch, Research Division - Research Analyst [53]

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This is Luke Washer on for Steve. I wanted to talk about the volume slowdown in your Refinish business. Was the slowdown -- did you see any kind of lower collision activity during the quarter? Or was that mostly destocking and the other factors you said?

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [54]

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

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Luke Emerson Washer, BofA Merrill Lynch, Research Division - Research Analyst [55]

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Great. 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 cost year-over-year this quarter?

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [56]

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The labor and distribution, relatively flat at the COGS level, variable COGS at about 60%, just for perspective.

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Operator [57]

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Your next question comes from the line of Bob Koort with Goldman Sachs.

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Anthony Walker, Goldman Sachs Group Inc., Research Division - Research Analyst [58]

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This is 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 how much share did you guys gain? And how much of that contributes to the quarterly performance.

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [59]

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Yes. 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.

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Anthony Walker, Goldman Sachs Group Inc., Research Division - Research Analyst [60]

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All right. And then just if you could comment on your ability to take share both on the Light Vehicle segment leading to some, I think, outgrowth relative to growth in (inaudible)

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [61]

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I think it continues to be -- we have good -- very good competitors in that market with good technologies. We have a very strong product portfolio. Our line service and technical support in that business is some of the best in the industry. 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.

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Operator [62]

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Your next question comes from the line of Jeff Zekauskas with JPMorgan.

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Silke Kueck-Valdes, JP Morgan Chase & Co, Research Division - VP [63]

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It's Silke Kueck for Jeff. I was wondering whether you 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, if that's a raw material headwind, if you really have that much, that's only maybe $20 million, 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 the -- whatever the price-cost realization -- like it's definitely much better, right, because you've had these really nice gross margin expansion. Or maybe...

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [64]

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I think, Silke, as Sean mentioned, although we did see 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 from an actual variable contribution margin perspective. The strong performance that we had in price mix dropped very well to the bottom line.

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Christopher H. Mecray, Axalta Coating Systems Ltd. - VP of IR, Treasury & Strategy [65]

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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.

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Silke Kueck-Valdes, JP Morgan Chase & Co, Research Division - VP [66]

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

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [67]

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Yes. I would say it's probably heavier weighted towards price mix when you look at the quarter in particular. The variable cost headwinds in the quarter, the way to think about, 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.

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Silke Kueck-Valdes, JP Morgan Chase & Co, Research Division - VP [68]

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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 that Bryant said like the Light Vehicles volumes being down, I don't know, maybe like 3% to 4%, something like that. And -- 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?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [69]

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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.

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Silke Kueck-Valdes, JP Morgan Chase & Co, Research Division - VP [70]

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

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [71]

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Yes. It was more of a regional mix. North America was actually fairly flat year-over-year. And had it not been for the strikes, we actually would have had a positive volume story, so it's more on the regional side than specific customer wins.

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Operator [72]

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The next question comes from the line of John McNulty with BMO Capital Markets.

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Colton Anderson Bina, BMO Capital Markets Equity Research - Associate [73]

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This is Colton Bina on for John McNulty. Just a follow-up on Light Vehicle volumes. I was wondering have you seen any impact there from the switchover 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.

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [74]

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Yes. That's a fair observation. We are seeing, as you know, the China 6 regulations being pulled about a year ahead to -- we are 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. So to the extent that someone is more heavily weighted to the international players as opposed to the domestics, you're seeing a benefit.

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Colton Anderson Bina, BMO Capital Markets Equity Research - Associate [75]

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Okay. So it would have been a slight benefit in the quarter then?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [76]

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Relative to those other what we're talking about Light Vehicle end customers, but those Light Vehicle end customers that are nondomestic are seeing a benefit because they've met those standards sooner.

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Operator [77]

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Your next question comes from the line of Laurence Alexander with Jefferies.

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Laurence Alexander, Jefferies LLC [78]

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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?

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [79]

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

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Laurence Alexander, Jefferies LLC [80]

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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?

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [81]

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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 is 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 Axalta Way initiatives as well as additional Axalta Way initiatives to go beyond that and reduce our structural base costs, those continue to be an area of keen focus.

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Operator [82]

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Your final question comes from Paretosh Misra with Berenberg.

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Paretosh Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [83]

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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 a still higher-margin subsegment versus Industrial? Of course, it would be great if you could give us a range.

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Robert W. Bryant, Axalta Coating Systems Ltd. - CEO & Director [84]

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Yes. 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 Coatings segment margins.

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Paretosh Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [85]

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Got it. And then 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?

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Sean M. Lannon, Axalta Coating Systems Ltd. - Senior VP & CFO [86]

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We actually haven't stated all the projects. There's just been a general delay in some of the spending. The original guidance was at $160 million and that's what you're seeing, bringing it down to $130 million. 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.

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Operator [87]

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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.