Ladies and gentlemen, thank you for standing by, and welcome to the Axalta Fourth Quarter and Full Year 2018 Earnings Conference Call. All participants will be in a listen-only mode. A question and answer session will follow the presentation by management. Today's call is being recorded, and replays will be available through February sixth. 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.
Thank you. Good morning. This is Chris Mecray, VP of Investor Relations. We appreciate your continued interest in Axalta, and welcome you to our fourth quarter and full year 2018 financial results conference call. Joining me today are Robert Bryant, CEO, and Sean Lannon, CFO. This morning, we released our quarterly financial results and posted a slide presentation to the investor relations section of our website at axalta.com, which we'll be referencing during this call. Both our prepared remarks and discussion today may contain forward-looking statements reflecting the company's current view of future events and the potential effect on Axalta's operating and financial performance. These statements involve uncertainties and risks, and actual results may differ materially from those forward-looking statements. Please note that the company is under no obligation to provide updates to these forward-looking statements. This presentation also contains various non-GAAP financial measures.
In the appendix, we've included reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information regarding forward-looking statements to non-GAAP financial measures, please refer to our filings with the SEC. I'll now turn the call over to Robert.
Good morning, everyone. Today, I'm pleased to share with you our financial results for the fourth quarter and full year, some key operational highlights, and a few changes we'll be making to our financial reporting basis and presentation consistent with our evolution as a public company and based on shareholder feedback. Our fourth quarter results met our previously communicated ranges for 2018 guidance on both the top and bottom lines, with fourth quarter organic net sales growth of over 2% and adjusted EBITDA of $235 million. We also exceeded our free cash flow expectations for the fourth quarter, which generated a full-year result of $362 million compared to our October guidance range of $330 million-$350 million. Customer demand and overall business trends remain generally consistent with our last quarterly update in October.
We saw ongoing organic net sales growth in our Refinish and Industrial end markets, strong continued price recapture in Performance Coatings to offset input inflation, and positive volume in North America Light Vehicle. We also saw the first reported quarter in over a year with positive price mix in Transportation, which is the first step in showing progress on our global efforts to offset variable cost inflation in this segment. We anticipate ongoing stability in each of these items looking forward into 2019. On the flip side, we've witnessed ongoing auto production slowness in China, as well as signs of reduced overall business activity in Europe. Overall, we're satisfied with our 2018 results, especially considering the headwinds from inflation, foreign exchange, and Light Vehicle pricing. Some of these headwinds will persist, including expected inflation impact to the P&L at least through the first half of 2019.
We're encouraged that we seem to be past the peak in some aspects of the inflation effect, while FX impacts appear sequentially stable. Turning to slide three, I'd like to review some highlights from the quarter. We grew Q4 net sales by 2.7% year-over-year, excluding the impact of foreign exchange, including substantial benefit from improved price and mix in the period. Net sales in Performance Coatings increased an impressive 6.4% before FX, with comparable growth from both Refinish and Industrial end markets. This growth came largely from improved price mix in the period. Volumes were stable globally, but with some regionally specific variations, including some slowing in Europe within both end markets. In Transportation Coatings, a net sales decrease in the low single digits was split between the Light Vehicle and Commercial Vehicle end markets.
One encouraging aspect in this segment was a reported increase in price mix at 0.8%, which was the first positive Transportation price mix metric in the last nine quarters. Though it included some mix benefits in the period. We also saw some volume growth in North America, though this was more than offset by lower demand in China and continued production curtailment in Europe, still being attributed to a large extent by emission testing headaches associated with the transition from diesel to gasoline engines. Shifting to adjusted EBITDA, we achieved $235 million for the quarter. Even sequentially, though below last year's $245 million, driven by double-digit inflation in variable costs at the adjusted EBITDA level and somewhat slower Light Vehicle volumes, offset partially by price mix benefits. This was coupled with the impact of foreign exchange drop through and inflation from sources including logistics and packaging contained in operating expense.
Adjusted EBITDA margins for Q4 decreased to 20.3% from 21.1%, with pressure from Transportation Coatings margins offset to a large extent by increased margins in Performance Coatings. We're really pleased that the combination of improved price mix in Performance Coatings and the combination of productivity across Axalta enabled us to hold margins largely constant in 2018 at 20.1% versus 20.3% in 2017. While we clearly still have a lot of work to do to offset inflation impacts that we've accrued over the last two years in Transportation Coatings, we saw modest initial progress this quarter and hope to show continued results in 2019 based on ongoing discussions with customers. For the full year 2018, Axalta reported net sales of $4.7 billion, up 6.7%, excluding the impact of foreign currency, coming largely from strong price and mix contribution, as well as the inclusion of 3.5% from M&A activity.
Net income had a more favorable comparison due to the absence of restructuring charges and other tax reform impacts in the prior year. While adjusted net income increased 5% in 2017. Adjusted EBITDA of $937 million for 2018 increased 6% from $885 million in 2017. This result was produced in spite of the significant headwinds from inflation, as well as incremental FX headwinds that emerged during the course of the year. Turning to slide four, briefly looking at the end market highlights for the quarter. Refinish net sales growth of 6.3% ex FX was solid, driven principally by positive price mix with sales growth from all regions. Business conditions in Europe were slower versus prior periods, and North America growth was constrained somewhat by lower mainstream coatings and refinish accessory sales in the period, but which also contributed to a richer mix overall.
Refinish demand globally appears broadly stable based on our run rates and indication from body shop customers, as well as sell-through indications from our distribution partners. We have also been successful in offsetting inflation with price actions to date. Our Industrial Coatings end market also grew in the quarter with a 6.6% net sales increase ex FX, including contribution from all regions except Latin America, which remains mixed. Price mix remains a bright spot in Industrial, with low to mid-single digit realization in the quarter. We're on track to offset accumulated inflation by mid-year 2019, at least to compensate for much of the accumulated inflation impacts for the last two years. We had a very good year overall for Industrial in 2018. Demand seems broadly stable, but we have seen some indications of slowing in certain markets in China, Latin America, and Europe already reflected in our fourth quarter volumes.
That said, we continue to project modest growth from Industrial in 2019, including new product introductions. Light Vehicle net sales were down 3.9% for the quarter ex FX. Volumes were down mid-single digits, with decreases seen in Asia, Latin America, and EMEA, offset partly by further North America growth. The China market downturn continued, though it is encouraging to hear that the Chinese government is now considering potential supportive measures, which have been helpful in the past to stimulate consumer behavior. EMEA continues to see production impacted by the WLTP engine technology changeover, which is expected to continue into early 2019, but then stabilize. Global production forecasts for 2018 were reduced again from growth of 0.7% to a decline of 1% since our last earnings call. More than half of the 1.7 million unit forecast reduction came from China, with Europe driving a significant portion of the remainder.
Commercial Vehicle net sales decreased 3.3% ex FX in the fourth quarter. Consistent with the third quarter, heavy-duty truck demand remains quite strong in the Americas, though we have seen more signs of slower demand from Europe in the fourth quarter. Price mix was down slightly in the period. On the topic of price cost gap in Transportation Coatings, we've undertaken several efforts in 2018 to achieve offsets to the variable cost inflation. Our most recent dialogue with certain customers has been impactful. We believe we will see progress regarding average selling prices this year. We continue to push for this outcome. Importantly, even with lower oil prices recently, we remain significantly impacted by variable cost inflation. We do not expect near-term relief in many of our inputs due to tight demand conditions across numerous raw material baskets and impacts of trade tariffs.
We also continue to focus on cost reduction actions in Transportation Coatings to help cover the price cost gap. Regarding our balance sheet and cash flows, fourth quarter free cash flow was $220 million to drive full-year free cash flow to $362 million, above our guidance range that we offered in October. We finished the year with a net debt to adjusted EBITDA ratio of 3.4x . On capital deployment, we repurchased $254 million worth of shares for the full year, with $106 million completed during the fourth quarter. Total spend on M&A for the year was $110 million, and we noted additional discretionary capital was used in 2018, in line with our prior guidance to invest in internal high-return investment opportunities with some of our key strategic customers. Next, I'd like to touch briefly on a few operating highlights.
First, we made early progress on relocating production from our Belgium plant, including engineering work and new construction starts in new locations. We also opened new research technical centers in three locations globally and initiated new Powder Coatings capacity upgrades in two locations to support growth plans in our Industrial end market. In terms of innovation investment, we introduced over 250 new products across Axalta, beating our target here for the third year in a row. Highlights in the fourth quarter include the launch of new Refinish products to complement and enhance our mainstream brands, while continuing with good success to launch and convert over 250 body shops in Asia and North America to our new Cromax EZ premium waterborne base coat system. In our Industrial end market, we launched a new steel conduit lining for the electrical wiring market called Strenex.
Transportation Coatings, we continued the launch of our HyperDur 3000 product line, which is a single component primer with improved performance for certain substrates. We also continued to gain share this quarter with our consolidated systems and OEM applications, with new wins in Latin America and Europe. Regarding our focus areas for 2019, we continue to concentrate first on growth across our business and profitably gaining share in each market that we serve today. Second, we're squarely focused on execution and working toward even more refined targets related to overall customer satisfaction. As an organization, we are committed to profitable growth, improving operating execution, and increased accountability across the company to deliver on our goals. My mantra to our leadership is focused on simplicity, nimbleness, a focus on fewer but more critical initiatives, and decision-making based on appropriate metrics with a long-term investment mindset.
I believe that if we move quickly with our customers' interests first, and with a focus on building a sustainable and competitive model, we will continue to win in our markets for many years to come. Lastly, beginning in the first quarter of 2019, we will be shifting our reported basis and presentation to earnings per share and adjusted EBIT metrics. We will continue to offer guidance and results on an adjusted EBITDA basis as well for a period of time. After carefully evaluating the change, it seems an appropriate time, given the maturity of our company, to adopt this approach, and also based on feedback from shareholders. We've also begun to move our internal incentive compensation plans away from adjusted EBITDA to adjusted EBIT and earnings per share to better align all aspects of the business, including capital allocation.
With that, I will now turn the call over to Sean, who will share some further detail on our financial results.
Thanks, Robert, and good morning, everyone. Starting with slide five, fourth quarter net sales before foreign currency impacts increased 2.7% year-over-year, including 6.4% growth in our Performance Coatings segment and a decrease of 3.7% for Transportation Coatings. Acquisition contribution this quarter was 0.4%, as all 2017 acquisitions have now been fully lapped. This fourth quarter result clearly represents two separate parts, with negative volume of 2.1%, largely driven by decreases in Transportation Coatings and positive price mix contribution driven principally by Performance Coatings. We note that our Light Vehicle end market in Transportation Coatings also reflected positive price mix in the quarter. FX translation shifted to a 2.5% headwind in the third quarter and remained largely consistent in the fourth quarter, with a 3.3% impact, with euro weakness versus the dollar still the primary driver, coupled with continued weakness in a broad set of emerging market currencies.
Fourth quarter adjusted EBITDA of $235 million was in line sequentially with the third quarter and 4% lower than the prior year. Adjusted EBITDA margins decreased 70 basis points, 20.3% in the fourth quarter. The quarterly results reflect lower Transportation Coatings net sales, significant headwinds from input cost inflation, notable FX headwinds, and higher overall inflation elements such as freight, logistics, and packaging within other operating expenses, offset by positive progress in price mix in the quarter. Starting with slide six. Performance Coatings Q4 net sales increased 6.4% year-over-year, excluding a 3% FX headwind. Constant currency growth was driven primarily by a 6.5% increase in average price mix, as well as 0.6% contribution from M&A.
Refinish produced 6.3% constant currency net sales growth in the fourth quarter, driven principally by improved price mix in the period, with product mix being a notable contributor to the results in this period. Axalta's Refinish end markets saw net sales growth in all regions in the fourth quarter. Organic volume growth was constrained, we believe in part due to cautious distributor behaviors in select markets, while body shop demand remained steady according to our collective feedback. Measured by body shop served, Axalta continued to gain market share both in the fourth quarter and for the full year. Industrial net sales before FX headwinds increased 6.6% year-over-year in the fourth quarter. This growth was mostly organic as acquisition contribution was negligible. Industrial top line growth was helped by solid mid-single digit positive price mix contribution from all regions for the quarter.
Volumes were also modestly positive, which included strong ongoing growth in North America and good growth in Asia Pacific, offset somewhat by decreases in Latin America and slower performance in Europe, which appears to be feeling some economic deceleration as a region in the recent period. Performance Coatings delivered Q4 adjusted EBITDA of $172 million, a 4% year-over-year increase with strong price mix benefits offset to a large extent by variable cost inflation, additional inflation from freight logistics and packaging within other operating costs, and modest volume and FX headwind effects. Q4 adjusted EBITDA margins of 22.7% were up 10 basis points year-over-year, underscoring sustained improvements with the low of 19.7% in the first quarter of 2018. This comes as a result of price action and mix improvement, as well as productivity actions as we work to offset raw material inflation in our markets with minimal delay through the cycle.
2018 was a great success story for Performance Coatings in this aspect. Turning to slide seven, Transportation Coatings net sales decreased 3.7% year-over-year in the quarter, excluding currency headwinds of 3.7%. Segment volumes decreased 4.5%, slightly offset by favorable price mix impacts resulting from early traction in this area, as Robert previously noted. Light Vehicle fourth quarter net sales decreased 3.9%, excluding a 4% FX headwind. Volumes decreased mid-single digits with ongoing growth in North America, more than offset by lower volume from EMEA and Asia Pacific as the WLTP issue, plus regional slowing in Europe and China continues to pressure global automotive markets. Average price and mix were up slightly in the quarter. However, we are encouraged by indications of additional pricing benefits expected to come through in 2019. Commercial Vehicle Q4 net sales decreased 3.3% before FX headwinds of 2.2%.
This moderate reduction reflects the ongoing strength of North America commercial trucks and other commercial markets, more than offset by slower business pace in both EMEA and China, consistent with what we noted in our last quarterly update. While China has little impact on our results in Commercial Vehicle, the slowdown in Europe has been more meaningful. Global forecasts for heavy-duty trucks have decreased modestly for 2019 since our last call, most impactfully for China, while the overall market dynamics we are seeing have not changed notably over that period. Transportation Coatings generated Q4 Adjusted EBITDA of $63 million compared with $80 million in Q4 2017, though up slightly sequentially from the third quarter. Adjusted EBITDA margins were 15.7% in the period, down from 18.5% in Q4 2017.
The lower margin comparison was driven primarily by significant and largely uncovered variable cost inflation witnessed over the last two years, coupled with some impact from lower volumes in the period. However, adjusted EBITDA margin increased for the third quarter's 15.2%. On slide eight, I will briefly comment on our consolidated 2018 results. The year was clearly challenged in several respects on a combination of substantial raw material and other variable cost inflation, as well as by fundamental headwinds in China and to some extent, Europe later in the year. That said, our overall results were still quite solid. We saw high single-digit net sales growth powered by strong price mix contribution in Performance Coatings, which was critical to offsetting inflation impacts. In combination with productivity efforts, we managed to hold adjusted EBITDA margins largely constant while growing adjusted EBITDA by nearly 6%.
While 2018 was a year of notable headwinds, we navigated through and produced a result that approximated the low end of our earlier communicated expectations from last February, especially considering the rapid and unforecasted shift in FX rates around the middle of this year. Excluding foreign currency, we produced net sales growth in line with our plan, and adjusted EBITDA came just below the low end of our original guidance, in spite of higher variable cost inflation than we had anticipated in early 2018, and also less pricing offset in Light Vehicle than we had expected. Turning to slide nine, cash and cash equivalents totaled $694 million at year-end. Total reported debt was $3.9 billion, resulting in a net debt balance of $3.2 billion versus $3.3 billion at September. Our net leverage ratio was slightly improved to 3.4x , largely driven by the benefit of a higher cash position.
Q4 free cash flow totaled $220 million compared to $196 million in the same quarter a year ago. The year-over-year increase was driven by improved net working capital outcomes, especially from better receivable collections, partly offset by higher upfront customer incentive payments that we addressed in detail last quarter, and modestly lower adjusted EBITDA. As a side note on free cash flow, we have also included $3 million of cash inflows from investing activities, which will equate to $9 million for the full year of 2019, which relates to the interest associated with our foreign currency swaps we executed in 2018 to fix our interest rates on $475 million of our term loan principal. We will include this within our free cash flow metric going forward, consistent with our other cash interest payments.
Our working capital to full-year net sales ratio at year end was 10.2%, compared with 10% a year ago, which is in line with our targeted levels of 10%-11%. Turning to slide 10, we have provided an update of our financial guidance for 2019, which we preliminarily shared with you on our 2019 outlook call in December. Most elements remain unchanged, and as Robert mentioned, we have added new elements of guidance to correspond with our shift in external reporting to an adjusted EBIT and adjusted EPS basis. One note, the adjusted EBIT and adjusted EPS metrics exclude $25 million in accelerated depreciation associated with the previously announced Mechelen, Belgium plant closure. For net sales and adjusted EBITDA, our guidance remains consistent. We have included an assumption of low single-digit inflation from variable input costs at the cost of goods sold level.
Our guidance also continues to assume an impact from tariffs of about $13 million. Regarding taxes, we are revising our adjusted effective income tax rate slightly to 20%-22%, from 20%-23% for the full year, with the increase from 2018 largely due to the lower forecasted excess benefits for stock-based compensation, which were approximately 200 basis points in 2018, as well as the negative impacts associated with year two of U.S. tax reform and slight impact of mix on jurisdictional earnings. As a reminder, this view of tax represents the adjusted tax rate corresponding to adjusted net income. Regarding phasing of adjusted EBITDA in 2019, we expect the first quarter to reflect approximately 20%-21% of total 2019 adjusted EBITDA. The remaining quarters should be closer to an even spread, though with moderate building as we move through the year.
This phasing assumes ongoing carryover of impacts from higher raw materials and other inflation, with the greatest impact on the first quarter, as well as a more challenging comparison in China versus the stronger first quarter in 2018. This concludes our prepared remarks. We will now be pleased to answer any questions. Operator, please open the lines for Q&A.
Thank you.
Six minutes.
At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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 key. Our first question comes from the line of John Roberts with UBS. Please proceed with your question.
Thank you. Robert, price mix was up 6.5% in auto Refinish. I assume the raws are up similarly in the auto OEM coatings area, or roughly approximate. I have a hard time seeing you get anywhere close to the amount of price in auto OEM that you've got in auto Refinish. Do you need additional restructuring there to get your margins back in auto OEM rather than just price?
If we look at the margin profile of both of those businesses, obviously they're two very different businesses with different market characteristics and different market structures. In order to return to the peak profitability that we had before, we do need to continue to raise prices. We also need to continue our flow of new products for those customers, we need to continue to create value for our customers. From a pure cost perspective, we have taken several cost measures in that business, we'll continue to take cost measures in that business as necessary, depending on the development of the market from this point forward.
Okay, just as a follow-up, what was the FX headwind at the EBITDA level? A lot of your raws are linked to the U.S. dollar, I don't think you see as much of a benefit on the cost side when currency's unfavorable as you see a hit on the revenue side.
Yeah. We haven't historically disclosed the actual FX impact at the bottom line, it's fair to assume the FX headwinds on the top line fall through at a consistent margin from an EBITDA perspective.
Okay. Thank you.
Thank you. Our next question comes from line of Don Carson with Susquehanna Financial. Please proceed with your question.
Yes. Thank you. Just want to go back to your inflation comments. Overall, what was the inflation in raw materials in 2018? What are you expecting in 2019? I think you mentioned that with Industrial, you expect to close that price cost gap by mid-year. On the Transportation side, can you comment more specifically when you would see that price cost gap closing, or do you think it can fully close?
On the first part of your question related to raw materials, as we highlighted, we saw low double-digit inflation on a year-over-year basis, 2018 compared to 2017. Our current assumption, based on our outlook and current oil prices, as well as other supply considerations, is for low single digits in 2019. Obviously, that can change and evolve as the year goes on, as we see the price of oil move up and down, as well as some of the other supply considerations. Regarding Transportation margins in that business, our goal long term is to get those margins back to where they were historically. Obviously, there are cycles that any business goes through, both from a demand perspective as well from a raw material perspective.
At the end of the day, the important thing for us and for our customers is that we continue to innovate with our products and that we continue to innovate with our services. If we do that, I'm confident that we will continue to be rewarded with an appropriate margin level in that business.
Thank you.
Thank you. Our next question comes from the line of Mike Harrison with Seaport Global Securities. Please proceed with your question.
Hi. Good morning.
Good morning.
Was just wondering if you could maybe give a little bit more detail on the volume weakness that you saw in the Refinish business. It sounds like you mentioned it was related to some caution among distributors. Just wondering where that was happening, and if you're seeing some of the macro weakness maybe start to weigh on demand at the consumer level, maybe lower propensity to get repairs done, given some of the macro uncertainty.
Mike, we continue to see that global demand appears steady. There was a general lack of urgency at the distributor level that drove a slightly lower outcome in Q4. We see this as a normal quarterly fluctuation in the market, not really any change to underlying end market demand. As we've highlighted, any given quarter, you can have movements up and down. In the solvents case, in particular in North America, we did see slightly negative volumes due to slower mainstream and accessory sales. We had strong pricing, and that led to a mid-single-digit net sales result for that business. I think we're very happy with the results of that business globally, as well as in North America.
As an additional data point, a couple of our largest body shop customers did see volumes and net sales up in the fourth quarter. We know that one of our competitors and an accessory supplier have highlighted slower sales. However, we believe that this appears to be more related to channel inventory as opposed to any type of end-market demand, at least from what we're seeing.
Thanks for that additional color. Just wondering if you can give an update on what you've been seeing in the industrial wood coatings business. I know that in China, there have been some signs of slowing, but I think that business is primarily North American for you. Any update on that business?
As you point out, our business currently is defined in the Americas region, so that's predominantly the U.S. and Mexico. Due to some of the macro trends, we did see volumes pull off just a little bit within core markets in the U.S., but we did have wood price increases that continued as a lot of our contracts are largely indexed to raw materials. Overall, we're quite happy with the result.
All right. Thanks very much.
Thank you. Our next question comes from the line of Christopher Parkinson with Credit Suisse. Please proceed with your question.
Thank you. You hit on this a little on the volume side, but can you just give us a broader state of the union on Refinish, just breaking out the price, I guess you already hit on volumes, but also market share trends, and whether or not you think there are any upcoming structural changes in the industry that we should be aware of. Thank you.
Chris, overall, we continue to see the Refinish market for us perform quite well. As you know, on a full year basis, we had good sales growth, as I said, in the mid-single-digit range. We saw stable market conditions overall. We continue to win shops and gain share in North America in particular, and also in Europe. As we look forward in 2019, we're expecting relatively stable markets around the world with growth in every region. The only two call-outs there might be China and Latin America, where we might see a little bit lower, or I should say more modest volume growth. Overall, if you look at the underlying dynamics of the Refinish business, we feel very good about that business and don't see any major changes occurring, at least at this juncture.
Great. Once again, you mentioned this a little on the raw basket, but just can you hit on that, just a few product SDS within the resin basket? Understanding there are a few moving targets, just what are you seeing in the various regions in epoxies, isocyanates, and some of the inputs that caused issues in 2018? Also, are you still seeing any residual effects from previous force majeures? Just any comments on that would be appreciated. Thank you.
For 2019, at least for the first quarter, resins overall, we expect to see prices potentially be slightly down. It does vary whether we're talking about epoxy or polyesters or melamines. The overall basket, we could see that be slightly down. In isocyanates, at least for the first quarter, we would expect prices to continue to be up, predominantly due to HDI. In solvents, if oil prices continue at their current levels, we would start to see our solvent prices come down a little bit, given how closely related that is to the price of oil. Then for monomers, overall, we're expecting prices to be up. There are some products that could potentially be down, but when you look at the overall weighting of what's in that basket for us, the monomers category we'd expect to be up.
With regard to pigments, finally, we do see some flattening in prices there, at least through the first quarter. Finally, in additives, we see prices that we expect to continue to move up, predominantly due to tariffs, and also China regulations.
Thank you very much.
Thank you. Our next question comes from the line of Robert Koort with Goldman Sachs. Please proceed with your question.
Good morning, guys. It's Chris stepping on for Bob. You cited price mix benefits frequently in your prepared remarks. Just curious, how much mix versus price did you see in the segments in the fourth quarter? Maybe could you give a little bit more color on the origin or sustainability of this improved mix?
It was probably a 50/50 split between price mix. It was certainly richer mix in Refinish. I think what we saw a little bit in the distribution behavior, some of their buy in the fourth quarter. They bought some of the higher priced product, which obviously impacted our mix benefit there, and part of the reason why you saw volumes down a little bit in the distribution channel. By and large, we're not expecting a bigger mix shift year-over-year heading into 2019.
Great. Maybe if you could reflect back on the net contributions you've witnessed in 2018 from productivity and cost reductions, and just curious how relevant productivity might be in your 2019 guidance.
Our Axalta Way program continues to move as we move forward. That being said, the premium end of the market in China, which is where we historically have been quite strong, is one area of focus. The other area of focus is the mainstream and the economy markets, where again, we continue a strong push in those markets in terms of building out distribution, putting feet on the street, and most importantly, having the right products at the right price point and with the right positioning to meet the needs of our customers in those segments.
I think mix longer term, where we see global room for volume improvements, it's partially in the economy and mainstream space. We're not necessarily expecting richer mix over the long term. When you go region by region and you look at the MSO space here in North America, where they really value some of our more producted systems, you could see some richer mix coming through in 2019.
Just a question on your auto OEM business. How many employees do you have that are in these OEM paint lines? When they slow, is that your cost burden to bear, or are you directly compensated for those employees?
For competitive reasons, we don't want to provide too much information in that regard. Just generally, we have over a thousand employees around the world that actually work on our OEM customer paint lines and/or involved in the support of those paint lines. Volumes come down, there are opportunities to pull back on that sales support area, if and when it was ever required.
Okay. Thank you.
Thank you. Our next question comes from the line of P.J. Juvekar with Citi. Please proceed with your question.
Yes. Hi, good morning.
Morning, P.J.
Robert, you and your competitor have had some de-stocking issues in the distributor channel in Refinish. Where do we stand on distributor inventories today? How do you get visibility for your planning purposes for demand from distributor channel?
It's hard to have. I think, as Axalta, we have pretty good visibility into how much product we have with our distributors in general, not necessarily at each and every point of distribution that they have. That visibility we have. We don't necessarily have visibility into competitor levels or other products like accessories that are in those warehouses. When we visit, of course, we might happen to take a glance over and see how much inventory might be there. For the most part, we don't have a lot of visibility about that overall from an industry perspective. I would say from an Axalta perspective is, last year, as you know, I should say in 2017, we made several changes there in adjusting many of our commercial policies, and that resulted in distributors carrying and pulling down inventory levels.
At this juncture, from an Axalta perspective, most of our distributors are carrying the amount of Axalta product that they need for the foreseeable future. Given some of those commercial changes, as well as some of the limits that we've placed on the ability to pre-buy ahead of price increases, certainly that has ameliorated that aspect of the supply chain. However, if there is consolidation within distribution, that would be, I guess, the primary remaining element that could result at some point in the future in actual reduction in total inventory held at distribution. I think, again, the important thing here is to look at distribution. Distribution is what happens in the middle. What happens at the end with the end consumer is what's most important for the long-term health of the business.
Thank you. A question for Sean. Sean, as a new CFO, how do you think about your net leverage of 3.4x ? We are late in the economic cycle. Some economies have slowed down. What's your comfort level in terms of leverage, and what should we expect for 2019 in terms of buyback and share repurchases? Thank you.
Today where we sit, we're very comfortable with the free cash flow profile and where our leverage sits. Where we are now targeting is 2.5x . We'll continue to build cash. We're not necessarily looking to actively pay down debt. When you think about our overall debt profile, we're at slightly below 3.8%, a pretty healthy interest rate there. Again, not a huge return by paying down debt. When we think about share buyback, we did slightly over $100 million just in the fourth quarter. We'll continue to be opportunistic, but we're not going to set targets for 2019. We want to continue to maintain flexibility and value all the potential items in the pipeline around M&A, internal projects as well as share buyback, from a capital deployment perspective.
Thank you.
Thank you. Our next question comes from the line of Arun Viswanathan with RBC Capital Markets. Please proceed with your question.
Great. Thanks. Good morning, guys.
Good morning.
Good morning. I just wanted to go back to the guidance range. I expect that you would probably narrow that as you go through the year, as you did in 2018, but maybe you can just help us confirm what would push you to the upper or lower end. Is it fair to assume, given some of your comments on weakness arising in China and Europe recently, that you're expecting now to be closer to the lower end? Also, is it fair to assume that volume is unlikely to surprise to the upside, so it would be more like price and cost that would be the main lever that would push you to the upside? Thanks.
I think as always, it's fairly consistent with prior years. The overall macro environment is certainly the most important variable from an overall demand perspective, although it affects cost, but it also affects volume. Certainly, the discussions that are ongoing with China and the trade discussions there, I think, if we see those get resolved favorably and quickly, we believe that we could see greater demand out of China across a multitude of product lines. The other element, of course, is always raw material inflation. We assumed a level of raw material inflation slightly above the current levels, at least from a rent perspective, and then from an oil forecast. We've layered in what we believe will continue to be some of the supply constraints, as well as the impact from at least phase 1 of the tariffs.
If we go to phase 2, of course, that could change things quite a bit. The overall raw material basket, our ability to push through price increases to offset that, if that's in excess of what we see in the budget, would be another element. Finally, the last element, of course, is foreign exchange.
Okay. That's helpful. Also, I just wanted to touch on this, if you didn't already, if I missed it, but the cost reductions that you've targeted for 2019, is that $50 million? Is there potential that you could find more, in case there is a greater slowdown, to stay within your EBITDA range?
Yeah. Currently, we are targeting the $50 million. That's largely offsetting inflation at this point. If we see any sort of slowdowns or potential slowdown as far as getting price in the LV space, there's more potential opportunity we would aggressively go after.
Perfect. Thanks a lot.
Thank you. Our next question comes from the line of Jeff Zekauskas with JP Morgan. Please proceed with your question.
Hi. Thanks very much. In your sales guidance for 2019, you estimate 2%-3% growth. I would expect that that would be all price. Your base case is that your volumes are flattish. Is that correct, on a consolidated basis?
Jeff, it's primarily price, but there is an aspect of volume growth in there. Modest, but there is an aspect.
In terms of the deployment of your cash flow, in 2016 and 2017, you really were pretty aggressive in making acquisitions. When 2018 came along, there was something in the first quarter. There really haven't been any acquisitions since then, and you've really elevated your share repurchase outlays. Is that because the acquisition pipeline thinned out, or acquisitions became more expensive, or was it that your own stock became more inexpensive, and you wanted to be opportunistic? Can you talk about the shift in cash flow deployment?
Jeff, we continue to focus on M&A, both small bolt-on transactions as well as more transformative transactions. We do have a good pipeline of deals. That being said, we have been selective in the transactions that we have pursued, and we've also been focused on integrating well the acquisitions that we've made thus far. We've been also pretty disciplined in terms of valuations. Not that valuations have been unreasonable, but a few of the major assets that have come to market in the past six to nine months, many of those have been in public auction or auction scenarios. We felt that some of the prices that were required and some of the prices that were eventually paid for some of those assets did not generate a return that we found satisfactory. I think we're going to continue to be disciplined on capital deployment.
The larger spend on our share repurchase program, that really fundamentally is linked to the fact, we had a $675 million program. To date, we've purchased about $312 million against that. We did want to show progress on our share repurchase program, especially given the lower stock price, it became very attractive to buy back our stock. That's the way that the share repurchase program was structured. It was structured to be highly opportunistic. We were offsetting dilution, but if we did see the stock price go down, the share repurchase program would kick in and would accelerate the volume of purchases, which is exactly what the program did.
Okay, great. Thank you so much.
Thank you. Our next question comes from the line of David Begleiter with Deutsche Bank. Please proceed with your question.
Thank you. Robert, where do you stand on your auto OEM price increases, and what's the level of competitor support you are seeing in the marketplace?
What I'd say is, we issued a press release towards the end of last year where we highlighted that we were going to be going out to the market with price increases. That we had made pretty much all of the efforts that we could make internally from a cost reduction perspective without starting to cut into muscle and bone in that business that would potentially compromise the long-term health of that business. I think we've supported our customers by trying to right-size our cost structure as much as we possibly could, but we reached a point where we had to go out with price increases. So, that is indeed what we've done, and you start to see some of the results of that in our Q4 results, and I'd expect that you would see that moving forward.
Very good. Just on Refinish, Robert, looking at your volumes, they were down in 2017. They were roughly flat in 2018. What's the level of confidence on actually growing volumes in Refinish in 2019?
I think big picture, you have to remember a couple things. First, we're always working with our customers. It's not about the volume of the paint, it's about the value that we're creating and the net sales that we're generating. We're always working with our customers to help them use less paint and to make them more efficient, number one. Number two, as we continue to see the shift from solvent-borne to water-borne, water-borne just uses a lower volume. It uses less paint than solvent-borne. Structurally, you will see volume decrease slightly over time, just given the nature of the business. We capture that through price, and we also capture that and are more focused on capturing the service element of what we do, not only in OEM, but also in the Refinish business.
If we look at the customer wins that we've had around the world, and if we look at the number of body shops that we have in the Axalta network, and given some of the paint management systems and the color matching systems that we have, we have pretty good insight into the number of shops that we're servicing. We've actually seen a net shop gain that is higher than that stated of our competitors, and we have also experienced some important customer wins over the last 12 months that will begin to materialize in our numbers in 2019. I think overall, we feel very good about the Refinish business.
Thank you.
Thank you. Our next question comes from the line of Aleksey Yefremov with Nomura Instinet. Please proceed with your question.
Thank you. Good morning, everyone. Just to piggyback on the Refinish volume question, thanks for the explanation, Robert. Is there a metric that we can use to assess sort of the underlying level of demand other than the number of shops? Do you have a number of cars painted or something similar to assess the demand level?
Aleksey, this is Chris. There really isn't a global metric that adequately captures the entire market. There's a hesitancy to provide something of that type for any given region that we might be able to source or capture, because while that might be accurate for any given country, it really wouldn't capture the global picture. We stay away from trying to quote specific market metrics because it could be misleading. It is a big global business. We sell in over 130 countries. We have a disparate business across both premium and mainstream products out there. What holds up and what's persistent is the growth in population, the growth in middle class, leading to increased car park, leading to increased miles driven globally, and there's a structural driver there underlying everything else.
All this discussion about water-borne versus solvent-borne and other things within given markets is in that broader context of market growth.
Just to follow up again, do you think the actual area painted by Axalta in the Refinish business, is it growing, flat, declining?
You mean geographic area?
No. I mean the, I don't know, square feet of panels painted in 2018 versus 2017 and so forth.
We wouldn't have visibility on a fine metric like that. We do know, for example, that broader trends like the removal of a bumper-
To repair lead to the painting of the entire bumper, whereas, years ago, they might just bang out a dent and paint that section. There are some things like that that happen in the market, but no, we don't have a fine point metric like that to capture.
Got it. Thank you very much.
Thank you. Our next question comes from the line of Ghansham Panjabi with Baird. Please proceed with your question.
Hey, guys. Good morning. I guess just a quick question on Industrial. Obviously, volumes were positive during the fourth quarter, which was encouraging given just what we've seen from the macro standpoint. Did you see any deterioration towards the end of the quarter as customers perhaps scale back on inventories? Just give us some more context on how volumes phase for that business during the quarter.
You have to remember that Industrial for us is a multitude of markets. It's wood, it's coil, it's energy solutions, it's our general Industrial business, it's Powder Coatings. It does vary a little bit by market. The one business where we did see a little softening through the quarter was in the North America wood business for us. That would be the main area that I think we would call out and highlight. Again, as we've mentioned before, our Industrial business, even though it's a $1.2 billion, $1.3 billion business for us globally, given the size of the addressable market, we still have a lot of room to grow, and we have a very good team that's executing extremely well. I think our general outlook on Industrial continues to be quite positive.
Okay, just to clarify Sean's point on 2.5x net debt to EBITDA being the target from a balancing standpoint, should we interpret that as the priority for 2019 being debt paydown? Or is that sort of a longer-term target, and we should still expect M&A and sort of share buybacks as the year unfolds? Thanks so much.
Yeah, unfortunately, debt paydown won't help us with our net leverage ratio, only with the gross leverage ratio. I think what you would expect to see there is, given how low our cost of debt is, it doesn't really make a lot of sense to pay down gross debt in this environment. It makes more sense to build up cash, and then selectively deploy that cash to the highest return projects across the company. That being said, if we do see rates move up more considerably, I remind everyone that we're fairly significantly hedged. We're capped out across the majority of our debt portfolio, so we're in a very good position. We wouldn't expect to do much debt paydown in 2019 unless, again, we were to see a spike in rates or a dramatic change in the macro environment.
When you look at something like interest rate coverage, we're in a very healthy position, even when you run certain downside scenarios on the business. That being said, if there are momentary aberrations in the debt markets where we have the opportunity to do something creative and potentially bring down our gross debt level, we will take advantage of those.
Thanks for clarifying.
Thank you. Our next question comes from the line of Vincent Andrews with Morgan Stanley. Please proceed with your question.
Thank you. Good morning. A question on Europe. Obviously, the WLTP situation is sort of shading volume there. Do you have any sense, when that sort of expires or runs its course, what do you think the underlying volume trends are going to be like in that market in 2019?
If you look at Europe overall for 2018, at least according to IHS, from a build or production perspective, the market was down about 1.2%. I think the current forecast that they have for Europe is to be flat on the year at 0%. Embedded in that assumption, it's a belief that WLTP will work its way through the system, and then as it does, you'll see production return to more normal rates unaffected by WLTP. That being said, I think with all the activities, the macroeconomic environment in Europe today, I think our view on at least Light Vehicle in that market and also Commercial Vehicle for 2019 is fairly cautious at this point.
Okay. If I could just ask a follow-up, Robert. When you talked about you're going to show EBIT instead of EBITDA. I thought you maybe said something about you're going to change the way you add back incentive comps. In other words, maybe you're not going to add back stock-based compensation anymore. Was that correct?
That's accurate. Robert also commented on the fact that we're changing our incentive compensation target internally for management to align with our externally reported numbers. You're exactly right. Stock-based compensation will no longer be added back for EBIT reporting going forward.
Okay, great. Thank you very much.
Thank you. Ladies and gentlemen, our final question for this morning will come from the line of Duffy Fischer with Barclays. Please proceed with your question.
Yeah. Good morning, fellas. Just first question on the P&L. SG&A was down almost 25% in Q4. What were the drivers there, and can we extend those lower levels going forward into this year?
Duffy, two points to kind of get back to apples to apples. In 2017, there was about $43 million in there related to severance and one-time elements around the merger and acquisition talks with Akzo and Nippon. Then there was an $18.7 million reclass out of SG&A up in the COGS in 2018. That drives your entire difference between 2017 and 2018. You roughly have a flat 2017 versus 2018 comparison when you normalize for those. As far as extrapolating the result for fourth quarter, yes. I mean, that should be a normal run rate as a percentage of net sales.
Okay, great. Then if you go to the cash flow statement, the prepaid expenses and other line has eaten roughly almost $250 million in cash over the last two years. Should we think about that as coming back in cash at some point, getting released, or is that more like an investment that we should think about that earning 10%, 12%, 15%, that's actually now running through the P&L today?
What you're seeing in that line item are these upfront customer incentive payments that we talked about at length last quarter. You saw an uptick from the run rates. Historically, it's been running around $80 million. You saw a bigger uptick this year because of a few bigger customers where we gave the incentives to. As far as the cash coming back in, that will be coming in through price over time. It won't be coming through that line item, but it will be coming back through AR collections as we get more price with those customers.
Great. Thanks, fellas.
Thank you. Ladies and gentlemen, that does conclude our question and answer session. I'll turn the floor back to Mr. Bryant for any final comments.
Thank you for everyone for joining today. Appreciate your interest in Axalta, and look forward to talking with you again when we have our Q1 results.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.