Axalta Coating Systems Ltd. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless noted. Axalta manufactures and sells coatings through Performance Coatings and Transportation Coatings segments. Financial statements are unaudited.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $1,096.3m | $1,026.3m | $3,204.6m | $3,060.1m |
| Operating income | $104.0m | $117.4m | $261.4m | $371.8m |
| Net income (loss) | $56.3m | ($5.4m) | $103.3m | $79.7m |
| Net income attributable to controlling interests | $54.9m | ($6.6m) | $98.2m | $76.0m |
| Diluted EPS | $0.22 | ($0.03) | $0.40 | $0.31 |
| Adjusted EBITDA | $209.5m | $230.4m | $639.8m | $677.9m |
- Q3 net sales rose 7.0%; nine-month net sales rose 4.8%. Nine-month sales growth reflected acquisitions; organic volume was flat, average selling prices reduced sales by 1.5%, and currency translation reduced sales by 0.6%.
- Profitability weakened despite higher sales. Cost of goods sold was 64.3% of net sales in Q3 versus 61.8%; for nine months it was 63.8% versus 62.0%. Operating margin was approximately 9.5% in Q3 versus 11.4%, and 8.2% year to date versus 12.2%.
- Q3 net income improved substantially from the prior-year loss, principally because 2016 included $81.9m of debt extinguishment and refinancing costs. Nine-month net income increased, while operating income declined, including a $70.9m Venezuela deconsolidation charge in 2017.
- Adjusted EBITDA margin was approximately 19.1% in Q3 versus 22.5%, and 20.0% for nine months versus 22.3%. The measure excludes items management considers non-core; it is not a GAAP substitute.
Segments and material changes
- Performance Coatings: Q3 sales increased 12.5% to $693.5m, while Adjusted EBITDA fell 7.3% to $135.1m. Nine-month sales rose 8.4% to $1,942.8m, while Adjusted EBITDA declined 3.5% to $398.8m. Acquisitions and industrial growth supported sales; refinish weakness, higher variable costs, and pricing pressure weighed on results.
- Transportation Coatings: Q3 sales decreased 1.4% to $398.3m and Adjusted EBITDA declined 12.2% to $74.4m. Nine-month sales fell 0.4% to $1,245.3m and Adjusted EBITDA decreased 9.0% to $241.0m, mainly due to lower selling prices and higher costs.
- Axalta completed six acquisitions in the first nine months, including Valspar’s North American Industrial Wood business. Acquisition spending was $559.3m net of cash acquired; acquisitions contributed $211.1m to nine-month sales. Purchase accounting remained preliminary at quarter-end.
- In June, Axalta refinanced its dollar term loans, increasing principal to $2.0bn, extending maturity to 2024, and lowering interest rates. Management estimated annual cash interest savings of approximately $7.7m versus the prior principal balances.
Cash flow, debt, and liquidity
- Nine-month operating cash flow was $306.4m, down from $331.3m. Working-capital uses totaled $164.7m, including increases in receivables, inventory, and other assets.
- Investing cash outflow was $646.7m, primarily reflecting $559.3m of acquisitions and $87.2m of capital expenditures. Financing cash inflow was $380.7m, including refinancing proceeds; Axalta repurchased $58.4m of shares during the period.
- Cash and cash equivalents were $588.9m at September 30, 2017, compared with $535.4m at year-end 2016. Total borrowings were $3,903.0m, versus $3,263.9m; approximate net debt was $3.31bn. Long-term debt was $3,865.2m.
- Available revolving-credit capacity was $378.2m, net of letters of credit; there were no revolver borrowings, and the company reported compliance with credit covenants. Management said cash, operating cash flow, and available facilities should be sufficient for debt service, operating needs, and capital expenditures over the next 12 months, while cautioning that cash generation and refinancing depend on factors outside its control.
Outlook, risks, and unusual items
- The filing provides no specific revenue, earnings, or margin guidance. Management cited acquisition integration and growth opportunities, while noting pricing pressure, higher variable costs, regional volume weakness, and working-capital demands.
- Axalta deconsolidated its Venezuelan subsidiary after concluding that currency exchange restrictions, political unrest, reduced demand, and expected losses meant it no longer controlled the entity for accounting purposes. The $70.9m charge included subsidiary net assets, intercompany receivables, and pension-related accumulated losses. The investment and prior intercompany balances were recorded at zero; future income is recognized only when inventory is paid for or dividends are received.
- Other unusual items included $7.6m of nine-month manufacturing-facility impairments, $13.0m of refinancing costs, acquisition and integration expenses, and elevated acquisition-related amortization. The company also reported that prior-period revenue-recognition errors were immaterial but revised historical presentation; Q3 and nine-month 2016 net sales were reduced by $2.8m and $2.7m, respectively.
- Risks include substantial indebtedness, interest and foreign-exchange exposure, raw-material costs, automotive and transportation demand, acquisition execution, competition, environmental matters, and litigation. Management could not determine the ultimate outcome of certain claims; potential effects could be material, though ordinary-course proceedings were not expected to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
- The company is assessing new revenue-recognition requirements; it expected expanded disclosures and possible timing changes, particularly for certain Transportation Coatings arrangements. Management reported disclosure controls were effective at September 30, 2017.
Important facts for investors to verify
- How much of sales and future earnings growth is organic versus acquired, and whether acquisition integration delivers expected returns.
- Whether margins and segment Adjusted EBITDA recover from higher variable costs, lower prices, and weaker refinish demand.
- Working-capital conversion and operating cash flow relative to acquisition spending, capital expenditures, repurchases, and debt service.
- Debt balances, variable-rate exposure, covenant headroom, and the extent to which expected refinancing savings are realized.
- Consequences of the Venezuela deconsolidation, including recoverability of any amounts and tax effects.
- Final acquisition purchase accounting and the effects of revenue-recognition changes and historical revenue corrections.