Axalta Coating Systems Ltd. quarterly report, Q3 FY2014

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Axalta Coating Systems Ltd. — Q3 2014 Form 10-Q

Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2014. Axalta manufactures and sells coatings through Performance Coatings (refinish and industrial) and Transportation Coatings (light and commercial vehicle OEMs). The company acquired DuPont Performance Coatings on February 1, 2013; acquisition accounting makes some historical periods non-comparable, so management also presents pro forma comparisons for the nine-month period.

Key financial results

  • Revenue: Q3 net sales were $1,108.9 million, up 3.2% from $1,074.6 million. Nine-month net sales were $3,282.9 million; on a pro forma basis, sales increased 3.1% from $3,184.4 million.
  • Quarterly profitability: Gross profit was $380.8 million, implying a 34.3% gross margin versus 31.2% a year earlier. Operating income rose to $104.0 million from $33.5 million. Axalta recorded a net loss of $18.3 million, versus net income of $6.4 million; loss attributable to controlling interests was $19.9 million, or $0.09 per share, versus income of $5.0 million, or $0.02 per share.
  • Nine-month results: Operating income was $283.6 million and net income was $33.8 million. On a pro forma basis, net income was $40.9 million, compared with a $42.6 million net loss in 2013; income attributable to controlling interests was $36.7 million versus a $46.9 million loss.
  • Adjusted EBITDA: Q3 was $228.0 million, up from $194.1 million; the corresponding margin was approximately 20.5% versus 18.1%. Nine-month Adjusted EBITDA was $635.8 million, up 18.9% from pro forma 2013’s $534.5 million; margin increased to approximately 19.4% from 16.8%. This is a company-defined non-GAAP measure with substantial adjustments.
  • Cash flow and investment: Nine-month operating cash flow was $59.4 million versus $263.9 million in the 2013 successor period. Working-capital movements used $239.3 million, including increased receivables and inventory. Capital expenditures were $155.6 million; investing cash outflow was $149.0 million. Cash and cash equivalents fell to $233.3 million from $459.3 million at year-end 2013.
  • Debt and liquidity: Reported borrowings were $3,731.6 million, including $3,696.1 million of long-term debt, down from $3,920.9 million in reported borrowings at year-end. Axalta prepaid $100 million of term debt and made scheduled repayments. Revolver availability was $384.3 million after letters of credit; additional non-U.S. credit-line availability was $19.7 million. Management said available cash, operating cash flow, and borrowing capacity should cover debt service, transition costs, liquidity needs, and capital expenditures for the next 12 months.

Material changes versus comparable periods

  • Q3 sales growth reflected higher volume and selling prices, partly offset by unfavorable currency effects. Latin America remained weak; North America and Asia contributed to volume growth.
  • Q3 cost of goods sold declined 1.5% despite higher sales, improving from 68.8% to 65.7% of net sales. Management cited lower raw-material costs, product mix, and operational improvements.
  • Q3 SG&A declined 9.9% to $249.4 million, primarily as nonrecurring standalone-transition costs fell to $32.2 million from $68.0 million. Nine-month SG&A remained $746.7 million on a pro forma comparison, as lower transition expense was offset by higher advertising and administrative costs.
  • Transportation Coatings drove much of the Q3 Adjusted EBITDA increase: segment EBITDA rose to $79.5 million from $46.8 million. Performance Coatings EBITDA was $148.5 million versus $147.3 million. For the nine-month pro forma comparison, segment EBITDA margins improved in both businesses, particularly Transportation Coatings.
  • Q3 other expense was $62.2 million, compared with $9.3 million of other income a year earlier. Foreign-exchange losses of $59.6 million, largely from intercompany balances as the euro weakened against the U.S. dollar, were the principal factor. Lower interest expense, $52.6 million versus $62.7 million, partly reflected the February 2014 refinancing and a further rate reduction.

Outlook, risks, contingencies, and unusual items

  • Management expects cost, procurement, IT, and manufacturing initiatives to continue improving profitability over the next several years. No specific numerical earnings or revenue guidance is provided.
  • Management reported net sales growth across regions except Latin America in the first nine months, and identified weak Latin American demand and currency movements as ongoing headwinds.
  • The company recorded a $21.1 million discrete nine-month tax benefit related primarily to documentation supporting pre-acquisition deductions, partly offset by a $12.5 million reduction in indemnity assets. A $6.6 million pension curtailment gain also benefited Q3 results.
  • Axalta changed the exchange rate used to remeasure its Venezuelan subsidiary based on Venezuela’s SICAD I auction process. The remeasurement generated gains, including $19.0 million for the nine months, but management said the future financial effect of Venezuelan government policies and currency processes was unclear. At September 30, the subsidiary had $40.5 million of net monetary liabilities and $150.5 million of non-U.S.-dollar net nonmonetary assets.
  • Pending lawsuits and civil, regulatory, and environmental claims have uncertain outcomes; potential effects could be material if probable and estimable. Management did not believe ordinary-course proceedings would individually or collectively materially adversely affect the company. Guarantees totaled $2.2 million, with no amount accrued.
  • Risks highlighted include substantial indebtedness, interest-rate and currency exposure, raw-material supply and pricing, competition, customer concentration, automotive-market conditions, environmental liabilities, litigation, and international operations. The filing states there were no material changes to previously disclosed risk factors.
  • The company identified errors in prior-period effective-interest amortization for deferred financing costs and original issue discounts. It judged the prior-period errors not material and revised comparative figures; investors should review the correction and its effect on reported interest expense.
  • After quarter-end, a 1.69-for-1 stock split became effective October 28, 2014. Axalta’s November 2014 IPO was a sale by existing shareholders; the company received no proceeds. The filing also reports a $13.4 million pre-tax charge associated with terminating Carlyle’s consulting agreement upon the IPO.

Most important facts for investors to verify

  • Whether revenue growth and margin gains persist, especially given Latin American weakness and currency volatility.
  • How much reported Adjusted EBITDA depends on exclusions for transition, consulting, foreign-exchange, and other unusual costs, and how those adjustments compare with cash generation.
  • Whether working-capital investment normalizes and operating cash flow improves after the $239.3 million nine-month working-capital use.
  • Debt repayment capacity, variable-rate exposure, covenant headroom, and the impact of the largely post-2018 debt maturities.
  • The ongoing financial exposure to Venezuela, unresolved legal and environmental matters, and the implications of the interest-amortization correction.
  • The distinction between the secondary IPO proceeds received by selling shareholders and cash proceeds received by Axalta, which were zero.