Axalta Coating Systems Ltd. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Financial statements are unaudited. Amounts are in millions except per-share data.
Business context and reporting period
Axalta manufactures and sells coatings globally through Performance Coatings (refinish and industrial) and Transportation Coatings (light vehicle and commercial vehicle). The company reported four strategic acquisitions during the first nine months of 2018, all benefiting Performance Coatings.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $1,146.0 | $1,096.3 | $3,530.2 | $3,204.6 |
| Net sales | $1,139.3 | $1,091.8 | $3,511.6 | $3,188.1 |
| Operating income | $47.8 | $103.9 | $314.3 | $261.8 |
| Net income (loss) | $(11.6) | $56.3 | $136.5 | $103.3 |
| Net income (loss) attributable to controlling interests | $(13.1) | $54.9 | $131.7 | $98.2 |
| Adjusted EBITDA | $234.7 | $209.5 | $702.3 | $639.8 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $245.5 | $306.4 |
Q3 net sales grew 4.4%; volume and pricing gains were partly offset by unfavorable currency translation. Performance Coatings sales rose 8.9% and segment Adjusted EBITDA increased 30.6% to $176.4. Transportation Coatings sales declined 3.5% and segment Adjusted EBITDA fell 21.6% to $58.3. For the first nine months, net sales increased 10.1%, while segment Adjusted EBITDA rose 24.4% in Performance Coatings and declined 14.4% in Transportation Coatings.
Q3 gross margin was approximately 33.4%, versus 35.7% a year earlier; operating margin was approximately 4.2%, versus 9.5%. The company said the new revenue standard affected cost-of-sales comparisons and classification; excluding that standard’s impact, cost of sales as a percentage of net sales was 65.1% in Q3 versus 64.3% reported a year earlier, with raw-material and operating costs contributing to pressure. Nine-month operating margin was approximately 8.9%, compared with 8.2%.
Q3 operating income and net income were sharply lower, principally reflecting restructuring charges tied to the planned Mechelen, Belgium facility closure, including $70.6 of severance, as well as higher raw-material costs. Q3 restructuring costs, net of estimate changes, were $81.4. The nine-month net-income comparison also benefited from the absence of the $70.9 Venezuela deconsolidation loss recorded in 2017.
For the first nine months, operating cash flow decreased to $245.5, with $212.2 of working-capital uses, notably receivables and prepaid expenses. Investing activities used $204.5, including $79.2 for acquisitions and $109.5 for capital expenditures. Financing activities used $212.5, including debt repayments and $147.8 of treasury-stock purchases. Cash and cash equivalents were $588.1 at September 30, 2018, down from $769.8 at December 31, 2017.
Total borrowings were $3,894.5, including current borrowings, compared with $3,915.6 at year-end 2017; long-term debt was $3,852.0. The $356.2 revolving-credit availability was net of $43.8 in letters of credit; there were no revolver borrowings. Current assets were $2,296.2 and current liabilities $1,031.3. The company reported compliance with debt covenants.
Material changes, outlook, risks, and unusual items
- In April 2018, Axalta repriced and increased its 2024 Dollar Term Loans by $475.0, using the proceeds and cash to repay the 2023 Euro Term Loans. Interest-rate and cross-currency swaps converted $475.0 of principal to euro fixed-rate debt at 1.95%, maturing in 2023. Management estimated combined annual cash-interest savings of approximately $10.0.
- The Mechelen closure plan included accelerated depreciation of $4.2 in Q3 and nine-month 2018 results. Payments related to restructuring actions were expected to be substantially completed within 12 to 24 months of the balance-sheet date.
- Management said cash flow from operations, cash on hand, and available borrowing capacity were expected to be adequate for debt service, cost-saving initiatives, liquidity needs, and necessary capital expenditures over the next 12 months. No specific revenue or earnings guidance was provided in the supplied filing text.
- Key stated risks include substantial indebtedness and refinancing needs; raw-material price or supply pressures; economic and automotive-market conditions; foreign-exchange exposure; customer and distributor concentration or credit risk; environmental liabilities, litigation, and other contingencies; and acquisition execution. Management cautioned that actual results may differ materially from forward-looking statements.
- Axalta recorded a $12.4 benefit from revising its provisional U.S. tax-reform charge based on additional Treasury guidance. The filing says the provisional tax charge could be adjusted further as guidance develops. The nine-month effective tax rate was 26.0%, compared with 17.2% in 2017.
- After quarter-end, the Board appointed the CFO as interim CEO on October 7, 2018, and appointed Sean M. Lannon interim CFO on October 12, 2018. This leadership transition is a notable subsequent event.
- Ordinary-course legal proceedings and customer-obligation guarantees were disclosed; management did not expect pending lawsuits to have a material effect and reported no guarantee liability at September 30, 2018.
Most important facts for investors to verify
- Whether Performance Coatings’ pricing, acquired growth, and margin gains can offset raw-material inflation and whether Transportation Coatings’ pricing and EBITDA weakness persists.
- The full earnings and cash consequences of the Mechelen closure, including restructuring payments, accelerated depreciation, and tax effects.
- Debt-service capacity and the assumptions underlying the stated approximately $10.0 annual interest savings, given leverage and variable-rate exposure.
- Whether working-capital outflows normalize and operating cash flow can support capital expenditures, acquisitions, buybacks, and debt obligations.
- How the CEO/CFO leadership transition and the integration of 2018 acquisitions affect execution and results.
- Potential changes to the provisional U.S. tax-reform accounting and the outcome or timing of uncertain tax positions and other contingencies.