Axalta Coating Systems Ltd. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Figures are in U.S. dollars; financial amounts are in millions unless noted.
Business context and period
Axalta manufactures and sells coatings globally through Performance Coatings (refinish and industrial) and Transportation Coatings (light and commercial vehicle). The quarter included the June 1 acquisition of Valspar’s North American Industrial Wood business and the deconsolidation of Axalta’s Venezuelan subsidiary.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $1,088.5 | $1,063.6 | $2,096.3 | $2,020.8 |
| Total revenue | $1,094.6 | $1,070.6 | $2,108.3 | $2,033.8 |
| Income from operations | $47.4 | $149.5 | $157.4 | $254.4 |
| Net income (loss) | $(18.9) | $52.3 | $47.0 | $85.1 |
| Net income (loss) attributable to controlling interests | $(20.8) | $50.7 | $43.3 | $82.6 |
| Adjusted EBITDA | $227.2 | $251.1 | $430.3 | $447.5 |
| Cash provided by operating activities | Not separately reported | Not separately reported | $94.1 | $186.0 |
Q2 gross margin was approximately 36.6%, versus 39.0%; first-half gross margin was approximately 36.5%, versus 37.9%. Q2 operating margin was approximately 4.3%, versus 14.0%; first-half operating margin was approximately 7.5%, versus 12.5%. These percentages are calculated from reported figures.
- First-half net sales rose 3.7%; volume increased 7.4%, including a 5.5% contribution from acquisitions. Lower average selling prices reduced sales 1.9%, and foreign currency translation reduced sales 1.8%.
- At June 30, cash and cash equivalents were $482.1, down from $535.4 at year-end 2016. Current assets were $2,095.0 and current liabilities $981.6.
- Total borrowings, net of unamortized discount and financing costs, were $3,858.9, compared with $3,263.9 at December 31, 2016. The revolving facility had $378.2 of availability, net of letters of credit; no revolver borrowings were outstanding. Axalta reported compliance with debt covenants.
- First-half investing cash outflow was $595.3, including $533.3 for acquisitions and $57.4 for capital expenditures. Financing cash inflow was $437.3, primarily reflecting refinancing proceeds. Operating cash flow fell to $94.1, principally as working-capital uses increased to $219.7, including higher receivables and prepaid/other assets.
Material changes versus the prior comparable period
- Q2 net loss reflected a $70.9 Venezuela deconsolidation charge. Axalta ceased consolidating the subsidiary because currency restrictions, political and economic conditions, reduced demand, and expected losses constrained control and access to its earnings. The subsidiary’s net assets, intercompany receivables, and accumulated pension losses were written off; the cost-method investment and prior intercompany balances were recorded at zero.
- Adjusted EBITDA declined 9.5% in Q2 and 3.8% in the first half. Performance Coatings first-half Adjusted EBITDA decreased 1.4%; Transportation Coatings decreased 7.4%, with pricing pressure and higher costs weighing on results.
- In Q2, Performance Coatings sales grew 5.1%, while Transportation Coatings sales declined 1.7%. For the first half, the respective sales increases were 6.3% and 0.2%.
- Interest expense decreased to $35.6 in Q2 and $71.4 in the first half, from $47.8 and $97.9, respectively, reflecting prior debt prepayments and refinancing. Axalta said the 2017 refinancing was expected to save $7.7 in annual cash interest versus previous principal balances.
- Five businesses were acquired in the first half, for total consideration of $539.2; cash used for business acquisitions was $533.3. Industrial Wood contributed $22.1 of sales from its acquisition date. Purchase accounting remained preliminary.
- Axalta disclosed corrections to prior-period revenue timing for certain refinish rebates and pricing concessions. It deemed prior-period errors immaterial, but revised historical presentation; the filing states no impact on historical operating cash flows.
Outlook, commentary, risks, and unusual items
- No specific earnings or revenue guidance is provided. Management expected cash from operations, available cash, and borrowing capacity to cover debt service, working capital, planned capital expenditures, cost-saving initiatives, and other liquidity needs for the next 12 months.
- The company authorized a $675.0 share-repurchase program in March 2017; $8.3 had been repurchased by June 30, leaving $666.7 authorized.
- Key disclosed risks include substantial indebtedness and refinancing needs; adverse automotive and economic conditions; raw-material price or supply disruptions; foreign-exchange exposure; competition and pricing pressure; acquisition integration and benefit realization; Venezuela-related restrictions and uncertainty; environmental and litigation exposures; and impairment risks.
- Pending lawsuits and claims include civil, regulatory, and environmental matters. Management could not determine the ultimate outcome of certain matters; the filing says ordinary-course proceedings were not expected, individually or collectively, to have a material adverse effect.
- Other unusual items included $12.4 of debt extinguishment/refinancing costs and $3.2 of property impairment in the first half. Management’s Adjusted EBITDA excludes specified items and is a non-GAAP measure, not a substitute for GAAP results.
- Management concluded disclosure controls were effective at June 30, 2017; it reported no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether acquisition-related growth translates into sustained organic sales and improved margins, particularly given pricing pressure in light vehicle and refinish markets.
- The final purchase accounting and expected contribution from the Industrial Wood and other 2017 acquisitions.
- Cash conversion and working-capital trends, including receivables and customer incentive payments, alongside acquisition and capital-spending requirements.
- Debt repayment, variable-rate exposure, covenant headroom, and the realization of stated interest savings.
- Further developments in Venezuela, including any ability to access cash, collect intercompany amounts, or resume consolidation.
- The effects of the disclosed historical revenue corrections and the company’s implementation of the forthcoming revenue-recognition standard.
- Potential outcomes and financial exposure from litigation, environmental matters, tax uncertainties, and asset impairments.