ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K.
This discussion and analysis deals with comparisons of material changes in the consolidated financial statements for 2022 and 2021. For the comparison of 2021 and 2020, see Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of our 2021 Annual Report on Form 10-K, filed with the SEC on February 18, 2022.
FORWARD-LOOKING STATEMENTS
Many statements made in the following discussion and analysis of our financial condition and results of operations and elsewhere in this Annual Report on Form 10-K that are not statements of historical fact, including statements about our beliefs and expectations, are "forward-looking statements" within the meaning of federal securities laws and should be evaluated as such. Forward-looking statements include information concerning possible or assumed future results of operations, including descriptions of our business plan, strategies and capital structure. These statements often include words such as "anticipate," "assumed," "expect," "believe," "intended," "estimates," "goal," "projections," "plans," "can," "could," "should," "would," "may," "will," "forecasts" and the negative of these words or other comparable or similar terminology. We base these forward-looking statements or projections on our current expectations, plans and assumptions that we have made in light of our experience in the industry, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances and at such time. As you read and consider this Annual Report on Form 10-K, you should understand that these statements are not guarantees of performance or results. The forward-looking statements and projections are subject to and involve risks and uncertainties, including, but not limited to, economic, competitive, governmental and technological factors outside of our control, including the effects of COVID-19, that may cause our business, industry, strategy, financing activities or actual results to differ materially. The impact and duration of COVID-19 on our business and operations is uncertain. Factors that will influence the impact on our business and operations include the duration and extent of COVID-19, the extent of imposed or recommended containment and mitigation measures, and the general economic consequences of COVID-19. More information on potential factors that could affect our financial results is available in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as "Risk Factors" in this Annual Report on Form 10-K and in other documents that we have filed with, or furnished to, the SEC, and you should not place undue reliance on these forward-looking statements or projections. Although we believe that these forward-looking statements and projections are based on reasonable assumptions at the time they are made, you should be aware that many factors, including, but not limited to, those described in "Risk Factors," could affect our actual financial results or results of operations and could cause actual results to differ materially from those expressed in the forward-looking statements and projections.
These forward-looking statements should not be construed by you to be exhaustive and are made only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update or revise any of the forward-looking statements contained herein, whether as a result of new information, future events or otherwise.
OVERVIEW
We are a leading global manufacturer, marketer and distributor of high-performance coatings systems and products. We have over a 150-year heritage in the coatings industry and are known for manufacturing high-quality products with well-recognized brands supported by market-leading technology and customer service. Our diverse global footprint of 45 manufacturing facilities, four technology centers, 48 customer training centers and approximately 12,000 team members allows us to meet the needs of customers in over 140 countries. We serve our customer base through an extensive sales force and technical support organization, as well as through approximately 4,000 independent, locally based distributors.
We operate our business in two operating segments, Performance Coatings and Mobility Coatings. Our segments are based on the type and concentration of customers served, service requirements, methods of distribution and major product lines.
Through our Performance Coatings segment, we provide high-quality liquid and powder coatings solutions to both large regional and global OEMs and to a fragmented and local customer base. We are one of only a few suppliers with the technology to provide precise color matching and highly durable coatings systems. The end-markets within this segment are refinish and industrial.
Through our Mobility Coatings segment, we provide coatings technologies for light vehicle and commercial vehicle OEMs. These global customers are faced with evolving megatrends in electrification, sustainability, personalization and autonomous driving that require a high level of technical expertise. The OEMs require efficient, environmentally responsible coatings systems that can be applied with a high degree of precision, consistency and speed. The end-markets within this segment are light vehicle and commercial vehicle.
34
Table of Contents
BUSINESS HIGHLIGHTS
General Business Highlights
Our net sales increased 10.6%, including a 4.9% headwind from foreign currency translation, for the year ended December 31, 2022 compared with the year ended December 31, 2021. The increased net sales were primarily driven by higher average selling price and product mix of 10.1%, higher volumes of 3.7% and a 1.7% contribution from acquisitions, net of the impact from the restructuring of a Performance Coatings commercial agreement ("Customer Contract Restructuring"), which is discussed in more detail in Note 2 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The following trends have impacted our segment net sales performance:
•Performance Coatings:Net sales increased 7.4% for the year ended December 31, 2022 compared with the year ended December 31, 2021. The increased net sales were primarily driven by higher average selling price and product mix of 10.9% and contributions from acquisitions, net of the impact from the Customer Contract Restructuring, of 2.4%, partially offset by a 5.5% headwind from unfavorable foreign currency translation driven primarily by the weakening of the Euro compared to the U.S. Dollar and a modest decline in volumes of 0.4%.
•Mobility Coatings: Net sales increased 18.0% for the year ended December 31, 2022 compared with the year ended December 31, 2021. The increased net sales were driven by higher sales volumes of 13.6% and higher average selling price and product mix of 8.1%, partially offset by unfavorable currency impact of 3.7%, driven primarily by the weakening of the Euro, Turkish Lira and Chinese Renminbi compared to the U.S. Dollar.
Our business serves four end-markets globally with net sales for the years ended December 31, 2022 and 2021 as follows:
Performance Coatings
Mobility Coatings
CEO transition
On July 26, 2022, we announced that Robert Bryant would step down as President and Chief Executive Officer and as a member of Axalta's Board, effective August 31, 2022. On August 31, 2022, Rakesh Sachdev, a member of the Board, assumed the role of Interim Chief Executive Officer and President. On November 11, 2022, the Board, upon the recommendation of the CEO Search Committee of the Board, appointed Chris Villavarayan as the Company’s Chief Executive Officer and President, effective January 1, 2023.
Raw material inflation, supply chain challenges and semiconductor chip shortages
During the year ended December 31, 2022, we were negatively impacted by continued raw material inflation, although in the second half of the year raw material inflation started to abate. Throughout the year, we were able to offset a significant portion of such inflation through the realization of improved pricing on our products.
During 2022, we were also negatively impacted by supply chain challenges as well as semiconductor chip shortages, which primarily affected production levels of our automotive OEM customers in our Light Vehicle end-market. These disruptions also led to increased inventory levels throughout 2022.
By the end of the year, each of these conditions had begun to normalize, but we will continue to monitor each condition and take appropriate actions that we believe will help mitigate costs and other operational impacts.
35
Table of Contents
Russia conflict with Ukraine
Russia's conflict with Ukraine and the sanctions and other measures imposed by various governments in response to this conflict have increased the level of economic and political uncertainty globally. While our operations in Russia and Ukraine constituted less than 1.5% of our net sales during the years ended December 31, 2022 and 2021, a significant escalation or expansion of economic disruption or countries subject to sanctions or the conflict's scope could have a material adverse effect on our results of operations, financial condition and cash flows. We are actively monitoring the broader economic impact on commodities and currency exchange rates from the current conflict, especially on the price and supply of raw materials. We recorded expenses of $5.0 million related to incremental reserves for accounts receivable, inventory and other assets as a result of sanctions imposed on Russia during the year ended December 31, 2022. Net assets of our Russian subsidiaries at December 31, 2022 were approximately $12.6 million, with $12.9 million comprising cash and cash equivalents.
COVID-19 Pandemic
During the year ended December 31, 2022, our business continued to recover from the significant adverse impact on the demand for our products and, thus, our income from operations caused by the COVID-19 pandemic, which began in early 2020. While we have seen a return to more stable quarter-over-quarter demand for our products and services, we remain cognizant of future COVID-19 developments, such as impacts from new variants, employee absenteeism, lockdowns or other restrictions that could impact our future results of operations, financial condition and cash flows. During the year ended December 31, 2022, our manufacturing sites and operations in China were temporarily impacted by the lockdowns imposed by local authorities in response to COVID-19 on multiple occasions, which negatively impacted demand in the country. The risks and uncertainties related to the COVID-19 pandemic are discussed in further detail within Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Capital and Liquidity Highlights
During the year ended December 31, 2022, we repurchased 7.4 million shares of our common stock for total consideration of $200.1 million as we continued to execute against our previously-approved share repurchase program.
During the year ended December 31, 2022, we entered into the Eleventh Amendment (as defined in Note 18 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K). We amended the Credit Agreement (as defined in Note 18 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K) to, among other things, provide a new seven-year $2.0 billion term loan maturing in December 2029, the proceeds of which, together with cash on hand, were used to refinance the Borrowers' (as defined in the Credit Agreement) existing $2.021 billion term loan due in June 2024. The interest rate payable on such new term loan is SOFR plus a margin of 300 basis points.
ESG Framework
In January 2022, we announced a new ESG framework that details longer-term ESG goals and strategies. For additional information, see Part I, Item 1, "Business—Environmental, Social and Governance" included elsewhere in this Annual Report on Form 10-K.
FACTORS AFFECTING OUR OPERATING RESULTS
The following discussion sets forth certain components of our statements of operations as well as factors that impact those items.
Net sales
We generate revenue from the sale of our products and services across all major geographic areas. Our net sales include total sales less estimates for returns and price allowances. Price allowances include discounts for prompt payment as well as volume-based incentives. Our overall net sales are generally impacted by the following factors:
•fluctuations in overall economic activity within the geographic markets in which we operate;
•underlying growth (or lack thereof) in one or more of our end-markets, either worldwide or in particular geographies in which we operate;
•the type of products used within existing customer applications, or the development of new applications requiring products similar to ours;
•changes in product sales prices (including volume discounts and cash discounts for prompt payment);
•changes in the level of competition faced by our products, including price competition, quality competition and the launch of new products by competitors;
•our ability to successfully develop and launch new products and applications;
36
Table of Contents
•changes in buying habits of our customers (including our distributors); and
•fluctuations in foreign exchange rates.
While the factors described above impact net sales in each of our operating segments, the impact of these factors on our operating segments can differ, as described below. For more information about risks relating to our business, see Part I, Item 1A, "Risk Factors—Risks Related to our Business."
Cost of goods sold ("cost of sales")
Our cost of sales consists principally of the following:
•Production materials costs. These include costs of the materials needed to manufacture products for distribution. These costs generally increase on an aggregate basis as production volumes increase, but materials prices are also influenced by changes in market dynamics. A significant amount of the materials used in production are purchased on a global lowest-cost basis.
•Employee costs. These include the compensation and benefit costs, including share-based compensation expense, for employees involved in our manufacturing operations and on-site technical support services. These costs generally increase on an aggregate basis as production volumes increase and may decline as a percent of net sales as a result of economies of scale associated with higher production volumes.
•Depreciation expense. Property, plant and equipment are stated at cost and depreciated or amortized on a straight-line basis over their estimated useful lives. Property, plant and equipment acquired through the Acquisition were recorded at their estimated fair value on the acquisition date resulting in a new cost basis for accounting purposes.
•Other. Our remaining cost of sales consists of freight costs, warehousing expenses, purchasing costs, costs associated with closing or idling of production facilities, functional costs supporting manufacturing, cost of poor quality, including product claims, and other general manufacturing expenses, such as expenses for utilities and energy consumption.
The main factors that influence our cost of sales as a percentage of net sales include:
•changes in the price of raw materials;
•changes in the costs of labor, logistics and energy;
•production volumes;
•the implementation of cost control measures aimed at improving productivity, including reduction of fixed production costs, refinements in inventory management and the coordination of purchasing within each subsidiary and at the business level;
•changes in sales volumes, average selling prices and product mix; and
•fluctuations in foreign exchange rates.
Selling, general and administrative expenses ("SG&A")
Our SG&A expense consists of all expenditures incurred in connection with the sales and marketing of our products, as well as technical support for our customers and administrative overhead costs, including:
•compensation and benefit costs for management, sales personnel and administrative staff, including share-based compensation expense. Expenses relating to our sales personnel increase or decrease principally with changes in sales volume due to the need to increase or decrease sales personnel to meet changes in demand. Expenses relating to administrative personnel generally do not increase or decrease directly with changes in sales volume; and
•depreciation, advertising and other selling expenses, such as expenses incurred in connection with travel and communications.
37
Table of Contents
Changes in SG&A expense as a percentage of net sales have historically been impacted by a number of factors, including:
•changes in the costs of labor, including inflationary pressures;
•changes in sales volume, as higher volumes enable us to spread the fixed portion of our administrative expense over higher sales;
•changes in our customer base, as new customers may require different levels of sales and marketing attention;
•new product launches in existing and new markets, as these launches typically involve a more intense sales activity and technical support before they are integrated into customer applications;
•customer credit issues requiring increases to the allowance for doubtful accounts; and
•fluctuations in foreign exchange rates.
Other operating charges
Our other operating charges include termination benefits and other employee-related costs, strategic review and retention costs, acquisition and divestiture-related costs, impairment charges, an operational matter, which is discussed further in Note 6 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, and gains of sales of facilities, details of which are included in our reconciliations of segment operating performance to income before income taxes.
Research and development expenses
Research and development expenses represent costs incurred to develop new products, services, processes and technologies or to generate improvements to existing products, services or processes.
Interest expense, net
Interest expense, net consists primarily of interest expense on institutional borrowings and other financing obligations and changes in fair value of interest rate derivative instruments, net of capitalized interest expense. Interest expense, net also includes the amortization of debt issuance costs and debt discounts associated with our Senior Secured Credit Facilities, Senior Notes and other indebtedness.
Other expense (income), net
Other expense (income), net represents costs incurred on various non-operational items including costs incurred in conjunction with our debt refinancing and extinguishment transactions, interest income, as well as foreign exchange gains and losses and non-operational impairment losses unrelated to our core business.
Provision for income taxes
We and our subsidiaries are subject to income tax in the various jurisdictions in which we operate. While the extent of our future tax liability is uncertain, changes to the debt and equity capitalization of our subsidiaries, the realignment of the functions performed, and risks assumed by the various subsidiaries are among the factors that will determine the future book and taxable income of the Company and its subsidiaries.
38
Table of Contents
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the information contained in the accompanying financial statements and related notes included elsewhere in this Annual Report on Form 10-K. Our historical results of operations summarized and analyzed below may not necessarily reflect what will occur in the future.
Net sales
Price/Mix effect 10.1 %
Volume effect 3.7 %
Impact of acquisitions and Customer Contract Restructuring 1.7 %
Exchange rate effect (4.9) %
Net sales increased primarily due to the following:
n Sales contributions from companies acquired during 2021
Partially offset by:
Cost of sales
Cost of sales increased primarily due to the following:
Partially offset by:
Partially offset by:
n More effective coverage of fixed cost as a result of higher sales volumes
39
Table of Contents
Selling, general and administrative expenses
Selling, general and administrative expenses $ 772.4 $ 738.7 $ 33.7 4.6 %
n Higher operating expenses due primarily to inflation of labor costs
n Increased costs from companies acquired during 2021 of $17.5 million
Partially offset by:
Other operating charges
Other operating charges decreased primarily due to the following:
n Absence of $9.7 million associated with retention awards earned in 2021
Partially offset by:
Research and development expenses
Research and development expenses $ 66.4 $ 62.4 $ 4.0 6.4 %
Research and development expenses increased primarily due to the following:
n Increased labor costs as a result of inflation
Partially offset by:
40
Table of Contents
Amortization of acquired intangibles
Amortization of acquired intangibles $ 125.3 $ 121.4 $ 3.9 3.2 %
Amortization of acquired intangibles increased primarily due to the following:
Partially offset by:
n Reduced amortization from intangibles reaching the end of their useful life
Interest expense, net
Interest expense, net increased primarily due to the following:
Partially offset by:
Other expense (income), net
Other expense (income), net changed primarily due to the following:
n Unfavorable impact of foreign exchange losses of $12.3 million
41
Table of Contents
Provision for income taxes
Year Ended December 31,
Income before income taxes $ 257.3 $ 340.5
Provision for income taxes 65.1 76.1
Statutory U.S. Federal income tax rate 21.0 % 21.0 %
Effective tax rate 25.3 % 22.4 %
Effective tax rate vs. statutory U.S. Federal income tax rate 4.3 % 1.4 %
(Favorable) Unfavorable Impact
Changes in valuation allowance 1.6 18.1
Foreign exchange (loss) gain, net (5.4) 2.2
Tax credits (8.7) (6.7)
Non-deductible expenses and interest 5.7 5.7
Change in unrecognized tax benefits 6.2 (4.9)
Foreign taxes 6.9 8.7
(1) Primarily related to earnings in Bermuda, Germany, Luxembourg and Switzerland.
(2) In 2022, the Company recorded a tax expense of $23.0 million in the Netherlands related to a historical impairment charge, which is fully offset by a tax benefit of $23.0 million for the decrease to the valuation allowance. In 2021, the Company recorded a tax benefit of $2.9 million in the Netherlands, which is fully offset by a tax expense of $2.9 million for an increase to the valuation allowance.
42
Table of Contents
SEGMENT RESULTS
The Company's products and operations are managed and reported in two operating segments: Performance Coatings and Mobility Coatings. See Note 20 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.
Performance Coatings Segment
Price/Mix effect 10.9 %
Impact of acquisitions and Customer Contract Restructuring 2.4 %
Volume effect (0.4) %
Exchange rate effect (5.5) %
Adjusted EBIT Margin 13.5 % 15.5 %
Net sales increased primarily due to the following:
n Sales from companies acquired in 2021
Partially offset by:
Adjusted EBIT and Adjusted EBIT margin decreased due to the following:
Partially offset by:
n Contributions from companies acquired in 2021
43
Table of Contents
Mobility Coatings Segment
Volume effect 13.6 %
Price/Mix effect 8.1 %
Exchange rate effect (3.7) %
Adjusted EBIT Margin 1.5 % 2.9 %
Net sales increased primarily due to the following:
Partially offset by:
Adjusted EBIT and Adjusted EBIT margin decreased due to the following:
Partially offset by:
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity are cash on hand, net cash provided by operating activities and available borrowing capacity under our Senior Secured Credit Facilities.
At December 31, 2022, availability under the Revolving Credit Facility was $529.3 million, net of $20.7 million of letters of credit outstanding. All such availability may be utilized without violating any covenants under the Credit Agreement or the indentures governing the Senior Notes. At December 31, 2022, we had $13.5 million of outstanding borrowings under other lines of credit. Our remaining available borrowing capacity under other lines of credit in certain non-U.S. jurisdictions totaled $46.4 million.
We, or our affiliates, at any time and from time to time, may purchase shares of our common stock or the Senior Notes, and may prepay our 2029 Dollar Term Loans or other indebtedness. Any such purchases of our common stock or Senior Notes may be made through the open market or privately negotiated transactions with third parties or pursuant to one or more redemption, tender or exchange offers or otherwise, upon such terms and at such prices, as well as with such consideration, as we, or any of our affiliates, may determine.
We have various supplier finance programs in place around the world. We partner with large banking institutions and utilize these programs to enhance our liquidity profile. Depending on the program, the liabilities under the program are classified either as accounts payable or current portion of borrowings on our consolidated balance sheets. Our supplier financing facility in China is more fully described in Note 18 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
44
Table of Contents
Cash Flows
Years ended December 31, 2022 and 2021
Years Ended December 31,
Net cash provided by (used for):
Operating activities:
Depreciation and amortization 303.1 316.5
Amortization of deferred financing costs and original issue discount 9.6 8.9
Debt extinguishment and refinancing-related costs 14.7 0.2
Deferred income taxes (3.4) 15.0
Realized and unrealized foreign exchange losses, net 15.5 10.1
Stock-based compensation 22.2 14.9
Gain on sales of facilities (1.5) (19.7)
Interest income on swaps designated as net investment hedges (19.9) (18.0)
Commercial agreement restructuring charge 25.0 —
Other non-cash, net 7.7 11.7
Net income adjusted for non-cash items 565.2 604.0
Changes in operating assets and liabilities (271.4) (45.4)
Effect of exchange rate changes on cash (14.8) (20.9)
Net (decrease) increase in cash $ (196.3) $ (512.8)
Year Ended December 31, 2022
Net Cash Provided by Operating Activities
Net cash provided by operating activities for the year ended December 31, 2022 was $293.8 million. Net income before deducting depreciation, amortization and other non-cash items generated cash of $565.2 million. This was offset by net uses of working capital of $271.4 million, for which the most significant drivers were increases in inventories, accounts and notes receivable, prepaid expenses and other assets of $195.4 million, $171.0 million and $80.5 million, respectively. These outflows were primarily driven by increased sales volumes and price-mix, increased inventory on hand caused by supply chain disruptions combined with inflation of raw material, freight, logistics and energy costs and payments of Business Incentive Plan assets. The outflows were partially offset by increases in accounts payable of $138.0 million primarily due to raw material cost inflation, as well as elevated freight, logistics and energy costs.
Net Cash Used for Investing Activities
Net cash used for investing activities for the year ended December 31, 2022 was $106.4 million. The primary use was for purchases of property, plant and equipment of $150.9 million, partially offset by proceeds of $44.9 million from settlements and interest from swaps designated as net investment hedges, which are discussed further in Note 19 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Net Cash Used for Financing Activities
Net cash used for financing activities for the year ended December 31, 2022 was $368.9 million. The primary uses were for purchases of our common stock totaling $200.1 million, payments, net of refinancing proceeds, of $153.0 million on borrowings, which includes $64.6 million for our China supplier financing program, and outflows of $15.1 million for fees associated with refinancing our 2024 Dollar Term Loans. Our China supplier financing program and our 2024 Dollar Term Loan refinancing are discussed further in Note 18 to the condensed consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
45
Table of Contents
Other Impacts on Cash
Currency exchange impacts on cash for the year ended December 31, 2022 were unfavorable by $14.8 million, which was driven primarily by weakening in the British Pound, Argentine Peso and Chinese Renminbi compared to the U.S. Dollar partially offset by the strengthening of the Mexican Peso.
Year Ended December 31, 2021
Net Cash Provided by Operating Activities
Net cash provided by operating activities for the year ended December 31, 2021 was $558.6 million. Net income before deducting depreciation, amortization and other non-cash items generated cash of $604.0 million. This was offset by net uses of working capital of $45.4 million, for which the most significant drivers were increases in inventory, accounts and notes receivable, prepaid expenses and other assets of $111.6 million, $80.5 million and $45.3 million, respectively. These outflows were primarily driven by inflation of raw material costs, increased accounts receivable associated with net sales growth, insurance receivables related to an operational matter within the Mobility Coatings segment, which is discussed further in Note 6 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, and timing of business incentive payments. The outflows were partially offset by increases in accounts payable of $140.1 million due to inflation of raw material costs and management of accounts payable and other accruals of $66.2 million primarily related to an operational matter within the Mobility Coatings segment, which is discussed further in Note 6 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Net Cash Used for Investing Activities
Net cash used for investing activities for the year ended December 31, 2021 was $716.0 million. The primary uses were $649.0 million for business acquisitions and purchases of property, plant and equipment of $121.6 million. The outflows were partially offset by proceeds received from sales of assets of $37.8 million, driven primarily by the sales of facilities, and $18.0 million of interest proceeds on swaps designated as net investment hedges.
Net Cash Used for Financing Activities
Net cash used for financing activities for the year ended December 31, 2021 was $334.5 million. The primary uses were for the purchase of common stock totaling $243.8 million and payments of $100.9 million on borrowings, which includes $63.8 million for our China supplier financing program discussed further in Note 18 to the condensed consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Other Impacts on Cash
Currency exchange impacts on cash for the year ended December 31, 2021 were unfavorable by $20.9 million, which was driven primarily by fluctuations in the Euro compared to the U.S. Dollar partially offset by fluctuations in the Chinese Renminbi compared to the U.S. Dollar.
Financial Condition
We had cash and cash equivalents at December 31, 2022 and 2021 of $645.2 million and $840.6 million, respectively. Of these balances, $433.6 million and $471.9 million were maintained in non-U.S. jurisdictions as of December 31, 2022 and 2021, respectively, with $12.9 million and $11.3 million, respectively, within Russia. We believe at this time our organizational structure allows us the necessary flexibility to move funds throughout our subsidiaries to meet our operational working capital needs.
Our business may not generate sufficient cash flow from operations and future borrowings may not be available under our Senior Secured Credit Facilities in an amount sufficient to enable us to pay our indebtedness, or to fund our other liquidity needs, including planned capital expenditures. In such circumstances, we may need to refinance all or a portion of our indebtedness on or before maturity. We may not be able to refinance any of our indebtedness on commercially reasonable terms or at all. If we cannot service our indebtedness, we may have to take actions such as selling assets, selling additional equity or reducing or delaying capital expenditures, strategic acquisitions, investments and alliances. Our primary sources of liquidity are cash on hand, cash flow from operations and available borrowing capacity under our Senior Secured Credit Facilities. Based on our forecasts, we believe that cash flow from operations, available cash on hand and available borrowing capacity under our Senior Secured Credit Facilities and existing lines of credit will be adequate to service debt, fund our cost saving initiatives, meet liquidity needs and fund necessary capital expenditures for the next twelve months.
Our ability to make scheduled payments of principal or interest on, or to refinance, our indebtedness or to fund working capital requirements, capital expenditures and other current obligations will depend on our ability to generate cash from operations. Such cash generation is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control, including the effects of COVID-19, inflationary pressures and Russia's conflict with Ukraine.
46
Table of Contents
If required, our ability to raise additional financing and our borrowing costs may be impacted by short and long-term debt ratings assigned by independent rating agencies, which are based, in significant part, on our performance as measured by certain credit metrics such as interest coverage and leverage ratios. Our highly leveraged nature may limit our ability to procure additional financing in the future and elevated interest rates, as experienced during 2022, may increase our interest expense and weaken our financial condition.
The following table details our borrowings outstanding at the dates indicated:
December 31,
Short-term and other borrowings 74.5 113.8
Unamortized original issue discount (22.4) (4.6)
Unamortized deferred financing costs (26.9) (27.3)
Less:
Short-term borrowings 16.0 55.4
Current portion of long-term borrowings 15.0 24.3
Our indebtedness, including the Senior Secured Credit Facilities, Senior Notes and short-term borrowings, is more fully described in Note 18 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
We believe that we continue to maintain sufficient liquidity to meet our requirements, including our leverage and associated interest payments as well as our working capital needs. Availability under the Revolving Credit Facility was $529.3 million and $527.9 million at December 31, 2022 and December 31, 2021, respectively, all of which may be borrowed by us without violating any covenants under the credit agreement governing such facility or the indentures governing the Senior Notes.
During the year ended December 31, 2022, we entered into the Eleventh Amendment discussed within Note 18 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The Eleventh Amendment amended the Credit Agreement to, among other things, provide a new seven-year $2.0 billion term loan maturing in December 2029, the proceeds of which, together with cash on hand, were used to refinance the Borrowers' existing $2.021 billion term loan due in June 2024. The interest rate payable on such new term loan is SOFR plus a margin of 300 basis points.
The following table details our borrowings outstanding, average effective interest rates and the associated interest expense for the years ended December 31, 2022 and 2021. Interest expense is inclusive of the amortization of debt issuance costs, debt discounts and the impact of derivative instruments for the years ended December 31, 2022 and 2021, respectively:
Years Ended December 31,
Revolving Credit Facility — N/A 2.7 — N/A 1.5
Short-term and other borrowings 74.5 Various 2.8 113.8 Various 4.6
47
Table of Contents
After giving effect to our cross-currency and interest rate hedges, our borrowings denominated in U.S. Dollars as of December 31, 2022 and 2021 were $2,434.0 million and $2,481.4 million, respectively, with weighted average interest rates of 5.4% and 3.4%, respectively. After giving effect to our cross-currency and interest rate hedges, borrowings denominated in Euros as of December 31, 2022 and 2021 were $1,319.6 million and $1,380.1 million, respectively, with weighted average interest rates of 2.5% and 2.5%, respectively. The cross-currency and interest rate hedges impacting our Euro denominated borrowings mature in March 2023 as discussed in Note 19 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Contractual Obligations
See Note 7 and Note 18 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for disclosure of our material contractual obligations.
Off Balance Sheet Arrangements
See Note 6 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for disclosure of our guarantees of certain customers' obligations to third parties.
Recent Accounting Guidance
See Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for a summary of recent accounting guidance.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of results of operations and financial condition are based upon our consolidated financial statements. These financial statements have been prepared in accordance with U.S. GAAP unless otherwise noted. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts reported in the financial statements. We base our estimates and judgments on historical experiences and assumptions believed to be reasonable under the circumstances and re-evaluate them on an ongoing basis. Actual results could differ from our estimates under different assumptions or conditions. Our significant accounting policies, which may be affected by our estimates and assumptions, are more fully described in Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect its most significant estimates and assumptions used in the preparation of the financial statements.
Accounting for Business Combinations
Determining the fair value of assets acquired and liabilities assumed in business combinations requires management's judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, royalty rates, customer attrition rates, technology migration rates, asset lives and market multiples, among other items.
The fair values of intangible assets are estimated using an income approach, either the excess earnings method (customer relationships) or the relief from royalty method (technology and trademarks). Under the excess earnings method, an intangible asset's fair value is equal to the present value of the incremental after-tax cash flows attributable solely to the intangible asset over its remaining useful life. With respect to customer relationships, fair values are calculated using the excess earnings method and customer attrition is a key input used to determine the applicable after-tax cash flows. Under the relief from royalty method, fair value is measured by estimating future revenue associated with the intangible asset over its useful life and applying a royalty rate to the revenue estimate. These intangible assets enable us to secure markets for our products, develop new products to meet evolving business needs and competitively produce our existing products.
The fair values of real properties acquired are based on the consideration of their highest and best use in the market. The fair values of property, plant and equipment, other than real properties, are based on the consideration that unless otherwise identified, they will continue to be used "as is" and as part of the ongoing business. In contemplation of the in-use premise and the nature of the assets, the fair value is developed primarily using a cost approach.
The fair value of noncontrolling interests, when applicable, are estimated by applying an income approach and is based on significant inputs that are not observable in the market and thus represents a fair value measurement categorized within Level 3 of the fair value hierarchy. Key assumptions in the valuation of noncontrolling interest included a discount rate, a terminal value based on a range of long-term sustainable growth rates and adjustments because of the lack of control that market participants would consider when measuring the fair value of the noncontrolling interests.
48
Table of Contents
The fair value of contingent consideration liabilities is estimated by applying an income approach using the Black-Scholes option pricing model. The fair value measurements are based on significant inputs that are not observable in the market and thus represents a fair value measurement categorized within Level 3 of the fair value hierarchy. Key assumptions in the valuation of contingent consideration liabilities include discount rates, expected terms, volatility rates and operating results as applicable based on the targets identified in the respective acquisition agreements.
See Notes 1 and 3 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.
Asset Impairments
Factors that could result in future impairment charges or changes in useful lives, among others, include changes in worldwide economic conditions, changes in technology, changes in competitive conditions and customer preferences, and fluctuations in foreign currency exchange rates. These risk factors are discussed in Part I, Item 1A, "Risk Factors," included elsewhere in this Annual Report on Form 10-K.
Goodwill and indefinite-lived intangible assets
The Company tests indefinite-lived intangible assets and goodwill for impairment annually by either performing a qualitative evaluation or a quantitative test. The qualitative evaluation is an assessment of factors to determine whether it is more likely than not that the fair values of a reporting unit or indefinite-lived intangible asset is less than its carrying amount. Fair values used under the quantitative impairment assessment are estimated using a combination of discounted projected future earnings or cash flow methods that are based on projections of the amounts and timing of future revenue and cash flows, and multiples of earnings in estimating fair value. In conjunction with our impairment assessments of indefinite-lived intangible assets, we also review the reasonableness of the indefinite useful lives associated with these assets, in which we evaluate whether indicators exist that future cash flows associated with these assets could be realized over a finite period.
In 2022, as a result of the time lapsed since our last quantitative evaluation in 2019, we bypassed the qualitative evaluation and tested for impairment of the goodwill of our reporting units and our indefinite-lived intangible assets by performing a quantitative evaluation. The quantitative analysis concluded that all reporting units and indefinite-lived intangible assets had fair values substantially in excess of carrying values.
The inputs utilized in a quantitative analysis are classified as Level 3 inputs within the fair value hierarchy as defined in ASC 820, "Fair Value Measurement." The process of evaluating the potential impairment of goodwill and indefinite-lived intangible assets is subjective because it requires the use of estimates and assumptions as to our future cash flows, discount rates commensurate with the risks involved in the assets, future economic and market conditions, as well as other key assumptions. We believe that the amounts recorded in the financial statements related to goodwill and indefinite-lived intangible assets are based on the best estimates and judgments of the appropriate Axalta management, although actual outcomes could differ from our estimates.
See Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.
Long-Lived Assets
Long-lived assets, which includes property, plant and equipment, and definite-lived intangible assets, such as technology, trademarks, customer relationships and non-compete agreements, are continually assessed for impairment at the asset group level whenever events or changes in circumstances indicate the carrying amount of the asset group may not be recoverable. Such impairment assessments involve comparing the carrying amount of the asset group, determined at the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets, to the forecasted undiscounted future cash flows generated by that asset group (i.e., a recoverability test). In the event the carrying amount of the asset group exceeds the undiscounted future cash flows generated by that asset group and the carrying amount is not considered recoverable, an impairment exists. An impairment loss is measured as the excess of the asset group's carrying amount over its fair value.
Stock-Based Compensation
Compensation expense related to service-based, non-qualified stock options is equivalent to the grant-date fair value of the awards determined under the Black-Scholes option pricing model and is recognized as compensation expense over the service period utilizing the graded vesting attribution method.
Compensation expense related to restricted stock units is equal to the grant-date fair value of the awards determined by the closing share price on the date of the grant. The related expense is recognized as compensation expense over the service period utilizing the graded vesting attribution method.
49
Table of Contents
Compensation expense related to performance share units, which are determined to have a market condition, is determined at the grant-date of the awards using a valuation methodology (Monte Carlo simulation model) to account for the market conditions linked to these awards and are recognized as compensation expense over the service period utilizing the graded vesting attribution method.
We recognize compensation expense net of forfeitures, which we have elected to record at the time of occurrence. Awards that are modified are evaluated for the type of modification and, if necessary, the fair value is adjusted and expense is recorded over any remaining service period.
See Note 9 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further detail on stock-based compensation.
Retirement Benefits
The amounts recognized in the audited financial statements related to pension benefits are determined from actuarial valuations. Inherent in these valuations are assumptions including expected return on plan assets, discount rates at which liabilities could have been settled, rate of increase in future compensations levels, and mortality rates. These assumptions are updated annually and are disclosed in Note 8 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. In accordance with U.S. GAAP, actual results that differed from the assumptions are accumulated and amortized over future periods and therefore affect expense recognized in future periods.
The estimated impact of either a 100 basis point increase or decrease of the discount rate to the net periodic benefit cost for 2023 would result in a decrease of approximately $0.5 million or an increase of approximately $0.4 million, respectively. The estimated impact of a 100 basis point increase or decrease of the expected return on assets assumption on the net periodic benefit cost for 2023 would result in a decrease or increase of approximately $1.4 million, respectively.
Derivative Instruments
The fair market value recognized in the audited financial statements related to derivative instruments is determined by using valuation models whose inputs are derived using market observable inputs, including interest rate yield curves, as well as foreign exchange and commodity spot and forward rates, and reflects the asset or liability position as of the end of each reporting period.
Income taxes
The provision for income taxes was determined using the asset and liability approach of accounting for income taxes. Under this approach, deferred taxes represent the future tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid. The provision for income taxes represents income taxes paid or payable for the current year plus the change in deferred taxes during the period. Deferred taxes result from differences between the financial and tax basis of our assets and liabilities and are adjusted for changes in tax rates and tax laws when changes are enacted. Deferred tax assets and liabilities are measured using enacted tax rates applicable in the years in which they are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax law is recognized in income in the period that includes the enactment date.
We evaluate the recoverability of deferred tax assets on a jurisdictional basis by assessing the adequacy of future expected taxable income from all sources, including the reversal of taxable temporary differences, forecasted core business earnings and available tax planning strategies. Our net deferred tax asset balance as of December 31, 2022 is $3.1 million, net of valuation allowances of $194.0 million. The Company records a valuation allowance if, based upon the weight of the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. In instances where we are in a three-year cumulative loss, we assess all positive and negative factors, including any potential aberrational items that may be included within our taxable results. The aberrational items that have impacted our results include debt extinguishment, refinancing and certain global restructuring costs. We believe, and have assumed, these types of losses are not indicative of our core earnings for purposes of assessing the appropriateness of a valuation allowance. Assumptions around sources of taxable income inherently rely heavily on estimates. We use our historical experience and our short and long-range business forecasts to provide insight. While the Company believes that its judgments and estimations regarding deferred tax assets are appropriate, significant differences in actual experience may require the Company to adjust its valuation allowance and could materially affect the Company's future financial results.
We provide for income and foreign withholding taxes, where applicable, on unremitted earnings of all subsidiaries and related companies to the extent that such earnings are not deemed to be permanently invested and cannot be repatriated in a tax-free manner. At December 31, 2022 and 2021, deferred income taxes of approximately $10.8 million and $10.6 million, respectively, have been provided on such subsidiary earnings. At December 31, 2022, and 2021, we have not recorded a deferred tax liability related to withholding taxes of approximately $177.5 million and $124.7 million, respectively, on unremitted earnings of subsidiaries that are permanently invested.
50
Table of Contents
The breadth of our operations and the global complexity of tax regulations require us to make assessments in estimating taxes we will ultimately pay factoring in various uncertainties. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in various jurisdictions, outcomes of tax litigation and resolution of disputes arising from federal, state and international tax audits in the normal course of business. Interest and penalties accrued related to unrecognized tax benefits are included in the provision for income taxes. At December 31, 2022 and 2021, the Company had gross unrecognized tax benefits, excluding interest and penalties, for both domestic and foreign operations of $98.2 million and $91.4 million, respectively.
See Note 11 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further detail on our accounting for income taxes.
Sales deductions
In our refinish end-market, our product sales are typically supplied through a network of distributors. Control transfers and revenue is recognized when our products are delivered to our distribution customers. Variable consideration in the form of price, less discounts and rebates, are estimated and recorded, as a reduction to net sales, upon the sale of our products based on our ability to make a reasonable estimate of the amounts expected to be received. The estimates of variable consideration involve significant assumptions based on the best estimates of inventory held by distributors, applicable pricing, as well as the use of historical actuals for sales, discounts and rebates, which may result in changes to estimates in the future.
The timing of payments associated with the above arrangements may differ from the timing associated with the satisfaction of our performance obligations. The period between the satisfaction of the performance obligation and the receipt of payment is dependent on terms and conditions specific to the customers. For transactions in which we expect, at contract inception, the period between the transfer of our products or services to our customer and when the customer pays for that good or service to be greater than one year, we adjust the promised amount of consideration for the effects of any significant financing components that materially changes the amount of revenue under the contract.
See Note 2 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further detail on our revenue.
Contingencies
Contingencies, by their nature, relate to uncertainties that require management to exercise judgment both in assessing the likelihood that a liability has been incurred as well as in estimating the amount of potential loss. The most important contingencies impacting our financial statements are those related to environmental remediation, operational matters, pending or threatened litigation against the Company and the resolution of matters related to open tax years.
Costs related to the operational matter described in Note 6 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K are accrued when it is probable that a liability has been incurred and the amount can be reasonably estimated. Estimates of probable liabilities for the operational matter require assumptions pertaining to costs incurred by our customers to repair the impacted products. Assumptions include the ultimate number of impacted products that are repaired, re-use of damaged materials, labor rates and efficiency of individuals performing the repairs. A 10% decrease in the total number of products repaired would result in an approximately $5.7 million reduction in the estimated liability. Insurance recoveries related to the operational matter are recorded when probable to the extent they cover incurred or probable liabilities, while recoveries in excess of incurred or probable liabilities are recorded when collection is realizable.
Environmental remediation costs are accrued when it is probable that a liability has been incurred and the amount can be reasonably estimated. Estimates of environmental reserves require evaluating the nature and extent of contamination, the outcome of discussions with regulatory agencies, available technology, site-specific information, remediation alternatives and, at multi-party sites, other PRPs and the number and financial viability of the other PRPs. We accrue an amount equal to our best estimate of the costs to remediate based upon the available information. The extent of environmental impacts may not be fully known, and the processes and costs of remediation may change as new information is obtained or technology for remediation improves. Adjustments to our estimates are made periodically as additional information is received and as remediation progresses. We do not believe that the amounts historically accrued for environmental remediation costs are material to our financial statements.
We are subject to legal proceedings, claims and potential claims arising out of our business operations. We routinely assess the likelihood of any adverse outcomes in these matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after analysis of each known matter. We have an active risk management program consisting of numerous insurance policies secured from many carriers. These policies often provide coverage that is intended to minimize the financial impact, if any, of the legal proceedings. The required reserves may change in the future due to new developments in each matter.
For more information on these matters, see Note 6 and Note 11 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
51
Table of Contents
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to changes in interest rates and foreign currency exchange rates because we finance certain operations through fixed and variable rate debt instruments and denominate our transactions in a variety of foreign currencies. We are also exposed to changes in the prices of certain commodities that we use in production. Changes in these rates and commodity prices may have an impact on future cash flows and earnings.
We manage these risks through normal operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. We do not enter into derivative financial instruments for trading or speculative purposes.
By using derivative instruments, we are subject to credit and market risk. The fair market value of the derivative instruments is determined by using valuation models whose inputs are derived using market observable inputs, including interest rate yield curves, as well as foreign exchange and commodity spot and forward rates, and reflects the asset or liability position as of the end of each reporting period. When the fair value of a derivative contract is positive, the counterparty owes us, thus creating a receivable risk for us. We are exposed to counterparty credit risk in the event of non-performance by counter-parties to our derivative agreements. We minimize counterparty credit (or repayment) risk by entering into transactions with major financial institutions of investment grade credit rating.
Our exposure to market risk is not hedged in a manner that completely eliminates the effects of changing market conditions on earnings or cash flow.
Interest rate risk
We are subject to interest rate market risk in connection with our borrowings. A one-eighth percent change in the applicable interest rate for borrowings under the Senior Secured Credit Facilities (assuming the Revolving Credit Facility is undrawn) would have an annual impact of approximately $2.4 million on cash interest expense considering the impact of our hedging positions currently in place.
We selectively use derivative instruments to reduce market risk associated with changes in interest rates. The use of derivatives is intended for hedging purposes only and we do not enter into derivative instruments for speculative purposes.
For further detail on our use of derivative instruments, see Note 19 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Foreign exchange rates risk
We are exposed to foreign currency exchange risk by virtue of the translation of our international operations from local currencies into the U.S. Dollar. The majority of our net sales for the years ended December 31, 2022, 2021 and 2020 were from operations outside the United States. At December 31, 2022 and 2021, the accumulated other comprehensive loss account in the consolidated balance sheets included a cumulative translation loss of $433.5 million and $331.3 million, respectively. A hypothetical 10% increase in the value of the U.S. Dollar relative to all foreign currencies would have increased the cumulative translation loss by $245.1 million. This sensitivity analysis is inherently limited as it assumes that rates of multiple foreign currencies are moving in the same direction relative to the value of the U.S. Dollar.
Uncertainty in global market conditions has resulted in, and may continue to cause, significant volatility in foreign currency exchange rates which could increase these risks.
In the majority of our jurisdictions, we earn revenue and incur costs in the local currency of such jurisdiction. We earn significant revenues and incur significant costs in foreign currencies including the Euro, Mexican Peso, Brazilian Real, Chinese Renminbi, British Pound and the Turkish Lira. As a result, movements in exchange rates could cause our revenues and expenses to materially fluctuate, impacting our future profitability and cash flows. Our purchases of raw materials in Latin America, EMEA and Asia Pacific and future business operations and opportunities, including the continued expansion of our business outside North America, may further increase the risk that cash flows resulting from these activities may be adversely affected by changes in currency exchange rates. If and when appropriate, we intend to manage these risks through foreign currency hedges and/or by utilizing local currency funding of these expansions. We do not intend to hold financial instruments for trading or speculative purposes.
Additionally, in order to fund the purchase price for certain assets of DPC and the capital stock and other equity interests of certain non-U.S. entities, a combination of equity contributions and intercompany loans were utilized to capitalize certain non-U.S. subsidiaries. In certain instances, the intercompany loans are denominated in currencies other than the functional currency of the affected subsidiaries. Where intercompany loans are not a component of permanently invested capital of the affected subsidiaries, increases or decreases in the value of the subsidiaries' functional currency against other currencies will affect our results of operations. We use these intercompany loans to offset the exposure to profitability and cash flows created by external loans denominated in currencies that are different from the functional currency of the issuing entities, including our 2025 Euro Senior Notes (as defined in Note 18 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K), which are denominated in Euros.
52
Table of Contents
Commodity price risk
While our raw material pricing fluctuates based on underlying feedstocks movements, we are also subject to supply and demand dynamics, or other macro-level factors, and also to changes in our cost of sales caused by movements in underlying commodity prices, such as oil and natural gas, among others, for energy spend and certain purchased raw materials, including monomers, resins and solvents. We try to manage these risks by ensuring we have strategic contracts in place on critical materials along with a balance of pricing mechanisms across categories, competitive sourcing options including low cost country sources, and utilizing our supplier relationship management program. In addition, we attempt to mitigate raw material inflation by passing along price increases to our customers. During 2022, a significant portion of the raw material inflation was passed through to our customers through a series of price increases.
Since 2001, on average, our total raw material spend has represented between 40% and 50% of our cost of sales; however, during 2022, our total raw material spend represented approximately 53% of our cost of sales driven by continued raw material inflation experienced throughout the year.
Treasury policy
Our treasury policy seeks to ensure that adequate financial resources are available for the development of our businesses while managing our currency and interest rate risks. Our policy is to not engage in speculative transactions. Our policies with respect to the major areas of our treasury activity are set forth above.
53
Table of Contents
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index
Report of Independent Registered Public Accounting Firm (PCAOB ID: 238) 55
Consolidated Statements of Operations 57
Consolidated Statements of Comprehensive Income 58
Consolidated Balance Sheets 59
Consolidated Statements of Changes in Shareholders' Equity 60
Consolidated Statements of Cash Flows 61
Notes to Consolidated Financial Statements 62
54
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Axalta Coating Systems Ltd.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Axalta Coating Systems Ltd. and its subsidiaries (the “Company”) as of December 31, 2022 and 2021, and the related consolidated statements of operations, of comprehensive income, of changes in shareholders' equity and of cash flows for each of the three years in the period ended December 31, 2022, including the related notes and schedule of valuation and qualifying accounts for each of the three years in the period ended December 31, 2022 appearing under Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
55
Table of Contents
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that (i) relates to accounts or disclosures that are material to the consolidated financial statements and (ii) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Measurement of Unrecognized Tax Benefits
As described in Notes 1 and 11 to the consolidated financial statements, management has recorded unrecognized tax benefits of $104.5 million as of December 31, 2022. As disclosed by management, the breadth of operations and the global complexity of tax regulations require assessments of uncertainties and judgments in estimating taxes. The final taxes paid are dependent upon many factors, including negotiations with taxing authorities in various jurisdictions, outcomes of tax litigation and resolution of disputes arising from federal, state and international tax audits in the normal course of business. A liability for unrecognized tax benefits is recorded when management concludes that the likelihood of sustaining such positions upon examination by taxing authorities is less than “more-likely-than not.”
The principal considerations for our determination that performing procedures relating to the measurement of unrecognized tax benefits is a critical audit matter are the significant judgments by management when applying the more-likely-than-not recognition criteria to the Company’s tax positions, which in turn led to a high degree of auditor judgment, subjectivity, and effort in performing procedures and evaluating audit evidence obtained related to the measurement of unrecognized tax benefits. Additionally, the audit effort involved the use of professionals with specialized skill and knowledge.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included testing the effectiveness of controls relating to the identification and recognition of the liability for unrecognized tax benefits, including controls addressing completeness of the unrecognized tax benefits and controls over measurement of the liability. These procedures also included, among others, evaluating the significant judgment used by management in applying the more-likely-than-not recognition criteria and in measuring the Company’s unrecognized tax benefits. Professionals with specialized skill and knowledge were used to assist in evaluating the reasonableness of assumptions made by management, the technical merits of positions taken based upon application of the tax law and new information, and the measurement of unrecognized tax benefits.
/s/ PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
February 16, 2023
We have served as the Company's auditor since 2011.
56
Table of Contents
AXALTA COATING SYSTEMS LTD.
Consolidated Statements of Operations
(In millions, except per share data)
Year Ended December 31,
Selling, general and administrative expenses 772.4 738.7 695.0
Research and development expenses 66.4 62.4 55.2
Less: Net income attributable to noncontrolling interests 0.6 0.5 0.4
Net income attributable to controlling interests $ 191.6 $ 263.9 $ 121.6
Basic net income per share $ 0.86 $ 1.14 $ 0.52
Diluted net income per share $ 0.86 $ 1.14 $ 0.52
The accompanying notes are an integral part of these consolidated financial statements.
57
Table of Contents
AXALTA COATING SYSTEMS LTD.
Consolidated Statements of Comprehensive Income
(In millions)
Year Ended December 31,
Other comprehensive (loss) income, before tax:
Foreign currency translation adjustments (102.6) (50.1) 13.8
Unrealized gain (loss) on derivatives 28.8 36.6 (30.0)
Other comprehensive (loss) income, before tax (39.0) 23.5 (41.5)
Other comprehensive (loss) income, net of tax (52.9) 9.6 (30.5)
The accompanying notes are an integral part of these consolidated financial statements.
58
Table of Contents
AXALTA COATING SYSTEMS LTD.
Consolidated Balance Sheets
(In millions, except per share data)
December 31,
Assets
Current assets:
Cash and cash equivalents $ 645.2 $ 840.6
Accounts and notes receivable, net 1,067.4 937.5
Prepaid expenses and other current assets 140.8 117.2
Liabilities, Shareholders' Equity
Current liabilities:
Current portion of borrowings 31.0 79.7
Commitments and contingent liabilities (Note 6)
Shareholders' equity
Accumulated other comprehensive loss (466.9) (414.4)
Noncontrolling interests 46.0 45.8
Total liabilities and shareholders' equity $ 7,059.2 $ 7,217.2
The accompanying notes are an integral part of these consolidated financial statements.
59
Table of Contents
AXALTA COATING SYSTEMS LTD.
Consolidated Statements of Changes in Shareholders' Equity
(In millions)
Common Stock
Comprehensive income (loss):
Total comprehensive income (loss) — — — 121.6 — (29.3) (0.8) 91.5
Cumulative effect of an accounting change — — — (1.5) — — — (1.5)
Recognition of stock-based compensation — — 15.1 — — — — 15.1
Net shares issued under compensation plans 0.8 1.0 3.2 — — — — 4.2
Changes in ownership of noncontrolling interests — — (5.3) — — — (6.9) (12.2)
Common stock purchases (0.9) — — — (26.0) — — (26.0)
Dividends declared to noncontrolling interests — — — — — — (0.9) (0.9)
Comprehensive income (loss):
Recognition of stock-based compensation — — 14.9 — — — — 14.9
Net shares issued under compensation plans 0.8 0.9 13.5 — — — — 14.4
Common stock purchases (8.2) — — — (243.7) — — (243.7)
Dividends declared to noncontrolling interests — — — — — — (0.7) (0.7)
Comprehensive income (loss):
Recognition of stock-based compensation — — 22.2 — — — — 22.2
Net shares issued under compensation plans 0.6 0.6 (0.9) — — — — (0.3)
Changes in ownership of noncontrolling interests — — (0.3) — — — 0.1 (0.2)
Common stock purchases (7.4) — — — (200.1) — — (200.1)
Dividends declared to noncontrolling interests — — — — — — (0.1) (0.1)
The accompanying notes are an integral part of these consolidated financial statements.
60
Table of Contents
AXALTA COATING SYSTEMS LTD.
Consolidated Statements of Cash Flows
(In millions)
Year Ended December 31,
Operating activities:
Adjustment to reconcile net income to cash provided by operating activities:
Amortization of deferred financing costs and original issue discount 9.6 8.9 9.0
Debt extinguishment and refinancing-related costs 14.7 0.2 34.4
Realized and unrealized foreign exchange losses, net 15.5 10.1 3.9
Gain on sales of facilities (1.5) (19.7) —
Commercial agreement restructuring charge 25.0 — —
Changes in operating assets and liabilities:
Trade accounts and notes receivable (171.0) (80.5) (26.0)
Prepaid expenses and other assets (80.5) (45.3) (19.9)
Investing activities:
Acquisitions, net of cash acquired (3.0) (649.0) (1.0)
Purchase of property, plant and equipment (150.9) (121.6) (82.1)
Proceeds from sales of assets 3.7 37.8 0.2
Interest proceeds on swaps designated as net investment hedges 19.9 18.0 14.5
Settlement proceeds on swaps designated as net investment hedges 25.0 — —
Other investing activities, net (1.1) (1.2) 6.9
Cash used for investing activities (106.4) (716.0) (61.5)
Financing activities:
Proceeds from long-term borrowings 1,980.0 — 1,200.0
Payments on short-term borrowings (91.1) (74.0) (38.8)
Financing-related costs (15.2) (3.0) (39.9)
Net cash flows associated with stock-based awards (0.3) 14.4 4.3
Purchase of noncontrolling interests (0.2) — (5.8)
Other financing activities, net (0.1) (1.2) (1.4)
(Decrease) increase in cash and cash equivalents (181.5) (491.9) 316.9
Effect of exchange rate changes on cash (14.8) (20.9) 26.6
Cash at end of period reconciliation:
Supplemental cash flow information:
Cash paid during the year for:
Non-cash investing activities:
Accrued capital expenditures $ 32.4 $ 35.1 $ 35.1
The accompanying notes are an integral part of these consolidated financial statements.
61
Table of Contents
Notes to Consolidated Financial Statements
(In millions, unless otherwise noted)
Index
Note Page
(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 63
(3) ACQUISITIONS 70
(4) GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS 71
(5) RESTRUCTURING 72
(6) COMMITMENTS AND CONTINGENCIES 72
(8) LONG-TERM EMPLOYEE BENEFITS 75
(9) STOCK-BASED COMPENSATION 80
(10) OTHER EXPENSE (INCOME), NET 82
(12) NET INCOME PER COMMON SHARE 87
(13) ACCOUNTS AND NOTES RECEIVABLE, NET 87
(15) PROPERTY, PLANT AND EQUIPMENT, NET 88
(17) ACCOUNTS PAYABLE AND OTHER ACCRUED LIABILITIES 89
(19) FINANCIAL INSTRUMENTS, HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENTS 94
(21) ACCUMULATED OTHER COMPREHENSIVE LOSS 103
62
Table of Contents
Notes to Consolidated Financial Statements
(In millions, unless otherwise noted)
(1) BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated balance sheets of Axalta Coating Systems Ltd. ("Axalta," the "Company," "we," "our" and "us"), at December 31, 2022 and 2021 and the related consolidated statements of operations, consolidated statements of comprehensive income, consolidated statements of cash flows and consolidated statements of changes in shareholders' equity for the years ended December 31, 2022, 2021 and 2020 included herein have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") and are audited. In the opinion of management, these statements include all adjustments, consisting only of normal, recurring adjustments, necessary for a fair statement of the financial position of Axalta.
Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of Axalta and its subsidiaries, and entities in which a controlling interest is maintained. For those consolidated subsidiaries in which the Company's ownership is less than 100%, the outside shareholders' interests are shown as noncontrolling interests. Investments in companies in which Axalta does not maintain control, but has the ability to exercise significant influence over operating and financial policies of the investee, are accounted for using the equity method of accounting. As a result, Axalta's share of the earnings or losses of such equity affiliates is included in the accompanying consolidated statements of operations and our share of these companies' stockholders' equity is included in the accompanying consolidated balance sheets. Certain of our joint ventures are accounted for on a one-month lag basis, the effect of which is not material. We eliminated all intercompany accounts and transactions in the preparation of the accompanying consolidated financial statements.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the period. The estimates and assumptions include, but are not limited to, receivable and inventory valuations, derivative instruments, fixed asset valuations, valuations of goodwill and identifiable intangible assets, including analysis of impairment, valuations of long-term employee benefit obligations, income taxes, environmental matters, contingencies, litigation, stock-based compensation, restructuring and allocations of costs. Our estimates are based on historical experience, facts and circumstances available at the time and various other assumptions that are believed to be reasonable. Actual results could differ materially from those estimates.
Accounting for Business Combinations
We account for business combinations under the acquisition method of accounting. This method requires the recording of acquired assets, including separately identifiable intangible assets and assumed liabilities at their acquisition date fair values. The method records any excess purchase price over the fair value of acquired net assets as goodwill. Included in the determination of the purchase price is the fair value of contingent consideration, if applicable, based on the terms and applicable targets described within the acquisition agreements (i.e., projected revenues or EBITDA). Subsequent to the acquisition date, the fair value of the contingent liability, if determined to be payable in cash, is revalued at each balance sheet date with adjustments recorded within earnings.
The determination of the fair value of assets acquired, liabilities assumed and noncontrolling interests involves assessments of factors such as the expected future cash flows associated with individual assets and liabilities and appropriate discount rates at the closing date of the acquisition. When necessary, we consult with external advisors to help determine fair value. For non-observable market values determined using Level 3 assumptions, we determine fair value using acceptable valuation principles, including most commonly the excess earnings method for customer relationships, relief from royalty method for technology and trademarks, cost method for inventory and a combination of cost and market methods for property, plant and equipment, as applicable.
We include the results of operations from the acquisition date in the financial statements for all businesses acquired.
Revenue Recognition
See Note 2 for disclosure of our revenue recognition accounting policy.
63
Table of Contents
Notes to Consolidated Financial Statements
(In millions, unless otherwise noted)
Cash, Cash Equivalents and Restricted Cash
Cash equivalents represent highly liquid investments considered readily convertible to known amounts of cash within three months or less from time of purchase. They are carried at cost plus accrued interest, which approximates fair value because of the short-term maturity of these instruments. Cash balances may exceed government insured limits in certain jurisdictions.
Restricted cash on our consolidated balance sheets represents cash held in escrow for pending contingent liabilities related to an acquisition made during the year ended December 31, 2021 and cash used to secure certain customer guarantees.
Fair Value Measurements
GAAP defines a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). A financial instrument's level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
The following valuation techniques are used to measure fair value for assets and liabilities:
Level 1—Quoted market prices in active markets for identical assets or liabilities;
Level 2—Significant other observable inputs (i.e., quoted prices for similar items in active markets, quoted prices for identical or similar items in markets that are not active, inputs other than quoted prices that are observable such as interest rate and yield curves, and market-corroborated inputs); and
Level 3—Unobservable inputs for the asset or liability, which are valued based on management's estimates of assumptions that market participants would use in pricing the asset or liability.
Derivatives and Hedging
The Company from time to time utilizes derivatives to manage exposures to currency exchange rates and interest rate risk. The fair values of all derivatives are recognized as assets or liabilities at the balance sheet date. Changes in the fair value of these instruments are reported in income or accumulated other comprehensive loss ("AOCI"), depending on the use of the derivative and whether it qualifies for hedge accounting treatment and is designated as such.
Gains and losses on derivatives that qualify and are designated as cash flow or net investment hedges are recorded in AOCI, to the extent the hedges are effective, until the underlying transactions are recognized in income.
Gains and losses on derivatives qualifying and designated as fair value hedging instruments, as well as the offsetting losses and gains on the hedged items, are reported in income in the same accounting period. Derivatives not designated as hedging instruments are marked-to-market at the end of each accounting period with the results included in income.
Cash flows from derivatives are presented in the consolidated statements of cash flows in a manner consistent with the underlying transactions.
Receivables and Allowance for Doubtful Accounts
Receivables are carried at amounts that approximate fair value. Receivables are recognized net of an allowance for doubtful accounts receivable. The allowance for doubtful accounts reflects the current estimate of credit losses expected to be incurred over the life of the financial asset, based on historical experience, current conditions and reasonable forecasts of future economic conditions. Accounts receivable are written down or off when a portion or all of such account receivable is determined to be uncollectible.
Inventories
Inventories are valued at the lower of cost or net realizable value with cost being determined on the weighted average cost method. Elements of cost in inventories include:
•raw materials,
•direct labor, and
•manufacturing and indirect overhead.
Stores and supplies are valued at the lower of cost or net realizable value; cost is generally determined by the weighted average cost method. Inventories deemed to have costs greater than their respective market values are reduced to net realizable value with a loss recorded in income in the period recognized.
64
Table of Contents
Notes to Consolidated Financial Statements
(In millions, unless otherwise noted)
Property, Plant and Equipment
Property, plant and equipment acquired in an acquisition are recorded at fair value as of the acquisition date and are depreciated over the estimated useful life using the straight-line method. Property, plant and equipment purchases are recorded at cost and are depreciated over the estimated useful life using the straight-line method starting on the date they are placed in service. See Note 15 for a range of estimated useful lives used for each property, plant and equipment class.
Software included in property, plant and equipment represents the costs of software developed or obtained for internal use. Software costs are amortized on a straight-line basis over their estimated useful lives. Upgrades and enhancements are capitalized if they result in added functionality, which enables the software to perform tasks it was previously incapable of performing. Software maintenance and training costs are expensed in the period in which they are incurred.
Leases
See Note 7 for disclosure of our accounting policy for leases.
Goodwill and Other Identifiable Intangible Assets
Goodwill represents the excess of the purchase price over the fair values of the underlying net assets acquired in a business combination. Goodwill and indefinite-lived intangible assets are tested for impairment on an annual basis as of October 1st; however, these tests are performed more frequently if events or changes in circumstances indicate that the asset may be impaired..
When testing goodwill and indefinite-lived intangible assets for impairment, we first have an option to assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (more than 50%) that an impairment exists. Such qualitative factors may include the evaluation of the following: macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; and other relevant asset-specific events. If based on this qualitative assessment we determine that an impairment is more likely than not, or if we elect not to perform a qualitative assessment, we would be required to perform a quantitative impairment test.
Under the quantitative impairment test, the evaluation of impairment involves comparing the current fair value of each reporting unit, with respect to goodwill, and indefinite-lived intangible asset to its carrying value. If the fair value of the reporting unit or indefinite-lived intangible asset is less than the carrying value, the difference is recorded as an impairment loss not to exceed the amount of recorded goodwill or carrying value of the respective indefinite-lived intangible asset.
In 2022, as a result of the time lapsed since our last quantitative evaluation in 2019, we bypassed the qualitative evaluation and tested for impairment of the goodwill of our reporting units and our indefinite-lived intangible assets by performing a quantitative evaluation. The quantitative analysis concluded that all reporting units and indefinite-lived intangible assets had fair values in significant excess of carrying values.
Definite-lived intangible assets, such as technology, trademarks, customer relationships, favorable contractual agreements and non-compete agreements are amortized over their estimated useful lives, generally for periods ranging from 3 to 25 years. We evaluate these assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets might not be recoverable. The reasonableness of the useful lives of definite and indefinite-lived assets are regularly evaluated.
Impairment of Long-Lived Assets
The carrying value of long-lived assets to be held and used is evaluated when events or changes in circumstances indicate the carrying value may not be recoverable. Evaluation for impairment is done at the asset group level. The carrying value of long-lived asset groupings is considered impaired when the total projected undiscounted cash flows from the asset group is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset group. The fair value methodology used is an estimate of fair market value and is based on prices of similar asset groupings or other valuation methodologies, including present value techniques. Long-lived asset groupings to be disposed of other than by sale are classified as held for use until their disposal. Long-lived asset groupings to be disposed of by sale are classified as held for sale after all applicable attributes in the guidance are met and are reported at the lower of carrying amount or fair market value less cost to sell. Depreciation is discontinued for long-lived asset groupings classified as held for sale.
65
Table of Contents
Notes to Consolidated Financial Statements
(In millions, unless otherwise noted)
Research and Development
Research and development costs incurred in the normal course of business consist primarily of employee-related costs and are expensed as incurred. In-process research and development projects acquired in a business combination are recorded as intangible assets at their fair value as of the acquisition date, using Level 3 assumptions. Subsequent costs related to acquired in-process research and development projects are expensed as incurred. In-process research and development intangible assets are considered indefinite-lived until the abandonment or completion of the associated research and development efforts. These indefinite-lived intangible assets are tested for impairment consistent with the impairment testing performed on other indefinite-lived intangible assets discussed above. Upon completion of the research and development process, the carrying value of acquired in-process research and development projects is reclassified as a finite-lived asset and is amortized over its useful life. Once amortization commences, these assets are tested for impairment consistent with long-lived assets as discussed above.
Environmental Liabilities and Expenditures
Accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Accrued environmental liabilities are not discounted. Claims for recovery from third parties, if any, are reflected separately as an asset. We record recoveries at the earlier of when the gain is probable and reasonably estimable or realized.
Costs related to environmental remediation are charged to expense in the period incurred. Other environmental costs are also charged to expense in the period incurred, unless they increase the value of the property or reduce or prevent contamination from future operations, in which case, they are capitalized and depreciated.
Contingencies and Litigation
We accrue for liabilities related to contingencies, including the operational matter discussed in Note 6, and litigation matters when available information indicates that the liability is probable, and the amount can be reasonably estimated. Legal costs such as outside counsel fees and expenses are charged to expense in the period incurred.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis. Deferred tax assets are also recognized for tax losses, interest and tax credit carryforwards. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates applicable in the years in which they are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax law is recognized in net income in the period that includes the enactment date.
Where we do not intend to indefinitely reinvest earnings of our subsidiaries, we provide for income taxes and withholding taxes, where applicable, on unremitted earnings. We do not provide for income taxes on unremitted earnings of our subsidiaries that are intended to be indefinitely reinvested.
We recognize the benefit of an income tax position only if it is "more likely than not" that the tax position will be sustained. The tax benefits recognized are measured based on the largest benefit that has a greater than 50% likelihood of being realized. Additionally, we recognize interest and penalties related to unrecognized tax benefits as a component of provision for income taxes. The current portion of unrecognized tax benefits is included in other accrued liabilities and the long-term portion is included in other liabilities in the consolidated balance sheets.
Foreign Currency Translation
Our reporting currency is the U.S. Dollar. In most cases, our non-U.S. based subsidiaries use their local currency as the functional currency for their respective business operations. Assets and liabilities of these operations are translated into U.S. Dollars at end-of-period exchange rates; income and expenses are translated using the average exchange rates for the reporting period. Resulting cumulative translation adjustments are recorded as a component of shareholders' equity in the accompanying consolidated balance sheets in AOCI.
Gains and losses from transactions denominated in currencies other than functional currencies are included in the consolidated statements of operations in other expense (income), net.
66
Table of Contents
Notes to Consolidated Financial Statements
(In millions, unless otherwise noted)
Employee Benefits
Defined benefit plans specify an amount of pension benefit that an employee will receive upon retirement, usually dependent on factors such as age, years of service and compensation. The obligation in respect of defined benefit plans is calculated separately for each plan by estimating the amount of the future benefits that employees earn in return for their service in the current and prior periods. These benefits are then discounted to determine the present value of the obligations and are then adjusted for the impact of any unamortized prior service costs. The discount rate used is based upon market indicators in the region (generally, the yield on bonds that are denominated in the currency in which the benefits will be paid and that have maturity dates approximating the terms of the obligations). The calculations are performed by qualified actuaries using the projected unit credit method. The obligation of defined benefit plans recorded on our consolidated balance sheets is net of the current fair value of assets within each respective plan. See Note 8 for further information.
Stock-Based Compensation
We provide directors and certain employees stock-based compensation comprising stock options, restricted stock units, and performance share units. The instruments are measured at fair value on the grant date or date of modification, as applicable. We recognize compensation expense on a graded-vesting attribution basis over the requisite service period, inclusive of impacts of any current period modifications of previously granted awards. Compensation expense is recorded net of forfeitures, which we have elected to record in the period they occur.
Earnings per Common Share
Basic earnings per common share is computed by dividing net income attributable to Axalta's common shareholders by the weighted average number of shares outstanding during the period. Diluted earnings per common share is computed by dividing net income attributable to Axalta's common shareholders by the weighted average number of shares outstanding during the period increased by the number of additional shares that would have been outstanding related to potentially dilutive securities; anti-dilutive securities are excluded from the calculation. These potentially dilutive securities are calculated under the treasury stock method and all outstanding stock options, restricted stock units, and performance share units are considered.
Accounting Guidance Issued But Not Yet Adopted
In September 2022, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2022-04, "Liabilities – Supplier Finance Programs." The ASU codifies disclosure requirements for supplier financing programs. The new standard is effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. We are currently evaluating the impact of ASU 2022-04 on our financial statements but do not expect the guidance to have a material impact.
Risks and Uncertainties
After experiencing significant impacts to our results of operations, financial condition and cash flows in 2020 from the coronavirus ("COVID-19") pandemic, we have seen a return to more stable demand for our products and services during 2021 and 2022, though we continue to see impacts to our business given the continued significant presence, and actual or potential spread, of the virus globally, as well as preventative measures enacted in certain regions of the world. We are currently unable to fully determine the future impact of COVID-19 on our business, though we believe the pandemic may continue to have a negative effect on our business through 2023, and potentially longer. We continue to monitor the progression of the pandemic and its ongoing and potential effect on our financial position, results of operations, and cash flows, which effects could be materially adverse in a particular quarterly reporting period as well as on an annual basis.
(2) REVENUE
We recognize revenue at the point our contractual performance obligations with our customers are satisfied. This occurs at the point in time when control of our products transfers to the customer based on considerations of right to payment, transfer of legal title, physical possession, risks and rewards of ownership and customer acceptance. For the majority of our revenue, control transfers upon shipment of our products to our customers. Our remaining revenue is recorded upon delivery or consumption for our product sales or as incurred for services provided and royalties earned.
Revenue is measured as the amount of consideration we expect to receive in exchange for our products or services. Our contracts, including those subject to standard terms and conditions under multi-year agreements, are largely short-term in nature and each customer purchase order typically represents a contract with the delivery of coatings representing the only separate performance obligation.
67
Table of Contents
Notes to Consolidated Financial Statements
(In millions, unless otherwise noted)
For certain customer arrangements within our light vehicle, industrial and commercial vehicle end-markets, revenue is recognized upon shipment, as this is the point in time we have concluded that control of our product has transferred to our customer based on our considerations of the indicators of control in the contracts, including right of use and risk and reward of ownership. For consignment arrangements, revenue is recognized upon actual consumption by our customers, as this represents the point in time that control is determined to have transferred to the customer based on the contractual arrangement.