Cabot Corporation — Q2 FY2017 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended March 31, 2017; fiscal Q2 comparisons are against the quarter ended March 31, 2016. Cabot reports Reinforcement Materials, Performance Chemicals, Purification Solutions and Specialty Fluids.
Financial performance and position
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Revenue | $678m | $568m | $1,289m | $1,171m |
| Gross profit | $169m | $150m | $326m | $249m |
| Operating income | $90m | $77m | $172m | $89m |
| Net income attributable to Cabot | $74m | $48m | $128m | $41m |
| Diluted EPS | $1.18 | $0.76 | $2.03 | $0.65 |
| Cash from operations | — | $51m | $188m |
Q2 gross margin was approximately 24.9% versus 26.4%; six-month gross margin was approximately 25.3% versus 21.3%. Revenue rose 19% in Q2 and 10% for the six months. Management attributed sales growth principally to higher volumes and improved price/product mix, partly offset by unfavorable currency translation.
Cash and cash equivalents were $133m at March 31, 2017, down from $200m at September 30, 2016. The company reported $996m of available revolving-credit borrowing capacity and $4m of commercial paper outstanding. Debt comprised $15m notes payable, $251m current portion of long-term debt and $664m long-term debt. A $250m 2.55% note matures January 15, 2018; Cabot said it intends to refinance it. The company reported compliance with credit-facility covenants.
Material changes and segment results
- Six-month operating cash flow fell to $51m from $188m, principally reflecting increases in receivables ($78m) and inventory ($63m), compared with cash releases from both working-capital accounts in the prior period.
- Q2 segment EBIT: Reinforcement Materials $54m (from $34m); Performance Chemicals $51m (from $58m); Purification Solutions $2m (from a $2m loss); Specialty Fluids approximately breakeven (from a $2m loss). Six-month segment EBIT was $94m, $100m, $6m and $2m, respectively.
- Reinforcement Materials benefited from higher unit margins, including improved customer pricing and China spot pricing. Performance Chemicals faced lower unit margins from higher feedstock costs and increased maintenance costs. Purification Solutions’ six-month improvement reflected higher volumes and favorable inventory comparisons.
- Six-month reported pretax income rose to $151m from $54m. The prior-year period included $57m of net certain-item charges, principally restructuring and currency devaluation losses; these did not recur in FY2017.
Outlook, risks and unusual items
- For Q3 FY2017, management expected Reinforcement Materials volumes to be similar to Q2, with higher planned-maintenance costs. Performance Chemicals end-market demand was expected to remain robust, but higher feedstock costs could continue to affect year-over-year results. Purification Solutions was expected to gain volume, offset by inventory drawdowns and higher turnaround costs.
- Management forecast FY2017 effective and operating tax rates of 17% and 24%, respectively. A $20m discrete tax benefit, primarily from excess foreign tax credits associated with repatriation of previously taxed foreign earnings, contributed to the low Q2 effective tax rate of negative 1% and the six-month 11% rate.
- Fiscal 2017 capital expenditures were expected to be approximately $150m; $45m was spent in the first six months.
- Cabot identified an EPA review of the cost-benefit analysis supporting the U.S. Mercury and Air Toxics Standards (MATS). A change to MATS could harm Purification Solutions and its goodwill valuation; that reporting unit’s fair value exceeded carrying value by 9% at the May 2016 impairment test.
- Environmental reserves were $13m and respirator-claim reserves were $19m at March 31, 2017. The filing says actual respirator liabilities could differ from estimates; pending cases involved approximately 37,000 claimants. Long-term raw-material purchase commitments totaled $2.472bn, with amounts for some agreements varying with market prices.
- Other stated risks include raw-material prices and availability, demand, currency movements, customer concentration, severe weather and plant interruptions, litigation, and environmental requirements. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether Q2 earnings growth is sustained by underlying segment margins and volumes, especially given Performance Chemicals’ lower unit margins.
- Whether working-capital investment converts back into operating cash flow and whether the FY2017 capital-spending plan remains near $150m.
- Refinancing terms and timing for the $250m note due in January 2018, and continued covenant compliance.
- Any EPA action on MATS and its implications for Purification Solutions demand, forecasts and goodwill headroom.
- The durability of the $20m discrete tax benefit and performance against the stated FY2017 effective-tax-rate outlook.
- Changes in respirator and environmental claims, related reserves, and the large long-term raw-material commitments.