Cabot Corporation — Form 10-Q Summary
Business context and period: Cabot Corporation filed this unaudited quarterly report for the fiscal quarter ended June 30, 2017, its third quarter of fiscal 2017. The filing compares the three- and nine-month periods ended June 30, 2017 with the corresponding 2016 periods. Cabot reports four segments: Reinforcement Materials, Performance Chemicals, Purification Solutions and Specialty Fluids.
Financial results and liquidity
| Metric | Three months 2017 | Three months 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales and other operating revenues | $705 million | $621 million | $1,994 million | $1,792 million |
| Gross profit | $159 million | $160 million | $485 million | $409 million |
| Income from operations | $82 million | $83 million | $254 million | $172 million |
| Income before taxes and affiliate earnings | $66 million | $74 million | $217 million | $128 million |
| Net income attributable to Cabot | $45 million | $56 million | $173 million | $97 million |
| Diluted EPS | $0.71 | $0.88 | $2.74 | $1.53 |
- Margins: Q3 gross margin was approximately 22.6%, versus 25.8% a year earlier; nine-month gross margin was approximately 24.3%, versus 22.8%. Q3 operating margin was approximately 11.6%, versus 13.4%.
- Cash flow: Operating cash flow was $183 million for the first nine months, down from $295 million. Investing activities used $89 million, including $86 million of capital expenditures; financing activities used $86 million. Cash declined $2 million to $198 million.
- Debt and liquidity: At June 30, total debt was $916 million, including $251 million classified as current; notes payable were $7 million. Cabot had $1 billion of available borrowing capacity under its revolving credit agreement, no commercial paper outstanding, and reported compliance with its facility covenants. A $250 million, 2.55% note matures January 15, 2018; Cabot said it intends to refinance it before maturity.
- Balance sheet: Total assets were $3.178 billion and stockholders’ equity was $1.477 billion. Current assets were $1.164 billion and current liabilities $679 million; the current debt classification reflects the upcoming note maturity.
- Shareholder returns: Nine-month dividends were $0.915 per share, up from $0.74. Cabot repurchased $43 million of common stock during the nine months and had 2,065,824 shares remaining under its repurchase authorization at June 30.
Material changes and segment performance
- Q3 revenue rose $84 million year over year, mainly from more favorable pricing and product mix, largely in Reinforcement Materials. Q3 income attributable to Cabot fell to $45 million from $56 million. Management attributed the weaker quarterly operating comparison to lower volumes across segments and higher fixed costs, partly offset by inventory effects and improved unit margins in Reinforcement Materials and Specialty Fluids.
- For the first nine months, revenue increased $202 million and income attributable to Cabot rose to $173 million from $97 million. Management cited higher volumes, stronger Reinforcement Materials margins, favorable inventory effects, and significantly lower restructuring charges than in 2016.
- Reinforcement Materials: Q3 sales were $367 million versus $270 million and segment EBIT was $51 million versus $35 million. Nine-month EBIT was $145 million versus $95 million, driven principally by higher unit margins and volumes.
- Performance Chemicals: Q3 sales were $229 million versus $228 million, while EBIT declined to $46 million from $59 million. Nine-month EBIT declined to $146 million from $167 million, mainly due to lower unit margins and higher costs, including maintenance and unplanned downtime.
- Purification Solutions: Q3 sales were $71 million versus $77 million and EBIT was a $2 million loss, compared with break-even. Nine-month EBIT improved to $4 million from a $7 million loss, helped by higher mercury-removal volumes and inventory effects.
- Specialty Fluids: Q3 sales fell to $12 million from $19 million and EBIT to $4 million from $10 million, chiefly because of lower project activity. Nine-month sales were $30 million versus $32 million and EBIT $6 million versus $8 million.
Outlook, risks and unusual items
- Near-term outlook: Management expected Reinforcement Materials to continue benefiting from favorable market conditions, with somewhat higher fixed costs. It expected Performance Chemicals volumes and mix to improve in Q4 as unplanned downtime was resolved, and Purification Solutions to benefit from seasonal volume growth and lower fixed costs.
- Fiscal 2017 estimates: Management forecast a 16% effective tax rate and a 21% operating tax rate. Fiscal 2017 capital expenditures were expected to be approximately $150 million. The filing provides no specific revenue or EPS guidance.
- Goodwill sensitivity: The Purification Solutions reporting unit’s estimated fair value exceeded carrying value by 13% in the May 2017 annual test. Its valuation depends partly on growth in activated-carbon applications and continued demand for mercury-removal products. The EPA said it would review the cost-benefit analysis supporting the Mercury and Air Toxics Standards; changes affecting the rule could reduce demand and potentially lead to impairment.
- Contingencies: Environmental reserves were $12 million. Cabot reserved $18 million for its expected share of existing and future respirator claims, with approximately 37,000 claimants in pending cases against American Optical. The company cautioned that actual liability could differ from its estimate. Other litigation outcomes could affect results or cash flows.
- Commitments and geographic exposure: Long-term raw-material purchase commitments totaled $2.541 billion, with amounts tied in part to market prices. Cabot’s 49% Venezuelan affiliate was exposed to currency and political developments; a third-quarter exchange-rate change produced a $1 million gain for the affiliate.
- Other notable items: Nine-month results included a $15 million net discrete tax benefit, primarily related to excess foreign tax credits on repatriated previously taxed earnings, while Q3 included a $5 million net discrete tax expense. Restructuring charges were $3 million for the nine months, versus $45 million in 2016.
- Key risks cited: Raw-material costs and availability, demand, customer concentration, plant disruptions, currency movements, regulation, technology and product development, litigation, environmental obligations, and the assumptions underlying reserves and goodwill valuations.
Important facts for investors to verify
- Whether Reinforcement Materials’ pricing and margin gains persist as raw-material costs and customer pricing adjust.
- Whether Performance Chemicals downtime and cost pressures are resolved and the expected Q4 improvement materializes.
- Whether Cabot refinances the $250 million note before its January 2018 maturity and maintains covenant compliance and liquidity.
- Whether cash generation recovers from the working-capital-driven decline in operating cash flow.
- Whether EPA action on MATS, coal-fired generation trends, or activated-carbon demand changes Purification Solutions’ outlook or goodwill headroom.
- Whether the $18 million respirator reserve and $12 million environmental reserve remain adequate as claims, remediation requirements, and legal developments evolve.