Cabot Corporation — Q3 FY2016 Form 10-Q
Business context and period: Cabot reported its fiscal third quarter ended June 30, 2016, and the first nine months of fiscal 2016. Its four reportable segments are Reinforcement Materials, Performance Chemicals, Purification Solutions, and Specialty Fluids. Amounts below are in millions of dollars except per-share data.
Financial performance and liquidity
- Third quarter: Revenue was $621, down 10.5% from $694. Gross profit rose to $160 from $150; gross margin was approximately 25.8%, versus 21.6%. Operating income was $83, compared with an operating loss of $494 in Q3 FY2015. Net income attributable to Cabot was $56, or $0.88 diluted EPS, versus a loss of $445, or $7.04 per diluted share.
- First nine months: Revenue was $1,792, down 18.5% from $2,200. Gross profit was $409 versus $446; gross margin was approximately 22.8%, versus 20.3%. Operating income was $172 versus an operating loss of $376. Net income attributable to Cabot was $97, or $1.53 diluted EPS, versus a loss of $374, or $5.88 per diluted share.
- Revenue drivers: Q3 revenue fell mainly from less favorable price and product mix ($93), partly offset by higher volumes ($19). Nine-month revenue declined mainly from price and product mix ($341) and foreign currency translation ($62), with lower volumes also contributing. Management attributed lower selling prices principally to customer price adjustments reflecting lower raw-material costs.
- Segment results: Q3 segment EBIT was $104 versus $86; nine-month segment EBIT was $263 versus $252. Q3 EBIT was $35 in Reinforcement Materials, $59 in Performance Chemicals, zero in Purification Solutions, and $10 in Specialty Fluids. Nine-month EBIT was $95, $167, $(7), and $8, respectively.
- Cash flow: Nine-month operating cash flow was $295 versus $278. Investing used $70, including $80 of capital expenditures and $16 of land-sale proceeds. Financing used $97, including $27 for share repurchases and $47 for common dividends. Cash increased $145 to $222.
- Balance sheet and liquidity: Cash was $222 at June 30, 2016, versus $77 at September 30, 2015. Total debt was approximately $970 ($301 current and $669 long-term), versus $971 at fiscal year-end. Current assets were $1,079 and current liabilities $661. Cabot reported $1 billion of available revolving-credit capacity, no commercial paper outstanding, and compliance with its debt-to-EBITDA covenant. A $300, 5% note matures October 1, 2016; management said it intends to refinance it.
- Other metrics: Quarterly and nine-month interest expense was $13 and $40, respectively, unchanged from the comparable periods. Common dividends were $0.30 per share for the quarter and $0.74 for the nine months. Fiscal 2016 capital expenditures were expected to total $115–$120.
Material changes and notable items
- The large year-over-year earnings swing primarily reflects $563 of Purification Solutions goodwill and long-lived-asset impairment charges recorded in Q3 FY2015. The filing says the prior-year charges were presented incorrectly below operating income in the earlier statements and corrects their presentation in this filing; it does not describe a new impairment charge in FY2016.
- Management’s annual impairment test as of May 31, 2016 found Purification Solutions fair value exceeded carrying value by 9%. The segment’s valuation depends on expected volumes and margins, including demand for activated-carbon mercury-removal products and the continued effect and enforcement of U.S. Mercury and Air Toxics Standards.
- Fiscal 2016 nine-month restructuring charges were $45, including $32 in cost of sales. The global cost-reduction plan affected approximately 300 positions. The Merak, Indonesia carbon-black facility ceased production in January 2016; related nine-month charges were approximately $25, including $22 of asset impairment and accelerated depreciation. Management expects additional, comparatively limited charges and cash outlays for these actions.
- Q3 FY2016 total segment EBIT improved $18, mainly from higher volumes and lower fixed costs, partly offset by Purification Solutions inventory-reduction effects. For the first nine months, gains from lower fixed costs were partly offset by weaker Purification Solutions inventory effects and lower Reinforcement Materials unit margins.
Outlook, risks, and contingencies
- For Q4 FY2016 compared with Q3, management expected Performance Chemicals and Specialty Fluids results to moderate, while Reinforcement Materials and Purification Solutions results were expected to strengthen. The filing provides no numerical earnings guidance.
- Management said expected liquidity from cash, operating cash flow, the revolving facility, and commercial-paper program should cover operating, capital-investment, and financial needs for the foreseeable future. Cash availability depends in part on timely receivables collection, raw-material costs, and inventory management.
- Environmental reserves were $14 at June 30, 2016. Management considered reasonably possible future remediation costs beyond recorded reserves immaterial based on available information, but noted that new findings, regulations, or remediation requirements could change costs.
- Respirator-related claims had approximately 37,000 pending claimants against American Optical; Cabot’s reserve for its expected share was $8. Other lawsuits and claims were not expected, in aggregate, to have a material adverse effect, according to management.
- Long-term raw-material purchase commitments totaled $2,102, including $1,413 due thereafter; amounts for certain commitments vary with market prices. Cabot said it had no material off-balance-sheet arrangements.
- Key stated risks include demand and raw-material changes, customer loss, currency fluctuations, competition, project execution, environmental and respirator liabilities, and litigation. Cabot also noted uncertainty around tax audits and potential changes in uncertain tax benefits that it could not quantify.
Important facts for investors to verify
- Whether Q4 segment trends matched management’s directional outlook, particularly the anticipated strengthening in Reinforcement Materials and Purification Solutions.
- Whether the Purification Solutions unit sustains operating performance sufficient to preserve its reported 9% impairment-test headroom, given sensitivity to mercury-removal demand and regulation.
- How the $300 note due October 2016 was refinanced and the resulting interest expense, debt profile, and covenant headroom.
- Whether restructuring delivers anticipated cost savings and whether remaining charges and cash outlays stay within management’s estimates.
- Whether environmental, respirator, and tax contingencies or the substantial long-term purchase commitments change materially.