Cabot Corporation — Q1 Fiscal 2017 Form 10-Q
Reporting period: Three months ended December 31, 2016; comparisons are with the three months ended December 31, 2015. Amounts are in U.S. dollars unless stated otherwise. The financial statements are unaudited.
Business context and financial performance
Cabot operates four reportable segments: Reinforcement Materials, Performance Chemicals, Purification Solutions and Specialty Fluids. Revenue was nearly flat, while profitability improved substantially, reflecting prior-year restructuring and other charges, higher volumes and stronger Reinforcement Materials margins.
- Revenue: $611 million, up $8 million (1.3%) from $603 million. Higher volumes contributed $20 million; less favorable price and product mix, currency translation and lower unallocated revenue partly offset the increase.
- Profit and margins: Gross profit was $157 million versus $99 million; gross margin was approximately 25.7% versus 16.4%. Operating income was $82 million versus $12 million. Net income attributable to Cabot was $54 million, or $0.85 per diluted share, compared with a $7 million loss, or $0.11 loss per share.
- Segment EBIT: Total segment EBIT, a non-GAAP measure, was $95 million versus $71 million. Reinforcement Materials contributed $40 million (prior year $26 million); Performance Chemicals $49 million ($50 million); Purification Solutions $4 million (loss of $5 million); Specialty Fluids $2 million (break-even).
- Cash flow: Operating cash flow was $102 million versus $83 million. Investing activities used $23 million, including $22 million of capital expenditures; financing activities used $27 million. Cash declined $11 million to $189 million, including a $63 million adverse effect from exchange-rate changes.
- Liquidity and debt: Cash was $189 million and revolving-credit borrowing availability was $1 billion; no commercial paper was outstanding. Notes payable, current debt and long-term debt totaled approximately $921 million. The company reported compliance with applicable credit-facility covenants.
- Other metrics: Interest expense was $13 million, unchanged. The effective tax rate was 24%, compared with 74% in the prior-year quarter, when Cabot recorded a tax benefit on a loss. Dividends were $0.30 per share versus $0.22.
Material changes versus the prior comparable period
- Pre-tax continuing-operations income rose to $73 million from an $8 million loss. The comparison includes $58 million of prior-year pre-tax “certain items,” mainly restructuring charges ($48 million), an Argentine-peso devaluation loss ($8 million), and legal and environmental matters ($2 million). Q1 fiscal 2017 certain-item charges were less than $1 million.
- Reinforcement Materials EBIT increased on higher unit margins, including customer-agreement and China spot pricing. Purification Solutions returned to positive EBIT, supported by higher volumes and a favorable inventory comparison; management attributed stronger demand partly to U.S. utilities’ MATS compliance requirements.
- Performance Chemicals EBIT edged down as higher maintenance costs offset volume gains. Specialty Fluids sales and EBIT increased, primarily on higher project activity in Asia.
- Other comprehensive loss was $124 million, mainly from a $125 million foreign-currency translation adjustment. Cabot therefore reported a comprehensive loss attributable to Cabot of $66 million despite positive net income.
Outlook, risks and unusual items
- Management anticipated solid volume comparisons continuing into Q2 fiscal 2017. It expected Reinforcement Materials to benefit from 2017 customer agreements and an improving China environment; Purification Solutions from a full year of MATS-related volumes and favorable inventory comparisons; and robust Performance Chemicals end-market demand, with margins potentially affected by rising oil prices.
- Management said Q1 inventory benefits were not expected to repeat in Q2. Fiscal 2017 capital expenditures were expected to be $150 million, primarily for sustaining and compliance projects. The company expected fiscal 2017 effective and operating tax rates of 24%.
- Management stated that available cash, operating cash flow and credit facilities were expected to fund foreseeable operating, investment and financial needs. Liquidity depends in part on timely receivable collection, raw-material costs and inventory management.
- Long-term raw-material purchase commitments totaled $2.225 billion, including $195 million due in the remainder of fiscal 2017. Some commitments have fixed quantities but prices that vary with market prices.
- Environmental reserves were $13 million. The respirator-liability reserve was $20 million, against approximately 38,000 pending claimant cases; Cabot cautioned actual costs could differ from its estimate. It reported that additional environmental remediation costs reasonably possible beyond recorded reserves were expected to be immaterial. Tax audits and uncertain tax positions also remain subject to developments that could not be quantified.
- Additional risks identified include raw-material availability and cost, demand and customer concentration, foreign exchange, litigation and environmental matters, project execution, competition, and Venezuela-related currency and investment recoverability. The fair value of the Purification Solutions reporting unit exceeded carrying value by 9% in the May 2016 impairment test, making its growth assumptions an area to monitor.
Most important facts for investors to verify
- Whether Q2 and full-year segment demand and margins meet management’s outlook, especially as Q1 inventory benefits fade and input costs rise.
- Whether the improvement in earnings persists apart from the substantial prior-year restructuring and other unusual charges.
- Cash conversion and working-capital trends, including inventory build, currency effects, and planned $150 million fiscal 2017 capital spending.
- Debt, credit availability and covenant compliance, alongside the $2.225 billion of purchase commitments.
- Developments affecting Purification Solutions’ valuation assumptions, environmental reserves, respirator claims, tax audits and the Venezuelan affiliate.