Cabot Corporation (NYSE: CBT) — Q3 FY2019 Form 10-Q
Reporting period: Quarter and nine months ended June 30, 2019; fiscal year ends September 30. Figures are unaudited and in U.S. dollars unless noted.
Business context and financial results
Cabot reported three segments after selling Specialty Fluids on June 28, 2019: Reinforcement Materials, Performance Chemicals and Purification Solutions. Comparisons are affected by the sale and by a change that moved by-product sales from a reduction in cost of sales to revenue; this added $18 million of reported revenue in the quarter and $58 million in the nine-month period, without changing profit.
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Revenue | $845 million | $854 million | $2,510 million | $2,392 million |
| Gross profit | $170 million | $197 million | $514 million | $561 million |
| Gross margin | 20.1% | 23.1% | 20.5% | 23.5% |
| Operating income | $81 million | $106 million | $231 million | $36 million |
| Net income attributable to Cabot | $32 million | $88 million | $124 million | $(207) million |
| Diluted EPS | $0.55 | $1.40 | $2.08 | $(3.36) |
Quarterly revenue fell 1%; nine-month revenue rose 5%, reflecting stronger pricing and mix, partly offset by foreign exchange and lower volumes. Operating income and nine-month earnings comparisons are distorted by substantial Purification Solutions impairments and tax effects in FY2018. Q3 FY2019 included a 43% effective tax rate, including a $17 million tax expense related to U.S. tax reform regulations.
Segments and material changes
- Reinforcement Materials: Q3 sales were $461 million versus $466 million; segment EBIT was $72 million versus $74 million. Nine-month EBIT declined to $195 million from $215 million, mainly on weaker unit margins, particularly in China, and lower volumes.
- Performance Chemicals: Q3 sales fell to $251 million from $274 million and EBIT to $37 million from $56 million. Nine-month EBIT was $111 million versus $160 million. Management cited softer automotive production, weaker pricing and mix, lower volumes, high-cost inventory and increased costs associated with growth investments.
- Purification Solutions: Q3 sales were $73 million and EBIT was $1 million, compared with $70 million and a $6 million EBIT loss a year earlier. Nine-month EBIT improved to a $1 million loss from a $6 million loss. A transformation plan is intended to focus the portfolio, optimize assets and reduce costs.
- Specialty Fluids sale: Sold to Sinomine for $133 million of proceeds, net of $2 million cash transferred; $5 million was held in escrow. Cabot recorded a $20 million impairment in Q2 and an $8 million sale loss in Q3. Additional lithium-product royalties of up to $5 million may be payable over ten years.
Cash flow, debt and liquidity
- For the first nine months, operating cash flow was $166 million, up from $143 million. Capital expenditures were $155 million; management expected FY2019 capital spending of $230–$240 million.
- Investing activities used $33 million, including capital spending, partly offset by $130 million of net cash proceeds from the Specialty Fluids sale. Financing activities used $146 million, including $144 million in share repurchases and $60 million in common dividends.
- Cash was $147 million at June 30, down from $175 million at September 30, 2018. Short-term borrowings were $84 million and long-term debt was $1.017 billion; current long-term debt was $5 million. The company issued $300 million of unsecured 4% notes due July 2029.
- Borrowing availability under revolving credit agreements was $1.278 billion. Cabot reported compliance with facility covenants and said available cash, operating cash flow and credit facilities should meet foreseeable operating, investment and financial needs.
- Common dividends were $0.35 per share for the quarter. The company repurchased $144 million of stock during the nine-month period.
Outlook, risks and contingencies
Management expected the U.S.-China trade dispute to remain unresolved and automotive production to stay weak in Q4 FY2019, weighing on Reinforcement Materials and Performance Chemicals. Expected offsets included favorable pricing and mix under 2019 tire agreements, higher fumed-silica volumes from the Wuhai, China plant, lower Purification Solutions costs under its transformation plan, and cost-management actions. The filing provides no numerical earnings guidance.
Risks include raw-material costs and availability, demand and customer concentration, automotive-market weakness, trade-policy and currency changes, execution of expansions and restructuring, and litigation and environmental matters. Environmental reserves were $14 million; the respirator-claims reserve was $21 million, against approximately 36,000 pending claimants in cases involving AO products. Cabot stated actual respirator liabilities could exceed reserves. Long-term raw-material purchase commitments totaled $3.086 billion, based on market prices at June 30, 2019. Management considered additional environmental remediation costs reasonably possible but estimated them to be immaterial; litigation outcomes remain uncertain.
Other notable items include an $11 million impairment of the Venezuelan equity investment, recorded in Q2, and $15 million of restructuring charges for the nine months. Management said the FY2019 effective and operating tax rates were expected to be 23%; tax audits could affect the outcome. Disclosure controls were assessed as effective, with no reported material change in internal control over financial reporting.
Key facts for investors to verify
- Underlying segment margins and volumes, especially whether weakness in automotive demand, China and Europe continues.
- Q4 performance against management’s stated offsets, including the Wuhai plant start-up and tire-agreement pricing benefits.
- Cash generation, working-capital needs, capital spending and leverage after the Specialty Fluids sale, debt issuance and share repurchases.
- Final sale adjustments, release of the $5 million escrow and any realization of potential lithium royalties.
- Potential changes to tax reserves, environmental liabilities and respirator-claim estimates; the filing does not quantify a maximum exposure for indemnities.
- Comparability of reported revenue and margins after the by-product revenue reclassification and the Specialty Fluids divestiture.