UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended December 31, 2016

or

For the transition period from                      to                     

Commission file number 1-5667

 

Cabot Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code: (617) 345-0100

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.

As of February 3, 2017 the Company had 62,191,740 shares of Common Stock, par value $1.00 per share, outstanding.

 

 

 

---

 

CABOT CORPORATION

INDEX

 

 

2

---

 

Part I. Financial Information

CABOT CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

UNAUDITED

 

 

The accompanying notes are an integral part of these consolidated financial statements.

3

---

 

CABOT CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

UNAUDITED

 

 

The accompanying notes are an integral part of these consolidated financial statements.

4

---

 

CABOT CORPORATION

CONSOLIDATED BALANCE SHEETS

ASSETS

UNAUDITED

 

 

The accompanying notes are an integral part of these consolidated financial statements.

5

---

 

CABOT CORPORATION

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS’ EQUITY

UNAUDITED

 

 

The accompanying notes are an integral part of these consolidated financial statements.

6

---

 

CABOT CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

UNAUDITED

 

 

The accompanying notes are an integral part of these consolidated financial statements.

7

---

 

CABOT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2016

UNAUDITED

 

A. Basis of Presentation

The consolidated financial statements have been prepared in accordance with accounting policies generally accepted in the United States and include the accounts of Cabot Corporation (“Cabot” or the “Company”) and its wholly owned subsidiaries and majority-owned and controlled U.S. and non-U.S. subsidiaries. Additionally, Cabot considers consolidation of entities over which control is achieved through means other than voting rights. Intercompany transactions have been eliminated in consolidation.

The unaudited consolidated financial statements have been prepared in accordance with the requirements of Form 10-Q and consequently do not include all disclosures required by Form 10-K. Additional information may be obtained by referring to Cabot’s Annual Report on Form 10-K for the fiscal year ended September 30, 2016 (“2016 10-K”).

The financial information submitted herewith is unaudited and reflects all adjustments which are, in the opinion of management, necessary to provide a fair statement of the results for the interim periods ended December 31, 2016 and 2015. All such adjustments are of a normal recurring nature. The results for interim periods are not necessarily indicative of the results to be expected for the fiscal year.

Effective October 1, 2016, the Company adopted a new accounting standard simplifying the presentation of debt issuance costs by presenting debt issuance costs as a reduction of the corresponding debt liability. In addition, the Company early adopted a new accounting standard that simplifies the presentation of deferred income taxes by classifying all deferred taxes as noncurrent assets or liabilities. These new standards were applied retrospectively. The retrospective application of the standard that simplifies the presentation of debt issuance costs resulted in the reclassification of $1 million and $3 million of unamortized debt issuance costs from Prepaid expenses and other current assets and Other assets, respectively, to Long-term debt within the Consolidated Balance Sheets as of September 30, 2016. The retrospective application of the standard that simplifies the presentation of deferred income taxes resulted in the reclassification of $41 million of current deferred tax assets and $1 million of current deferred tax liabilities to noncurrent deferred tax accounts within the Consolidated Balance Sheets as of September 30, 2016.

 

 

B. Significant Accounting Policies

Revenue Recognition and Accounts Receivable

Cabot recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. Cabot generally is able to ensure that products meet customer specifications prior to shipment. If the Company is unable to determine that the product has met the specified objective criteria prior to shipment or if title has not transferred because of sales terms, the revenue is considered “unearned” and is deferred until the revenue recognition criteria are met.

Shipping and handling charges related to sales transactions are recorded as sales revenue when billed to customers or included in the sales price. Taxes collected on sales to customers are excluded from revenues.

The following table shows the relative size of the revenue recognized in each of the Company’s reportable segments.

 

 

Cabot derives the substantial majority of its revenues from the sale of products in the Reinforcement Materials, Performance Chemicals, and Purification Solutions segments. Revenue from these products is typically recognized when the product is shipped

8

---

 

and title and risk of loss have passed to the customer. The Company offers certain of its customers cash discounts and volume rebates as sales incentives. The discounts and volume rebates are recorded as a reduction in sales at the time revenue is recognized and are estimated based on historical experience and contractual obligations. Cabot periodically reviews the assumptions underlying its estimates of discounts and volume rebates and adjusts its revenues accordingly.

For major activated carbon injection systems projects in Purification Solutions, revenue is recognized using the percentage-of-completion method.

Revenue in Specialty Fluids arises primarily from the rental of cesium formate. This revenue is recognized throughout the rental period based on the contracted rental terms. Customers are also billed and revenue is recognized, typically at the end of the job, for cesium formate product that is not returned. The Company also generates revenues from cesium formate sold outside of a rental process and revenue is recognized upon delivery of the fluid.

Cabot maintains allowances for doubtful accounts based on an assessment of the collectability of specific customer accounts, the aging of accounts receivable and other economic information on both a historical and prospective basis. Customer account balances are charged against the allowance when it is probable the receivable will not be recovered. There were no material changes in the allowance for any of the years presented. There is no material off-balance sheet credit exposure related to customer receivable balances.

Intangible Assets and Goodwill Impairment

The Company records tangible and intangible assets acquired and liabilities assumed in business combinations under the acquisition method of accounting. Amounts paid for an acquisition are allocated to the assets acquired and liabilities assumed based on their fair values at the date of acquisition. Goodwill is comprised of the purchase price of business acquisitions in excess of the fair value assigned to the net tangible and identifiable intangible assets acquired. Goodwill is not amortized, but is reviewed for impairment annually as of May 31, or when events or changes in the business environment indicate that the carrying value of the reporting unit may exceed its fair value. A reporting unit, for the purpose of the impairment test, is at or below the operating segment level, and constitutes a business for which discrete financial information is available and regularly reviewed by segment management. The reporting units with goodwill balances are Reinforcement Materials, Purification Solutions, and Fumed Metal Oxides. The separate businesses included within Performance Chemicals are considered separate reporting units. As such, the goodwill balance relative to Performance Chemicals is recorded in the Fumed Metal Oxides reporting unit.

For the purpose of the goodwill impairment test, the Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an initial qualitative assessment identifies that it is more likely than not that the carrying value of a reporting unit exceeds its estimated fair value, an additional quantitative evaluation is performed under the two-step impairment test. Alternatively, the Company may elect to proceed directly to the quantitative goodwill impairment test. If based on the quantitative evaluation the fair value of the reporting unit is less than its carrying amount, the Company performs an analysis of the fair value of all assets and liabilities of the reporting unit. If the implied fair value of the reporting unit’s goodwill is determined to be less than its carrying amount, an impairment is recognized for the difference. The fair value of a reporting unit is based on discounted estimated future cash flows. The fair value is also benchmarked against a market approach using the guideline public companies method. The assumptions used to estimate fair value include management’s best estimates of future growth rates, operating cash flows, capital expenditures and discount rates over an estimate of the remaining operating period at the reporting unit level. Should the fair value of any of the Company’s reporting units decline below its carrying amount because of reduced operating performance, market declines, changes in the discount rate, or other conditions, charges for impairment may be necessary.

Based on the Company’s most recent annual goodwill impairment test performed as of May 31, 2016, the fair values of the Reinforcement Materials and Fumed Metal Oxides reporting units were substantially in excess of their carrying values. The fair value of the Purification Solutions reporting unit exceeded its carrying amount by 9%. The fair value of the Purification Solutions reporting unit includes certain growth assumptions that are primarily dependent on: (1) further growth in the mercury removal related portion of the business, which is largely dependent on the amount of coal-based power generation used in the United States and the continued regulation of those utilities under the Mercury and Air Toxics Standards and (2) growth in demand for Cabot’s activated carbon products in other applications, while meeting the Company’s margin expectations. Realizing these assumptions is generally driven by the macroeconomic environment, environmental regulations, and global and regional competition.

9

---

 

The Company uses assumptions and estimates in determining the fair value of assets acquired and liabilities assumed in a business combination. The determination of the fair value of intangible assets requires the use of significant judgment with regard to assumptions used in the valuation model. The Company estimates the fair value of identifiable acquisition-related intangible assets principally based on projections of cash flows that will arise from these assets. The projected cash flows are discounted to determine the fair value of the assets at the dates of acquisition.

Definite-lived intangible assets, which are comprised of trademarks, customer relationships and developed technologies, are amortized over their estimated useful lives and are reviewed for impairment when indication of potential impairment exists, such as a significant reduction in cash flows associated with the assets.

Long-lived Assets Impairment

The Company’s long-lived assets primarily include property, plant and equipment, intangible assets, long-term investments and assets held for rent. The carrying values of long-lived assets are reviewed for impairment whenever events or changes in business circumstances indicate that the carrying amount of an asset may not be recoverable.

To test for impairment of assets, the Company generally uses a probability-weighted estimate of the future undiscounted net cash flows of the assets over their remaining lives to determine if the value of the asset is recoverable. Long-lived assets are grouped with other assets and liabilities at the lowest level for which independent identifiable cash flows are determinable.

An asset impairment is recognized when the carrying value of the asset is not recoverable based on the analysis described above, in which case the asset is written down to its fair value. If the asset does not have a readily determinable market value, a discounted cash flow model may be used to determine the fair value of the asset. In circumstances when an asset does not have separate identifiable cash flows, an impairment charge is recorded when the Company no longer intends to use the asset.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Depreciation of property, plant and equipment is calculated using the straight-line method over the estimated useful lives. The depreciable lives for buildings, machinery and equipment, and other fixed assets are twenty to twenty-five years, ten to twenty-five years, and three to twenty-five years, respectively. The cost and accumulated depreciation for property, plant and equipment sold, retired, or otherwise disposed of are removed from the Consolidated Balance Sheets and resulting gains or losses are included in earnings in the Consolidated Statements of Operations. Expenditures for repairs and maintenance are charged to expenses as incurred. Expenditures for major renewals and betterments, which significantly extend the useful lives of existing plant and equipment, are capitalized and depreciated.

Income Tax in Interim Periods

The Company records its tax provision or benefit on an interim basis using an estimated annual effective tax rate. This rate is applied to the current period ordinary income or loss to determine the income tax provision or benefit allocated to the interim period. Losses from jurisdictions for which no benefit can be recognized and the income tax effects of unusual or infrequent items are excluded from the estimated annual effective tax rate and are recognized in the impacted interim period.

Valuation allowances are provided against the future tax benefits that arise from the deferred tax assets in jurisdictions for which no benefit can be recognized. The estimated annual effective tax rate may be significantly impacted by nondeductible expenses and the Company’s projected earnings mix by tax jurisdiction. Adjustments to the estimated annual effective income tax rate are recognized in the period when such estimates are revised.

Inventory Valuation

Inventories are stated at the lower of cost or market. The cost of all carbon black inventories in the U.S. is determined using the last-in, first-out (“LIFO”) method. Had the Company used the first-in, first-out (“FIFO”) method instead of the LIFO method for such inventories, the value of those inventories would have been $28 million and $27 million higher as of December 31, 2016 and September 30, 2016, respectively. The cost of Specialty Fluids inventories, which are classified as assets held for rent, is determined using the average cost method. The cost of other U.S. and non-U.S. inventories is determined using the first-in, first-out (“FIFO”) method.

10

---

 

Cabot reviews inventory for both potential obsolescence and potential declines in anticipated selling prices. In this review, the Company makes assumptions about the future demand for and market value of the inventory, and based on these assumptions estimates the amount of any obsolete, unmarketable, slow moving, or overvalued inventory. Cabot writes down the value of these inventories by an amount equal to the difference between the cost of the inventory and its estimated net realizable value.

Pensions and Other Postretirement Benefits

The Company recognizes the funded status of defined benefit pension and other postretirement benefit plans as an asset or liability. This amount is defined as the difference between the fair value of plan assets and the benefit obligation. The Company is required to recognize as a component of other comprehensive income (loss), net of tax, the actuarial gains/losses and prior service costs/credits that arise but were not previously required to be recognized as components of net periodic benefit cost. Other comprehensive income (loss) is adjusted as these amounts are later recognized in income as components of net periodic benefit cost.

Accumulated Other Comprehensive Income (Loss)

Accumulated other comprehensive income (loss) (“AOCI”), which is included as a component of stockholders’ equity, includes unrealized gains or losses on available-for-sale marketable securities and derivative instruments, currency translation adjustments in foreign subsidiaries, translation adjustments on foreign equity securities and minimum pension liability adjustments.

Recent Accounting Pronouncements

In May 2014, the FASB issued a new standard, “Revenue from Contracts with Customers”, which amends the existing accounting standards for revenue recognition. The standard requires entities to recognize revenue when they transfer promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for those goods or services. This standard is applicable for fiscal years beginning after December 15, 2017 and for interim periods within those years and early adoption is permitted for the fiscal years beginning after December 15, 2016. The Company expects to adopt this standard on October 1, 2018. The Company is currently evaluating the impact the adoption of this standard may have on its consolidated financial statements.

In April 2015, the FASB issued a new standard simplifying the presentation of debt issuance costs by requiring debt issuance costs to be presented as a reduction of the corresponding debt liability. This makes the presentation of debt issuance costs consistent with the presentation of debt discounts or premiums. This standard is applicable for fiscal years beginning after December 15, 2015 and for interim periods within those years. The Company adopted this standard on October 1, 2016. The standard required retrospective application, which resulted in the reclassification of $1 million and $3 million of unamortized debt issuance costs from Prepaid expenses and other current assets and Other assets, respectively, to Long-term debt within the Consolidated Balance Sheets as of September 30, 2016.

In November 2015, the FASB issued a new standard that amends the existing accounting standard for income taxes and simplifies the presentation of deferred income taxes. This standard requires that deferred tax assets and liabilities be classified as noncurrent on the balance sheet. It is effective for fiscal years beginning after December 15, 2016 and for interim periods within those years and early adoption is permitted. The Company elected to early adopt this standard effective October 1, 2016 and retrospectively apply the standard, which resulted in the reclassification of $41 million of current deferred tax assets and $1 million of current deferred tax liabilities into noncurrent deferred tax accounts within the Consolidated Balance Sheets as of September 30, 2016.

In February 2016, the FASB issued a new standard for the accounting for leases. This new standard requires lessees to recognize assets and liabilities for most leases, but recognize expenses on their income statements in a manner that is similar to the current accounting treatment for leases. The standard is applicable for fiscal years beginning after December 15, 2018 and for interim periods within those years and early adoption is permitted. The Company expects to adopt the standard on October 1, 2019. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

In March 2016, the FASB issued a new standard that amends the accounting standard for stock compensation by simplifying several aspects of the accounting for employee share-based payment transactions, including the related accounting for income taxes, forfeitures, and the withholding of shares to satisfy the employer’s tax withholding requirements, as well as classification in the statements of cash flows. The new standard is effective for fiscal years beginning after December 15, 2016, including interim

11

---

 

periods within those years and early adoption is permitted. The Company is evaluating this standard and the timing of its adoption. The adoption of this standard is not expected to materially impact the Company’s consolidated financial statements.

In August 2016, the FASB issued final amendments to clarify how entities should classify certain cash receipts and cash payments on the statement of cash flows such as distributions received from equity method investees, proceeds from settlement of insurance claims, and proceeds from the settlement of corporate-owned life insurance. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those years and early adoption is permitted. The Company is evaluating this standard and the timing of its adoption. The adoption of this standard is not expected to materially impact the Company’s consolidated financial statements.

 

 

C. Employee Benefit Plans

Net periodic defined benefit pension and other postretirement benefit costs include the following:

 

 

 

 

D. Goodwill and Intangible Assets

Cabot had goodwill balances of $147 million and $152 million at December 31, 2016 and September 30, 2016, respectively. The carrying amount of goodwill attributable to each reportable segment with goodwill balances and the changes in those balances during the three month period ended December 31, 2016 are as follows:

 

 

The following table provides information regarding the Company’s intangible assets:

 

 

Intangible assets are amortized over their estimated useful lives, which range from fourteen to twenty-five years, with a weighted average amortization period of approximately nineteen years. Amortization expense for the three months ended both

12

---

 

December 31, 2016 and 2015 was $2 million, and is included in Cost of sales and Selling and administrative expenses in the Consolidated Statements of Operations. Total amortization expense is estimated to be approximately $7 million each year for the next five fiscal years.

 

 

E. Stockholders’ Equity

In January 2015, the Board of Directors authorized Cabot to repurchase up to five million shares of its common stock in the open market or in privately negotiated transactions. Cabot has repurchased 2,429,176 shares of its common stock under this authorization. As of December 31, 2016, 2,570,824 shares remain available for repurchase under the current authorization. The Company retired the repurchased shares and recorded the excess of the purchase price over par value to additional paid-in capital until such amount was reduced to zero and then charged the remainder against retained earnings.

During the first three months of fiscal 2017 and 2016, Cabot paid cash dividends in the amount of $0.30 and $0.22, respectively, per share of common stock, with a total cost of $19 million and $14 million, respectively.

Noncontrolling interest

The following table illustrates the noncontrolling interest activity for the periods presented:

 

 

During the three months ended December 31, 2016, $7 million of dividends were declared to noncontrolling interests, none of which were paid during the period. During the three months ended December 31, 2015, $9 million of dividends were declared to noncontrolling interests, all of which were paid later in the fiscal year.

 

 

F. Accumulated Other Comprehensive Income (Loss)

Comprehensive income combines net income (loss) and other comprehensive income items, which are reported as components of stockholders’ equity in the accompanying Consolidated Balance Sheets.

Changes in each component of AOCI, net of tax, were as follows:

 

 

13

---

 

The amounts reclassified out of AOCI and into the Consolidated Statements of Operations in the three months ended December 31, 2016 and 2015 were as follows:

 

 

 

 

G. Commitments and Contingencies

Purchase Commitments

Cabot has entered into long-term purchase agreements primarily for the purchase of raw materials. Under certain of these agreements the quantity of material being purchased is fixed, but the price paid changes as market prices change. For those commitments, the amounts included in the table below are based on market prices at December 31, 2016.

 

 

Guarantee Agreements

Cabot has provided certain indemnities pursuant to which it may be required to make payments to an indemnified party in connection with certain transactions and agreements. In connection with certain acquisitions and divestitures, Cabot has provided routine indemnities with respect to such matters as environmental, tax, insurance, product and employee liabilities. In connection with various other agreements, including service and supply agreements with customers, Cabot has provided indemnities for certain contingencies and routine warranties. Cabot is unable to estimate the maximum potential liability for these types of indemnities as a maximum obligation is not explicitly stated in most cases and the amounts, if any, are dependent upon the outcome of future contingent events, the nature and likelihood of which cannot be reasonably estimated. The duration of the indemnities vary, and in many cases are indefinite. Cabot has not recorded any liability for these indemnities in the consolidated financial statements, except as otherwise disclosed.

Contingencies

Cabot is a defendant, or potentially responsible party, in various lawsuits and environmental proceedings wherein substantial amounts are claimed or at issue.

14

---

 

Environmental Matters

As of December 31, 2016 and September 30, 2016, Cabot had $13 million and $14 million, respectively, reserved for environmental matters. These environmental matters mainly relate to former operations. These reserves represent Cabot’s best estimates of the probable costs to be incurred at those sites where costs are reasonably estimable based on the Company’s analysis of the extent of clean up required, alternative clean-up methods available, abilities of other responsible parties to contribute and its interpretation of laws and regulations applicable to each site. Cash payments related to these environmental matters were less than $1 million in the first three months of both fiscal 2017 and 2016. Cabot reviews the adequacy of the reserves as circumstances change at individual sites and adjusts the reserves as appropriate. Almost all of Cabot’s environmental issues relate to sites that are mature and have been investigated and studied and, in many cases, are subject to agreed upon remediation plans. However, depending on the results of future testing, changes in risk assessment practices, remediation techniques and regulatory requirements, newly discovered conditions, and other factors, it is reasonably possible that the Company could incur additional costs in excess of environmental reserves currently recorded. Management estimates, based on the latest available information, that any such future environmental remediation costs that are reasonably possible to be in excess of amounts already recorded would be immaterial to the Company’s consolidated financial statements.

Other Matters

Respirator Liabilities

Cabot has exposure in connection with a safety respiratory products business that a subsidiary acquired from American Optical Corporation (“AO”) in an April 1990 asset purchase transaction. The subsidiary manufactured respirators under the AO brand and disposed of that business in July 1995. In connection with its acquisition of the business, the subsidiary agreed, in certain circumstances, to assume a portion of AO’s liabilities, including costs of legal fees together with amounts paid in settlements and judgments, allocable to AO respiratory products used prior to the 1990 purchase by the Cabot subsidiary. In exchange for the subsidiary’s assumption of certain of AO’s respirator liabilities, AO agreed to provide to the subsidiary the benefits of: (i) AO’s insurance coverage for the period prior to the 1990 acquisition and (ii) a former owner’s indemnity of AO holding it harmless from any liability allocable to AO respiratory products used prior to May 1982. As more fully described in the 2016 10-K, the respirator liabilities generally involve claims for personal injury, including asbestosis, silicosis and coal worker’s pneumoconiosis, allegedly resulting from the use of respirators that are alleged to have been negligently designed and/or labeled. Neither Cabot, nor its past or present subsidiaries, at any time manufactured asbestos or asbestos-containing products. At no time did this respiratory product line represent a significant portion of the respirator market.

As of both December 31, 2016 and September 30, 2016, there were approximately 38,000 claimants in pending cases asserting claims against AO in connection with respiratory products. Cabot has a reserve to cover its expected share of liability for existing and future respirator liability claims. At December 31, 2016 and September 30, 2016, the reserve was $20 million and $21 million, respectively. Cash payments related to this liability were $1 million in the first three months of both fiscal 2017 and 2016.

Cabot’s current estimate of the cost of its share of existing and future respirator liability claims is based on facts and circumstances existing at this time. Developments that could affect the Company’s estimate include, but are not limited to, (i) significant changes in the number of future claims, (ii) changes in the rate of dismissals without payment of pending claims, (iii) significant changes in the average cost of resolving claims, (iv) significant changes in the legal costs of defending these claims, (v) changes in the nature of claims received, (vi) changes in the law and procedure applicable to these claims, (vii) the financial viability of other parties which contribute to the settlement of respirator claims, (viii) a change in the availability of insurance coverage maintained by certain of the other parties which contribute to the settlement of respirator claims, or the indemnity provided by a former owner of the business, (ix) changes in the allocation of costs among the various parties paying legal and settlement costs, and (x) a determination that the assumptions that were used to estimate Cabot’s share of liability are no longer reasonable. The Company cannot determine the impact of these potential developments on its current estimate of its share of liability for existing and future claims. Accordingly, the actual amount of these liabilities for existing and future claims could be different than the reserved amount.

Other

The Company has various other lawsuits, claims and contingent liabilities arising in the ordinary course of its business and with respect to the Company’s divested businesses. In the opinion of the Company, although final disposition of some or all of these other suits and claims may impact the Company’s consolidated financial statements in a particular period, they are not expected, in the aggregate, to have a material adverse effect on the Company’s consolidated financial statements.

15

---

 

 

 

H. Income Tax

Effective Tax Rate

 

 

During the three months ended December 31, 2016, the Company recorded a tax provision of $17 million resulting in an effective tax rate of 24%. This amount included a net discrete tax benefit of less than $1 million, primarily comprised of a tax benefit from releases of reserves for uncertain tax positions, partially offset by a net tax charge from excludible foreign exchange gains and losses. During the three months ended December 31, 2015, the Company recorded a tax benefit of $5 million, resulting in an effective tax rate of 74%. This amount included net discrete tax benefits of $6 million, primarily comprised of the net tax benefit from certain foreign exchange gains and losses, the renewal of the U.S. Research and Experimentation credit and releases of reserves for uncertain tax positions.

Uncertainties

Cabot and certain subsidiaries are under audit in a number of jurisdictions. In addition, certain statutes of limitations are scheduled to expire in the near future. It is reasonably possible that a further change in the unrecognized tax benefits may also occur within the next twelve months related to the settlement of one or more of these audits or the lapse of applicable statutes of limitations. However, an estimated range of the impact on the unrecognized tax benefits cannot be quantified at this time.

Cabot files U.S. federal and state and non-U.S. income tax returns in jurisdictions with varying statutes of limitations. The 2012 through 2014 tax years generally remain subject to examination by the United States Internal Revenue Service and various tax years from 2005 through 2014 remain subject to examination by the respective state tax authorities. In significant non-U.S. jurisdictions, various tax years from 2002 through 2015 remain subject to examination by their respective tax authorities. As of December 31, 2016, Cabot’s significant non-U.S. jurisdictions include Canada, China, France, Germany, Italy, Japan, and the Netherlands.

During both the three months ended December 31, 2016 and 2015, Cabot released uncertain tax positions of $2 million due to the expirations of statutes of limitations in various jurisdictions.

 

 

16

---

 

I. Earnings Per Share

The following tables summarize the components of the basic and diluted earnings per common share computations:

 

 

17

---

 

Undistributed earnings are the earnings which remain after dividends declared during the period are assumed to be distributed to the common and participating shareholders. Undistributed earnings are allocated to common and participating shareholders on the same basis as dividend distributions. The calculation of undistributed earnings is as follows:

 

 

 

 

 

J. Restructuring

Cabot recorded a net benefit of less than $1 million related to restructuring activities in Cost of Sales in its Consolidated Statement of Operations for the three months ended December 31, 2016. Cabot’s restructuring activities were recorded in the Consolidated Statements of Operations in the three months ended December 31, 2015 as follows:

 

 

18

---

 

Details of all restructuring activities and the related reserves during the three months ended December 31, 2016 were as follows:

 

 

2016 Plan

In October 2015, in response to challenging macroeconomic conditions, the Company announced its intention to restructure its operations subject to local consultation requirements and processes in certain locations. Cabot’s plan resulted in termination of employment for approximately 300 employees across the Company’s global locations. These actions are intended to result in a more competitive cost structure.

Total charges related to these actions are expected to be $30 million, of which approximately $29 million was recorded in fiscal 2016. The Company recorded pre-tax charges of less than $1 million for the first three months of fiscal 2017 and expects to record approximately $1 million through the rest of fiscal 2017 related to these actions. The Company recorded pre-tax charges of approximately $24 million in the first three months of fiscal 2016 related to these actions. The charges recorded and anticipated are comprised of severance, employee benefits and other transition costs.

Cumulative net cash outlays related to these actions are expected to be approximately $30 million, comprised of severance, employee benefits and other transition costs. Through December 31, 2016, the Company has made $28 million in cash payments related to this plan, of which $27 million was paid in fiscal 2016, and expects to make $2 million in cash payments through the remainder of fiscal 2017.

As of December 31, 2016, Cabot has $1 million of accrued severance charges in the Consolidated Balance Sheet related to these actions.

Additionally, in fiscal 2016 Cabot closed its carbon black manufacturing facility in Merak, Indonesia to consolidate production in Asia using the Company’s Cilegon, Indonesia and other Asian and global carbon black production sites to meet regional demand. The decision was driven by the financial performance at the Merak facility in the past several years. Manufacturing operations ceased at the end of January 2016 and the employment of approximately 50 employees was terminated.

Total charges related to the Merak closure are expected to be $27 million, of which $25 million was recorded in fiscal 2016. The Company has recorded a net pre-tax benefit of less than $1 million in the three months ended December 31, 2016 and charges of $24 million in the three months ended December 31, 2015. The charges in the first quarter of fiscal 2016 were comprised of $22 million of asset impairments and accelerated depreciation and $2 million of severance and employee benefits.

Future anticipated site closure costs for the Merak facility, comprised mainly of site demolition, clearing and environmental remediation charges, and other miscellaneous costs, are expected to total approximately $1 million in the remainder of fiscal 2017 and approximately $2 million thereafter.

Total net cash outlays related to this closure are expected to be approximately $6 million, comprised of $3 million of severance payments, $3 million of site demolition, clearing and environmental costs, and less than $1 million for other charges. Through December 31, 2016, the Company has made $2 million in cash payments related to this plan, mainly for severance, and expects to pay approximately $1 million through the remainder of fiscal 2017 and $3 million thereafter mainly for site demolition, clearing and environmental remediation costs.

As of December 31, 2016, Cabot has approximately $1 million of accrued severance costs in the Consolidated Balance Sheet related to the Merak facility closure.

19

---

 

Other Actions

In previous years, the Company has entered into other various restructuring actions which have been substantially completed, pending the sale of assets from certain closed sites, including the sale of a former manufacturing site in Thane, India. The Company has recorded a total net benefit of less than $1 million related to these plans in the three months ended December 31, 2016 and a net charge of less than $1 million in the three months ended December 31, 2015.

Cabot expects to pay $2 million related to these actions in the remainder of fiscal 2017 and thereafter mainly for accrued environmental and other closure related costs. As of December 31, 2016, Cabot has approximately $2 million of accrued environmental and other closure related costs in the Consolidated Balance Sheets related to these activities.

 

 

K. Financial Instruments and Fair Value Measurements

The FASB authoritative guidance on fair value measurements defines fair value, provides a framework for measuring fair value in generally accepted accounting principles, and requires certain disclosures about fair value measurements. The disclosures focus on the inputs used to measure fair value. The guidance establishes the following hierarchy for categorizing these inputs:

 

 

There were no transfers of financial assets or liabilities measured at fair value between Level 1 and Level 2 and there were no Level 3 investments during the first three months of either fiscal 2017 or 2016.

 

At December 31, 2016 and September 30, 2016, Cabot had derivatives relating to foreign currency risks carried at fair value and included in Prepaid expenses and other current assets, Other assets, and Accounts payable and accrued liabilities of $8 million and $1 million, respectively. These derivatives are classified as Level 2 instruments within the fair value hierarchy as the fair value determination was based on observable inputs.

At December 31, 2016 and September 30, 2016, the fair value of guaranteed investment contracts, included in Other assets on the Consolidated Balance Sheets, was $11 million and $12 million, respectively. Guaranteed investment contracts were classified as Level 2 instruments within the fair value hierarchy as the fair value determination was based on other observable inputs.

At December 31, 2016 and September 30, 2016, the fair values of cash and cash equivalents, accounts and notes receivable, accounts payable and accrued liabilities, and notes payable and variable rate debt approximated their carrying values due to the short-term nature of these instruments. The carrying value and fair value of the long-term fixed rate debt were $0.91 billion and $0.94 billion, respectively, as of December 31, 2016 and $0.91 billion and $0.98 billion, respectively, as of September 30, 2016. The fair values of Cabot’s fixed rate long-term debt and capital lease obligations are estimated based on comparable quoted market prices at the respective period ends. The carrying amounts of Cabot’s floating rate long-term debt and capital lease obligations approximate their fair values. All such measurements are based on observable inputs and are classified as Level 2 within the fair value hierarchy. The valuation technique used is the discounted cash flow model.

 

 

L. Derivatives

Foreign Currency Risk Management

Cabot’s international operations are subject to certain risks, including currency exchange rate fluctuations and government actions. Cabot endeavors to match the currency in which debt is issued to the currency of the Company’s major, stable cash receipts. In some situations Cabot has issued debt denominated in U.S. dollars and then entered into cross currency swaps that exchange the dollar principal and interest payments into Euro denominated principal and interest payments.

Additionally, the Company has foreign currency exposure arising from its net investments in foreign operations. Cabot may enter into cross-currency swaps to mitigate the impact of currency rate changes on the Company’s net investments.

20

---

 

The Company also has foreign currency exposure arising from the denomination of monetary assets and liabilities in foreign currencies other than the functional currency of a given subsidiary as well as the risk that currency fluctuations could affect the dollar value of future cash flows generated in foreign currencies. Accordingly, Cabot uses short-term forward contracts to minimize the exposure to foreign currency risk. In certain situations where the Company has forecasted purchases under a long-term commitment or forecasted sales denominated in a foreign currency, Cabot may enter into appropriate financial instruments in accordance with the Company’s risk management policy to hedge future cash flow exposures.

The following table provides details of the derivatives held as of December 31, 2016 and September 30, 2016 to manage foreign currency risk.

 

 

Accounting for Derivative Instruments and Hedging Activities

The Company determines the fair value of financial instruments using quoted market prices whenever available. When quoted market prices are not available for various types of financial instruments (such as forwards, options and swaps), the Company uses standard models with market-based inputs, which take into account the present value of estimated future cash flows and the ability of Cabot or the financial counterparty to perform. For interest rate and cross-currency swaps, the significant inputs to these models are interest rate curves for discounting future cash flows and are adjusted for credit risk. For forward foreign currency contracts, the significant inputs are interest rate curves for discounting future cash flows, and exchange rate curves of the foreign currency for translating future cash flows.

Fair Value Hedge

For derivative instruments that are designated and qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in current period earnings.

Cash Flow Hedge

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is recorded in Accumulated other comprehensive income (loss) and reclassified to earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current period earnings.

Net Investment Hedge

For net investment hedges, changes in the fair value of the effective portion of the derivatives’ gains or losses are reported as foreign currency translation gains or losses in AOCI while changes in the ineffective portion are reported in earnings. Effectiveness is assessed based on the hypothetical derivative method. There was no ineffectiveness for the quarter ended December 31, 2016. The gains or losses on derivative instruments reported in AOCI are reclassified to earnings in the period in which earnings are affected by the underlying item, such as a disposal or substantial liquidations of the entities being hedged.

During the fourth quarter of fiscal 2016, the Company entered into cross currency swaps with a notional amount of $250 million, which are designated as hedges of its net investments in certain Euro denominated subsidiaries. Cash settlements periodically occur for fixed rate interest payments and a cash exchange of the notional currency amount will occur at the end of the term in 2026 under these cross currency swaps. During the three months ended December 31, 2016, the Company recognized a gain of $7 million related to these swaps through Foreign currency translation adjustment in other comprehensive income (loss). As of

21

---

 

December 31, 2016 and September 30, 2016, the fair value of these swaps was $8 million and $1 million, respectively, and was included in Prepaid expenses and other current assets and Other assets on the Consolidated Balance Sheets. As of December 31, 2016 and September 30, 2016, cumulative gain included in AOCI was $8 million and $1 million, respectively. There were no gains or losses reclassified from AOCI into earnings during the first three months of fiscal 2017 or fiscal 2016.

Other Derivative Instruments

From time to time, the Company may enter into certain derivative instruments that may not be designated as hedges for accounting purposes, which may include cross currency swaps, foreign currency forward contracts and commodity derivatives. For cross currency swaps and foreign currency forward contracts not designated as hedges, the Company uses standard models with market-based inputs. The significant inputs to these models are interest rate curves for discounting future cash flows, and exchange rate curves of the foreign currency for translating future cash flows. In determining the fair value of the commodity derivatives, the significant inputs to valuation models are quoted market prices of similar instruments in active markets. Although these derivatives do not qualify for hedge accounting, Cabot believes that such instruments are closely correlated with the underlying exposure, thus managing the associated risk. The gains or losses from changes in the fair value of derivative instruments that are not accounted for as hedges are recognized in current period earnings.

At both December 31, 2016 and September 30, 2016, the fair value of derivative instruments not designated as hedges were immaterial and were presented in Accounts payable and accrued liabilities and Prepaid expenses and other current assets, respectively, on the Consolidated Balance Sheets.

 

 

M. Venezuela

Cabot owns 49% of an operating carbon black affiliate in Venezuela, which is accounted for as an equity affiliate, through wholly-owned subsidiaries that carry the investment and receive its dividends. As of December 31, 2016, these subsidiaries carried the operating affiliate investment of $13 million.

During the three month periods ended December 31, 2016 and 2015, the Company received dividends in the amounts of $1 million and $2 million, respectively, which were paid in U.S. dollars.

A significant portion of the Company’s operating affiliate’s sales are exports denominated in U.S. dollars. The Venezuelan government mandates that a certain percentage of the dollars collected from these sales be converted into bolivars. The exchange rate made available to the Company as of December 31, 2016 was 674 bolivars to the U.S. dollar. The operating affiliate and the Company’s wholly-owned subsidiaries remeasured their bolivar denominated monetary accounts to reflect the current rate.

The operating entity has generally been profitable. The Company continues to closely monitor developments in Venezuela and their potential impact on the recoverability of its equity affiliate investment. Any future change in the exchange rate made available to the Company or opening of additional parallel markets could cause the Company to change the exchange rate it uses and result in gains or losses on the bolivar denominated assets held by its operating affiliate and wholly-owned subsidiaries.

 

 

N. Financial Information by Segment

The Company identifies a business as an operating segment if: i) it engages in business activities from which it may earn revenues and incur expenses; ii) its operating results are regularly reviewed by the Chief Operating Decision Maker (“CODM”), who is Cabot’s President and Chief Executive Officer, to make decisions about resources to be allocated to the segment and assess its performance; and iii) it has available discrete financial information. The Company has determined that all of its businesses are operating segments. The CODM reviews financial information at the operating segment level to allocate resources and to assess the operating results and financial performance for each operating segment. Operating segments are aggregated into a reportable segment if the operating segments are determined to have similar economic characteristics and if the operating segments are similar in the following areas: i) nature of products and services; ii) nature of production processes; iii) type or class of customer for their products and services; iv) methods used to distribute the products or provide services; and v) if applicable, the nature of the regulatory environment.

The Company has four reportable segments: Reinforcement Materials, Performance Chemicals, Purification Solutions and Specialty Fluids.

22

---

 

The Reinforcement Materials segment represents the rubber blacks and elastomer composites product lines.

 

The Performance Chemicals segment combines the specialty carbons and compounds and inkjet colorants product lines into the Specialty Carbons and Formulations business, and combines the fumed metal oxides and aerogel product lines into the Metal Oxides business. These businesses are similar in terms of economic characteristics, nature of products, processes, customer class and product distribution methods, and, therefore, have been aggregated into one reportable segment. The net sales from each of these businesses for the three months ended December 31, 2016 and 2015 were as follows:

 

 

The Purification Solutions segment represents the Company’s activated carbon business and the Specialty Fluids segment includes cesium formate oil and gas drilling fluids and high-purity fine cesium chemicals product lines.

Reportable segment Income (loss) from continuing operation before taxes and equity in earnings from affiliated companies (“Segment EBIT”) is presented for each reportable segment in the financial information by reportable segment table below. Segment EBIT excludes certain items, meaning items management does not consider representative of on-going operating segment results. In addition, Segment EBIT includes Equity in earnings of affiliated companies, net of tax, the full operating results of a contractual joint venture in Purification Solutions, royalties, Net income attributable to noncontrolling interests, net of tax, and discounting charges for certain Notes receivable, but excludes Interest expense, foreign currency transaction gains and losses, interest income, dividend income, unearned revenue, the effects of LIFO accounting for inventory, general unallocated expense and unallocated corporate costs.

Financial information by reportable segment is as follows:

 

 

23

---

 

 

 

 

 

 

 

24

---

 

Critical Accounting Policies

The preparation of our financial statements is in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent assets and liabilities. We consider an accounting estimate to be critical to the financial statements if (i) the estimate is complex in nature or requires a high degree of judgment and (ii) different estimates and assumptions were used, the results could have a material impact on the consolidated financial statements. On an ongoing basis, we evaluate our estimates and the application of our policies. We base our estimates on historical experience, current conditions and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies have not substantially changed from those described in the 2016 Form 10-K.

 

 

Results of Operations

Cabot is organized into four reportable business segments: Reinforcement Materials, Performance Chemicals, Purification Solutions and Specialty Fluids. Cabot is also organized for operational purposes into three geographic regions: the Americas; Europe, Middle East and Africa; and Asia Pacific. The discussions of our results of operations for the periods presented reflect these structures.

Our analysis of our financial condition and operating results should be read with our consolidated financial statements and accompanying notes.

Definition of Terms and Non-GAAP Financial Measures

When discussing our results of operations, we use several terms as described below.

The term “product mix” refers to the mix of types and grades of products sold or the mix of geographic regions where products are sold, and the positive or negative impact this has on the revenue or profitability of the business and/or segment.

The term “LIFO” includes two factors: (i) the impact of current inventory costs being recognized immediately in Cost of sales under a last-in first-out method, compared to the older costs that would have been included in Cost of sales under a first-in first-out method (“Cost of sales impact”); and (ii) the impact of reductions in inventory quantities, causing historical inventory costs to flow through Cost of sales (“liquidation impact”).

Our discussion under the heading “Provision (Benefit) for Income Taxes and Reconciliation of Effective Tax Rate to Operating Tax Rate” includes a discussion of our “effective tax rate” and our “operating tax rate” and includes a reconciliation of the two rates. Our operating tax rate is a non-GAAP financial measure and should not be considered as an alternative to our effective tax rate, the most comparable GAAP financial measure. In calculating our operating tax rate, we exclude discrete tax items, which include: i) unusual or infrequent items, such as a significant release or establishment of a valuation allowance, ii) items related to uncertain tax positions, such as the tax impact of audit settlements, interest on tax reserves, and the release of tax reserves from the expiration of statutes of limitations, and iii) other discrete tax items, such as the tax impact of legislative changes and, on a quarterly basis, the timing of losses in certain jurisdictions and the cumulative rate adjustment, if applicable. We also exclude the tax impact of certain items, as defined below in the discussion of Total segment EBIT, on both operating income and the tax provision. Our definition of the operating tax rate may not be comparable to the definition used by other companies. Management believes that this non-GAAP financial measure is useful supplemental information because it helps our investors compare our tax rate year to year on a consistent basis and to understand what our tax rate on current operations would be without the impact of these items.

Our discussion under the heading “First Quarter of Fiscal 2017 versus First Quarter of Fiscal 2016—By Business Segment” includes a discussion of Total segment EBIT, which is a non-GAAP financial measure defined as Income (loss) from continuing operations before income taxes and equity in earnings from affiliated companies less certain items and other unallocated items. Our Chief Operating Decision Maker, who is our President and Chief Executive Officer, uses segment EBIT to evaluate the operating results of each segment and to allocate resources to the segments. We believe Total segment EBIT, which reflects the sum of EBIT from our four reportable segments,  provides useful supplemental information for our investors as it is an important indicator of the

25

---

 

Company’s operational strength and performance, allows investors to see our results through the eyes of management, and provides context for our discussion of individual business segment performance. Total segment EBIT should not be considered an alternative for Income (loss) from continuing operations before income taxes and equity in earnings of affiliated companies, which is the most directly comparable GAAP financial measure. A reconciliation of Total segment EBIT to Income (loss) from continuing operations before income taxes and equity in earnings of affiliated companies is provided under the heading “First Quarter of Fiscal 2017 versus First Quarter of Fiscal 2016—By Business Segment”. Investors should consider the limitations associated with this non-GAAP measure, including the potential lack of comparability of this measure from one company to another.

In calculating Total segment EBIT, we exclude from our Income (loss) from continuing operations before income taxes and equity in earnings of affiliated companies (i) items of expense and income that management does not consider representative of our fundamental on-going segment results, which we refer to as “certain items”, and (ii) items that, because they are not controlled by the business segments and primarily benefit corporate objectives, are not allocated to our business segments, such as interest expense and other corporate costs, which include unallocated corporate overhead expenses such as certain corporate salaries and headquarter expenses, plus costs related to special projects and initiatives, which we refer to as “other unallocated items”. Management believes excluding the items identified as certain items facilitates operating performance comparisons from period to period by eliminating differences caused by the existence and timing of certain expense and income items that would not otherwise be apparent on a GAAP basis and also facilitates an evaluation of the Company’s operating performance without the impact of these costs or benefits. The items of income and expense that we have excluded from Total segment EBIT in prior periods, as applicable, but that are included in our GAAP Income (loss) from continuing operations before income taxes and equity in earnings of affiliated companies, as applicable, are described below.

Overview

During the first quarter of fiscal 2017, income (loss) from continuing operations before income taxes and equity in earnings of affiliated companies increased compared to the first quarter of fiscal 2016 primarily due to charges associated with restructuring plans that we recorded in the first quarter of fiscal 2016, including the planned closure of our carbon black manufacturing plant in Merak, Indonesia. In addition, results in the first quarter of fiscal 2017 improved compared to the first quarter of fiscal 2016 due to higher volumes across all segments and higher unit margins in Reinforcement Materials.

26

---

 

First Quarter of Fiscal 2017 versus First Quarter of Fiscal 2016—Consolidated

Net Sales and Other Operating Revenues and Gross Profit

 

 

The $8 million increase in net sales in the first quarter of fiscal 2017 compared to the first quarter of fiscal 2016 was primarily driven by higher volumes ($20 million) in the Performance Chemicals, Purification Solutions and Specialty Fluids segments. The increase in volumes was partially offset by a less favorable price and product mix ($6 million), an unfavorable impact from foreign currency translation ($3 million), and a decrease in revenue from unallocated sources ($4 million).

Gross profit increased by $58 million in the first quarter of fiscal 2017 compared to the first quarter of fiscal 2016 primarily due to charges taken in fiscal 2016 associated with restructuring plans, including the closure of our Merak, Indonesia carbon black manufacturing plant. In addition, gross profit improved due to higher volumes and the favorable impact from increasing inventory levels.

Selling and Administrative Expenses

 

 

Selling and administrative expenses decreased by $8 million in the first quarter of fiscal 2017 compared to the same period of fiscal 2016 primarily as a result of charges recorded in fiscal 2016 for restructuring actions taken to reduce fixed costs across the Company.

Research and Technical Expenses

 

 

Research and technical expenses decreased by $4 million in the first quarter of fiscal 2017 compared to the same period of fiscal 2016 primarily as a result of charges recorded in fiscal 2016 for restructuring actions taken to reduce fixed costs across the Company.

Interest and Dividend Income, Interest Expense and Other Income (Expense)

 

 

27

---

 

Interest and dividend income increased by $1 million in the first three months of fiscal 2017 compared to the same period of fiscal 2016 due to interest earned on higher cash balances.

Interest expense was consistent in the first quarter of fiscal 2017 as compared to the same period in fiscal 2016.

Other income (expense) changed by $10 million in the first quarter of fiscal 2017 compared to the first quarter of fiscal 2016 due to a favorable comparison of foreign currency movements, primarily the devaluation of the Argentine peso in fiscal 2016, which resulted in a loss of $8 million.

Provision (Benefit) for Income Taxes and Reconciliation of Effective Tax Rate to Operating Tax Rate

 

 

During the three months ended December 31, 2016, we recorded a tax provision of $17 million, resulting in an effective tax rate of 24%. This amount included a net discrete tax benefit of less than $1 million. The operating tax rate for the three months ended December 31, 2016 was also 24%. During the three months ended December 31, 2015, we recorded a tax benefit of $5 million, resulting in an effective tax rate of 74%. This amount included net discrete tax benefits of $3 million, primarily comprised of the net tax benefit from certain foreign exchange gains and losses, the renewal of the U.S. Research and Experimentation credit and releases of reserves for uncertain tax positions. The operating tax rate for the three months ended December 31, 2015 was 26%.

We expect our effective and operating tax rates for fiscal 2017 to be 24%.

Cabot files U.S. federal and state and non-U.S. income tax returns in jurisdictions with varying statutes of limitations. The 2012 through 2014 tax years generally remain subject to examination by the IRS and various tax years from 2005 through 2014 remain subject to examination by the respective state tax authorities. In significant non-U.S. jurisdictions, various tax years from 2002 through 2015 remain subject to examination by their respective tax authorities. As of December 31, 2016, Cabot’s significant non-U.S. jurisdictions include Canada, China, France, Germany, Italy, Japan, and the Netherlands.

28

---

 

Equity in Earnings of Affiliated Companies and Net Income Attributable to Noncontrolling Interests

 

 

Equity in earnings of affiliated companies, net of tax, increased by $2 million in the first quarter fiscal 2017 compared to the first quarter of fiscal 2016 primarily due to higher earnings from our Venezuelan equity affiliate.

Net income attributable to noncontrolling interests, net of tax, remained consistent in the first quarter of fiscal 2017 as compared to the same period in fiscal 2016.

Net Income Attributable to Cabot Corporation

In the first quarter of fiscal 2017, we reported net income (loss) attributable to Cabot Corporation of $54 million ($0.85 per diluted common share). This is compared to net income (loss) attributable to Cabot Corporation of $(7) million (($0.11) per diluted common share) in the first quarter of fiscal 2016.

First Quarter of Fiscal 2017 versus First Quarter of Fiscal 2016—By Business Segment

Income (loss) from continuing operations before income taxes and equity in earnings of affiliated companies, certain items, other unallocated items, and Total segment EBIT for the three months ended December 31, 2016 and 2015 are set forth in the table below. The details of certain items and other unallocated items are shown below and in Note N of our consolidated financial statements.

 

 

In the first quarter of fiscal 2017, total segment EBIT increased by $24 million when compared to the same period of fiscal 2016. The increase was primarily driven by higher volumes ($13 million), the favorable impact of increasing inventory levels ($9 million), higher unit margins ($6 million), and the favorable impact of foreign currency translation ($3 million), partially offset by higher fixed costs ($7 million).

29

---

 

Certain Items

Details of the certain items for the first quarter of fiscal 2017 and 2016 are as follows:

 

 

Certain items for the first quarter of fiscal 2017 included charges of less than $1 million. Certain items for the first quarter of fiscal 2016 included charges primarily related to restructuring activities, a foreign currency loss from the devaluation of the Argentine peso, and tax-related certain items. Details of restructuring activities are included in Note J of the consolidated financial statements. Tax-related certain items included discrete tax items, which are unusual and infrequent, and the tax impact of certain foreign exchange losses.

The tax impact of certain items is determined by (1) starting with the current and deferred income tax expense or benefit included in Net income (loss) attributable to Cabot Corporation, and (2) subtracting the tax expense or benefit on “adjusted earnings”. Adjusted earnings is defined as the pre-tax income attributable to Cabot Corporation excluding certain items. The tax expense or benefit on adjusted earnings is calculated by applying the operating tax rate, as defined under the section Definition of Terms and Non-GAAP Financial Measures, to adjusted earnings.

Other Unallocated Items

 

 

A discussion of items that we refer to as “other unallocated items” can be found under the heading “Definition of Terms and Non-GAAP Financial Measures”. The balances of unallocated corporate costs are primarily comprised of expenditures related to managing a public company that are not allocated to the segments and corporate business development costs related to new technology efforts. The balances of General unallocated income (expense) consists of gains (losses) arising from foreign currency transactions, net of other foreign currency risk management activities, the impact of accounting for certain inventory on a LIFO basis, the profit or loss related to the corporate adjustment for unearned revenue, and the impact of including the full operating results of an equity affiliate in Purification Solutions Segment EBIT.

Costs from Total other unallocated items changed by $1 million in the first quarter of fiscal 2017 as compared to the same period in fiscal 2016. Equity in earnings of affiliated companies changed by $2 million primarily due to an increase in earnings from our Venezuelan equity affiliate.

30

---

 

Reinforcement Materials

Sales and EBIT for Reinforcement Materials for the first quarter of fiscal 2017 and fiscal 2016 were as follows:

 

 

In the first quarter of fiscal 2017, sales in Reinforcement Materials increased by $7 million when compared to the first quarter of fiscal 2016. The increase was principally driven by a more favorable price and product mix (combined $5 million) and higher volumes ($2 million). The favorable price and product mix impact was primarily due to higher selling prices in the quarter from price adjustments to customers for increases in raw material costs and higher contract prices.

EBIT in Reinforcement Materials increased by $14 million in the first quarter of fiscal 2017 when compared to the same period of fiscal 2016. The increase was principally driven by higher unit margins ($11 million), the favorable impact of foreign currency translation ($2 million), and the favorable impact of increasing inventory levels ($2 million), partially offset by higher fixed costs ($2 million). Higher unit margins were driven by higher calendar year 2016 customer agreements and spot pricing in China.

Performance Chemicals

Sales and EBIT for Performance Chemicals for the first quarter of fiscal 2017 and fiscal 2016 were as follows:

 

 

In the first quarter of fiscal 2017, sales in Performance Chemicals decreased by $2 million when compared to the first quarter of fiscal 2016. The decrease was due to a less favorable price and product mix (combined $5 million) and the unfavorable impact of foreign currency translation ($2 million), partially offset by higher volumes ($5 million). The price and product mix impact was primarily driven by an unfavorable mix of sales by application, with lower Metal Oxides sales into electronics, as well as lower prices in Specialty Carbons associated with lower raw material costs and an unfavorable regional mix. Overall volumes increased in the Metal Oxides business driven by stronger China sales in the automotive and infrastructure sectors, which more than offset the decline in sales to the electronics market.

EBIT in Performance Chemicals decreased by $1 million in the first quarter of fiscal 2017 when compared to the same quarter of fiscal 2016 principally due to higher fixed costs ($5 million), partially offset by higher volumes ($4 million). Higher fixed costs were primarily due to increased maintenance costs from plant turnarounds.

Purification Solutions

Sales and EBIT for Purification Solutions for the first quarter of fiscal 2017 and fiscal 2016 were as follows:

 

31

---

 

 

Sales in Purification Solutions increased by $3 million in the first quarter of fiscal 2017 when compared to the same period of fiscal 2016 due to higher volumes ($9 million), partially offset by lower selling prices and a less favorable product mix (combined $6 million). Higher volumes were driven by higher demand for activated carbon in gas and air applications as coal fired utilities were required to be in compliance with the U.S. Mercury and Air Toxics Standards regulation (“MATS”) beginning in April 2016. The less favorable price and product mix was primarily due to lower selling prices as well as a less favorable product mix.

EBIT in Purification Solutions increased by $9 million in the first quarter of fiscal 2017 when compared to the same quarter of fiscal 2016 due to the favorable impact from higher volumes ($5 million) and an increase in inventory levels this year compared to a reduction in inventory levels last year ($5 million), partially offset by lower unit margins ($2 million).

Specialty Fluids

Sales and EBIT for Specialty Fluids for the first quarter of fiscal 2017 and 2016 were as follows:

 

 

Sales in Specialty Fluids increased by $4 million in the first quarter of fiscal 2017 when compared to the same period of fiscal 2016, primarily due to higher volumes ($4 million). The increase in volumes was driven by a higher level of project activity in Asia during the first quarter of fiscal 2017.

EBIT in Specialty Fluids increased by $2 million in the first quarter of fiscal 2017 when compared to the same period of fiscal 2016. The increase was due to higher volumes ($3 million) partially offset by lower unit margins ($1 million).

Outlook

We anticipate solid volume comparisons to continue into our second quarter of fiscal 2017. Reinforcement Materials is expected to benefit from the calendar year 2017 customer agreements, and we are beginning to see the business environment in China improve. Purification Solutions is expected to benefit from a full year of MATS volumes and favorable inventory comparisons. Demand in our Performance Chemicals end markets remains robust; however, margin comparisons are likely to be impacted with rising oil prices. We do not expect the inventory benefits that we experienced in the first quarter of fiscal 2017 to repeat in the second quarter of fiscal 2017.

 

 

Cash Flows and Liquidity

Overview

Our liquidity position, as measured by cash and cash equivalents plus borrowing availability, decreased by $11 million during the first three months of fiscal 2017 which was attributable to a lower cash balance at December 31, 2016. As of December 31, 2016, we had cash and cash equivalents of $189 million and borrowing availability under our revolving credit agreement of $1 billion. Borrowings under our revolving credit agreement may be used for working capital, letters of credit and other general corporate purposes. There was no outstanding balance of commercial paper as of December 31, 2016. At December 31, 2016, we were in compliance with all applicable covenants under our revolving credit facility including the total consolidated debt to consolidated EBITDA (earnings before interest, taxes, depreciation and amortization) covenant.

We generally manage our cash and debt on a global basis to provide for working capital requirements as needed by region or site. Cash and debt are generally denominated in the local currency of the subsidiary holding the assets or liabilities, except where there are operational cash flow reasons to hold non-functional currency or debt. The vast majority of our cash and cash equivalent holdings tend to be held outside the U.S., as excess cash balances in the U.S. are generally used to repay commercial paper issued during the period.

32

---

 

We anticipate sufficient liquidity from (i) cash on hand; (ii) cash flows from operating activities; and (iii) cash available from our revolving credit agreement and our commercial paper program to meet our operational and capital investment needs and financial obligations for the foreseeable future. The liquidity we derive from cash flows from operations is, to a large degree, predicated on our ability to collect our receivables in a timely manner, the cost of our raw materials, and our ability to manage inventory levels.

The following discussion of the changes in our cash balance refers to the various sections of our Consolidated Statements of Cash Flows.

Cash Flows from Operating Activities

Cash provided by operating activities, which consists of net income adjusted for the various non-cash items included in income, changes in working capital and changes in certain other balance sheet accounts, totaled $102 million in the first three months of fiscal 2017 compared to $83 million during the same period of fiscal 2016.

Cash provided by operating activities in the first three months of fiscal 2017 was driven primarily by net income excluding the non-cash impact of depreciation and amortization of $38 million. In addition, there was a decrease in accounts receivable and an increase in accounts payable and accrued liabilities. Partially offsetting these cash inflows was an increase in inventories.

Cash provided by operating activities in the first three months of fiscal 2016 was driven primarily by net income excluding the non-cash impact of certain long-lived asset write-offs ($23 million) and depreciation and amortization ($41 million). In addition, there was a decrease in accounts receivable and inventories, largely driven by lower raw material costs and associated price reductions as well as overall lower volumes. Partially offsetting these cash inflows were lower accounts payable and accrued liabilities.

Cash Flows from Investing Activities

In the three months ended December 31, 2016, investing activities consumed $23 million of cash which was primarily driven by capital expenditures of $22 million. These capital expenditures were primarily for sustaining and compliance capital projects at our operating facilities. In the three months ended December 31, 2015, investing activities consumed $18 million of cash and were primarily driven by capital expenditures of $24 million, offset by $7 million of proceeds from the sale of land in Port Dickson, Malaysia.

Capital expenditures for fiscal 2017 are expected to be $150 million. Our planned capital spending program for fiscal 2017 is primarily for sustaining and compliance capital projects at our operating facilities.

Cash Flows from Financing Activities

Financing activities consumed $27 million of cash in the first three months of fiscal 2017 compared to $41 million of cash consumed in the first three months of fiscal 2016. In the first three months of fiscal 2017, we used our cash for share repurchases and dividend distributions.

In the first three months of fiscal 2016, we used our cash for share repurchases, dividend distributions and to repay debt.

33

---

 

Purchase Commitments

We have entered into long-term purchase agreements primarily for the purchase of raw materials. Under certain of these agreements the quantity of material being purchased is fixed, but the price paid changes as market prices change. For those commitments, the amounts included in the table below are based on market prices at December 31, 2016.

 

 

Off-balance sheet arrangements

We have no material transactions that meet the definition of an off-balance sheet arrangement.

Forward-Looking Information

This report on Form 10-Q contains “forward-looking statements” under the Federal securities laws. These forward-looking statements address expectations or projections about the future, including our expectations for future financial performance; demand for our products and our overall expectations for segment results in the second quarter of fiscal 2017; the amount and timing of the charge to earnings we will record and the cash outlays we will make in connection with the closing of certain manufacturing facilities and restructuring initiatives; our estimated future amortization expenses for our intangible assets; the sufficiency of our cash on hand, cash provided from operations and cash available under our credit facilities to fund our cash requirements; uses of available cash including anticipated capital spending and future cash outlays associated with long-term contractual obligations; our expected tax rate for fiscal 2017; and the possible outcome of legal and environmental proceedings. From time to time, we also provide forward-looking statements in other materials we release to the public and in oral statements made by authorized officers.

Forward-looking statements are based on our current expectations, assumptions, estimates and projections about Cabot’s businesses and strategies, market trends and conditions, economic conditions and other factors. These statements are not guarantees of future performance and are subject to risks, uncertainties, potentially inaccurate assumptions, and other factors, some of which are beyond our control or difficult to predict. If known or unknown risks materialize, or should underlying assumptions prove inaccurate, our actual results could differ materially from those expressed in the forward-looking statements.

In addition to factors described elsewhere in this report, the following are some of the factors that could cause our actual results to differ materially from those expressed in the forward-looking statements: changes in raw material costs; lower than expected demand for our products; the loss of one or more of our important customers; our inability to complete capacity expansions or other development projects; the availability of raw materials; our failure to develop new products or to keep pace with technological developments; fluctuations in currency exchange rates; patent rights of others; stock and credit market conditions; the timely commercialization of products under development (which may be disrupted or delayed by technical difficulties, market acceptance, competitors’ new products, as well as difficulties in moving from the experimental stage to the production stage); demand for our customers’ products; competitors’ reactions to market conditions; delays in the successful integration of structural changes, including acquisitions or joint ventures; severe weather events that cause business interruptions, including plant and power outages or disruptions in supplier or customer operations; the accuracy of the assumptions we used in establishing reserves for environmental matters and for our share of liability for respirator claims; and the outcome of pending litigation. Other factors and risks are discussed in our 2016 10-K.

Recently Issued Accounting Pronouncements

In May 2014, the FASB issued a new standard, the “Revenue from Contracts with Customers”, which amends the existing accounting standards for revenue recognition. The standard requires entities to recognize revenue when they transfer promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to in exchange for

34

---

 

those goods or services. This standard is applicable for fiscal years beginning after December 15, 2017 and for interim periods within those years and early adoption is permitted for the fiscal years beginning after December 15, 2016. We expect to adopt this standard on October 1, 2018. We are currently evaluating the impact the adoption of this standard may have on our consolidated financial statements.

In April 2015, the FASB issued a new standard simplifying the presentation of debt issuance costs by requiring debt issuance costs to be presented as a reduction of the corresponding debt liability. This makes the presentation of debt issuance costs consistent with the presentation of debt discounts or premiums. This standard is applicable for fiscal years beginning after December 15, 2015 and for interim periods within those years. We adopted this standard on October 1, 2016. The standard required retrospective application, which resulted in the reclassification of $1 million and $3 million of unamortized debt issuance costs from Prepaid expenses and other current assets and Other assets, respectively, to Long-term debt within the Consolidated Balance Sheets as of September 30, 2016.

In November 2015, the FASB issued a new standard that amends the existing accounting standard for income taxes and simplifies the presentation of deferred income taxes. This standard requires that deferred income tax assets and liabilities be classified as noncurrent on the balance sheet. It is effective for fiscal years beginning after December 15, 2016 and for interim periods within those years and early adoption is permitted. We elected to early adopt this standard effective October 1, 2016 and retrospectively apply the standard, which resulted in the reclassification of $41 million of current deferred tax assets and $1 million of current deferred tax liabilities into noncurrent deferred tax accounts within the Consolidated Balance Sheets as of September 30, 2016.

In February 2016, the FASB issued a new standard for the accounting for leases. This new standard requires lessees to recognize assets and liabilities for most leases, but recognize expenses on their income statements in a manner that is similar to the current accounting treatment for leases. The standard is applicable for fiscal years beginning after December 15, 2018 and for interim periods within those years and early adoption is permitted. We expect to adopt the standard on October 1, 2019. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.

In March 2016, the FASB issued a new standard that amends the accounting standard for stock compensation by simplifying several aspects of the accounting for employee share-based payment transactions, including the related accounting for income taxes, forfeitures, and the withholding of shares to satisfy the employer’s tax withholding requirements, as well as classification in the statements of cash flows. The new standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those years and early adoption is permitted. We are evaluating this standard and the timing of its adoption. The adoption of this standard is not expected to materially impact our consolidated financial statements.

In August 2016, the FASB issued final amendments to clarify how entities should classify certain cash receipts and cash payments on the statement of cash flows such as distributions received from equity method investees, proceeds from settlement of insurance claims, and proceeds from the settlement of corporate-owned life insurance. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those years and early adoption is permitted. The Company is evaluating this standard and the timing of its adoption. The adoption of this standard is not expected to materially impact the Company’s consolidated financial statements.

 

 

Information about market risks for the period ended December 31, 2016 does not differ materially from that discussed under Item 7A of our 2016 10-K.

As of December 31, 2016, we carried out an evaluation, under the supervision and with the participation of our management, including our Principal Executive Officer and our Executive Vice President and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon that evaluation, our Principal Executive Officer and our Executive Vice President and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of that date.

There were no changes in our internal control over financial reporting that occurred during our fiscal quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

35

---

 

Part II. Other Information

Respirator Liabilities

We have exposure in connection with a safety respiratory products business that a subsidiary acquired from American Optical Corporation (“AO”) in an April 1990 asset purchase transaction. The subsidiary manufactured respirators under the AO brand and disposed of that business in July 1995. In connection with its acquisition of the business, the subsidiary agreed, in certain circumstances, to assume a portion of AO’s liabilities, including costs of legal fees together with amounts paid in settlements and judgments, allocable to AO respiratory products used prior to the 1990 purchase by the Cabot subsidiary. In exchange for the subsidiary’s assumption of certain of AO’s respirator liabilities, AO agreed to provide to the subsidiary the benefits of: (i) AO’s insurance coverage for the period prior to the 1990 acquisition and (ii) a former owner’s indemnity of AO holding it harmless from any liability allocable to AO respiratory products used prior to May 1982. As more fully described in our 2016 10-K, the respirator liabilities generally involve claims for personal injury, including asbestosis, silicosis and coal worker’s pneumoconiosis, allegedly resulting from the use of respirators that are alleged to have been negligently designed and/or labeled. Neither Cabot, nor its past or present subsidiaries, at any time manufactured asbestos or asbestos-containing products. At no time did this respiratory product line represent a significant portion of the respirator market.

As of both December 31, 2016 and September 30, 2016, there were approximately 38,000 claimants in pending cases asserting claims against AO in connection with respiratory products. We have a reserve to cover our expected share of liability for existing and future respirator liability claims. At December 31, 2016 and September 30, 2016, the reserve was $20 million and $21 million, respectively. Cash payments related to this liability were $1 million in the first three months of both fiscal 2017 and 2016.

Our current estimate of the cost of our share of existing and future respirator liability claims is based on facts and circumstances existing at this time. Developments that could affect our estimate include, but are not limited to, (i) significant changes in the number of future claims, (ii) changes in the rate of dismissals without payment of pending claims, (iii) significant changes in the average cost of resolving claims, (iv) significant changes in the legal costs of defending these claims, (v) changes in the nature of claims received, (vi) changes in the law and procedure applicable to these claims, (vii) the financial viability of other parties which contribute to the settlement of respirator claims, (viii) a change in the availability of insurance coverage maintained by certain of the other parties which contribute to the settlement of respirator claims, or the indemnity provided by a former owner of the business, (ix) changes in the allocation of costs among the various parties paying legal and settlement costs, and (x) a determination that the assumptions that were used to estimate our share of liability are no longer reasonable. We cannot determine the impact of these potential developments on our current estimate of our share of liability for existing and future claims. Accordingly, the actual amount of these liabilities for existing and future claims could be different than the reserved amount.

Other Matters

We are subject to various other lawsuits, claims and contingent liabilities arising in the ordinary course of our business and with respect to our divested businesses. In our opinion, although final disposition of some or all of these other suits and claims may impact our consolidated financial statements in a particular period, they are not expected, in the aggregate, to have a material adverse effect on our consolidated financial statements.

36

---

 

The table below sets forth information regarding Cabot’s purchases of its equity securities during the quarter ended December 31, 2016:

Issuer Purchases of Equity Securities

 

 

The following Exhibits are filed herewith:

 

 

37

---

 

Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Operations for the three months ended December 31, 2016 and 2015; (ii) the Consolidated Statements of Comprehensive Income for the three months ended December 31, 2016 and 2015; (iii) the Consolidated Balance Sheets as of December 31, 2016 and September 30, 2016; (iv) the Consolidated Statements of Cash Flows for the three months ended December 31, 2016 and 2015; and (v) Notes to Consolidated Financial Statements, December 31, 2016.

38

---

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

39

---

 

Exhibit Index

 

 

Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Operations for the three months ended December 31, 2016 and 2015; (ii) the Consolidated Statements of Comprehensive Income for the three months ended December 31, 2016 and 2015; (iii) the Consolidated Balance Sheets as of December 31, 2016 and September 30, 2016; (iv) the Consolidated Statements of Cash Flows for the three months ended December 31, 2016 and 2015; and (v) Notes to Consolidated Financial Statements, December 31, 2016.

 

40