CABOT CORPORATION Critical Accounting Policies
Our critical accounting policies have not substantially changed from those described in the 2019 10-K.
Recently Issued Accounting Pronouncements
Refer to the discussion under the headings "Recently Adopted Accounting Standards" and "Recent Accounting Pronouncements" in Note B of our Notes to the Consolidated Financial Statements.
Results of Operations Cabot was organized into four reportable business segments throughJune 28, 2019 : Reinforcement Materials, Performance Chemicals, Purification Solutions and Specialty Fluids. The Specialty Fluids business was divested as ofJune 28, 2019 and since that time Cabot has been organized into the three remaining reportable business segments. Cabot is also organized for operational purposes into three geographic regions: theAmericas ;Europe ,Middle East andAfrica ; andAsia Pacific . The discussion 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. Our discussion under the heading "(Provision) Benefit for Income Taxes and Reconciliation of Effective Tax Rate to Operating Tax Rate" includes a discussion and reconciliation of our "effective tax rate" and our "operating tax rate" for the periods presented, as well as management's projection of our operating tax rate range for the full fiscal year. 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. When the tax impact of a certain item is also a discrete tax item, it is classified as a certain item for our definition of operating tax rate. 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 "Third Quarter and First Nine Months of Fiscal 2020 versus Third Quarter and First Nine Months of Fiscal 2019-By Business Segment" includes a discussion of Total segment EBIT, which is a non-GAAP financial measure defined as Income (loss) 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 reportable segments, provides useful supplemental information for our investors as it is an important indicator of our 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) 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) before income taxes and equity in earnings of affiliated companies is provided under the heading "Third quarter of Fiscal 2020 versus Third quarter of Fiscal 2019-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. 30 -------------------------------------------------------------------------------- In calculating Total segment EBIT, we exclude from our Income (loss) 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 our operating performance without the impact of these costs or benefits. The items of income and expense that we exclude from Total segment EBIT but that are included in our GAAP Income (loss) before income taxes and equity in earnings of affiliated companies, as applicable in a particular reporting period, include, but are not limited to, the following:
• Asset impairment charges, which primarily include charges associated with
an impairment of goodwill or other long-lived assets.
• Inventory reserve adjustment, which generally result from an evaluation
performed as part of an impairment analysis.
• Global restructuring activities, which include costs or benefitsassociated with cost reduction initiatives or plant closures and are
primarily related to (i) employee termination costs, (ii) asset impairment
charges associated with restructuring actions, (iii) costs to close
facilities, including environmental costs and contract termination
penalties and (iv) gains realized on the sale of land or equipment
associated with restructured plants or locations.
• Indirect tax settlement credits, which includes favorable settlements
resulting in the recoveries of indirect taxes.
• Acquisition and integration-related charges, which include transaction
costs, redundant costs incurred during the period of integration, and
costs associated with transitioning certain management and business
processes to our processes.
• Legal and environmental matters and reserves, which consist of costs or
benefits for matters typically related to former businesses or that are
otherwise incurred outside of the ordinary course of business.
• Gains (losses) on sale of investments, which primarily relate to the sale
of investments accounted for using the cost method.
• Gains (losses) on sale of businesses.
• Non-recurring gains (losses) on foreign exchange, which primarily relate
to the impact of controlled currency devaluations on our net monetary
assets denominated in that currency.
• Executive transition costs, which include incremental charges, including
stock compensation charges, associated with the retirement or termination
of employment of senior executives of the Company.
• Employee benefit plan settlements, which consist of either charges or
benefits associated with the termination of a pension plan or the transfer
of a pension plan to a multi-employer plan.
Overview
During the third quarter of fiscal 2020, Income (loss) before income taxes and equity in earnings of affiliated companies decreased compared to the third quarter of fiscal 2019. The decrease primarily reflects the decrease in Total Segment EBIT of$94 million . Total Segment EBIT in the third quarter of fiscal 2019 included$2 million related to our Specialty Fluids business, which we divested in the third quarter of fiscal 2019. Excluding the impact from the divestiture of our Specialty Fluids business, Total Segment EBIT decreased$92 million driven by lower volumes in all segments and lower margins in Reinforcement Materials and Performance Chemicals, partially offset by lower fixed costs due to cost reduction activities.
COVID-19 Impact and Outlook
InDecember 2019 , a novel coronavirus disease ("COVID-19") was first reported and inJanuary 2020 , theWorld Health Organization ("WHO") declared it a Public Health Emergency of International Concern. OnMarch 11, 2020 , theWHO characterized COVID-19 as a global pandemic, due to the continued increase in the number of cases and affected countries. In an effort to contain COVID-19 or slow its spread, governments around the world enacted various measures, including orders to close all businesses not deemed "essential," isolate residents in their places of residence, and practice social distancing when engaging in essential activities. The coronavirus pandemic and the associated containment efforts have had a serious adverse impact on the economy, the severity and duration of which are uncertain. Government stabilization efforts will only partially mitigate the consequences. 31 -------------------------------------------------------------------------------- The coronavirus pandemic has adversely affected and is expected to continue to adversely affect, our business, results of operations and cash flows. While most of our facilities have remained open given the "essential" status of many of our end-markets, such as infrastructure, agriculture and pharmaceutical production, we have operated at low production and utilization rates beginning late in the second fiscal quarter due to declined demand from the halt of customer operations within the tire and automotive sectors. Beginning during our second fiscal quarter, as the virus spread inChina , we experienced volume declines principally in our Reinforcement Materials segment as operations at many of our customers' plants inChina were completely or partially curtailed. As the COVID-19 pandemic began to further spread around the globe, on the recommendation or mandate of public health officials, a number of our key customers, notably most automotive and tire manufacturers in theAmericas andEurope , temporarily closed their manufacturing operations beginning inMarch 2020 . As a result, in the third fiscal quarter, we experienced further volume declines in our Reinforcement Materials segment as well as volume declines and weaker product mix in our Performance Chemicals and Purification Solutions segments. In the third quarter, we also operated at significantly lower manufacturing levels at many of our plants and temporarily suspended operations or idled production lines at certain facilities to comply with government mandates to cease operations. Beginning at the end of March, the domestic automotive and tire end-markets inChina began to restart operations, and in the months of May andJune 2020 , our major tire customers in theAmericas andEurope slowly restarted their operations although, at lower than normal operating rates. Along with these improvements, volumes in our Reinforcement Materials segment improved from May to June, and continued to improve in July. Based on volumes to date in the fourth quarter, we expect improved results in our Reinforcement Materials segment for the quarter, as well as improved production and utilization rates, although not to normal levels. We also expect volumes in our Performance Chemicals segment to improve modestly in the fourth fiscal quarter from those in the third fiscal quarter. Despite certain indications that demand for our products is improving from the low demand levels we experienced in our third fiscal quarter, because the duration and scope of the COVID-19 pandemic continue to be uncertain we are unable to predict with certainty the speed and shape of a recovery to more normal customer demand levels for our products or more normal manufacturing operating levels at our facilities. To date, the coronavirus pandemic has not affected our ability to adequately staff and maintain our operations and we have been able to continue to supply our customers around the globe. However, a prolonged duration of the pandemic could materially impair our ability to do so in the future. This is, particularly the case as the spread of the virus increases in certain geographies and with the possibility that government authorities may impose further mandatory closures, extend work-from-home orders and social distancing protocols, and seek voluntary facility closures and impose other restrictions to mitigate the further spread of the virus. Further, because we reduced inventory to respond to an unusually low customer demand environment, a prolonged duration of any future interruption in our manufacturing operations could impair our ability to meet customer demand in the future. We took a number of actions during the third fiscal quarter to mitigate the impact of the coronavirus on our cash flow and results of operations and financial condition. While manufacturing operations were curtailed, we managed inventory levels, and reduced our manufacturing costs. We also reduced discretionary spending and net working capital with lower raw material costs and reductions in our accounts receivable and inventories. While our liquidity position remains strong, effectiveJune 8, 2020 , we amended our revolving credit agreements to temporarily increase the maximum leverage ratio permitted under those agreements to provide incremental headroom in light of the uncertainty in demand due to the coronavirus pandemic, as described in detail below under the heading "Cash Flow and Liquidity". In addition, we have reduced our planned capital expenditures in fiscal 2020 to approximately$200 million , prioritizing growth projects in our Performance Additives business as well as necessary sustaining and compliance projects. We also suspended our share repurchases and do not anticipate repurchasing shares for the remainder of the fiscal year. We expect COVID-19 to continue to have an adverse impact on our revenue as well as our overall profitability and may lead to an increase in inventory reserves, allowances for doubtful accounts, and valuation allowances on certain of our deferred tax assets. Additionally, if the business impacts of the COVID-19 pandemic carry on for an extended period, it could cause us to recognize impairments for certain long-lived assets including goodwill, intangible assets or property, plant and equipment.
Third quarter of Fiscal 2020 versus Third quarter of Fiscal 2019-Consolidated
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(Inmillions)
Net sales and other operating revenues
$ 1,955 $ 2,510 Gross profit $ 69$ 170 $ 363 $ 514 32
-------------------------------------------------------------------------------- Net sales in the third quarter of fiscal 2020 decreased by$327 million compared to the third quarter of fiscal 2019. The third quarter of fiscal 2019 included$13 million of revenue for our Specialty Fluids business. The remaining$314 million decline in net sales was primarily driven by lower volumes ($221 million ), a less favorable price and product mix (combined$65 million ), and the unfavorable impact from foreign currency translation ($18 million ). The lower volumes were driven by our Reinforcement Materials segment due to weaker demand related to declines in automotive and tire production resulting from the impact of the COVID-19 pandemic. Declines in automotive production also adversely impacted volumes in Specialty Carbons. The less favorable price and product mix was due to lower prices from lower feedstock costs that are passed through to our customers in the Reinforcement Materials segment and unfavorable product mix in the Performance Chemicals segment due to more competitive pricing and weaker product mix in the fumed metal oxides product line inChina andEurope and the less favorable product mix in the specialty carbons product line from lower demand in automotive applications. Net sales in the first nine months of fiscal 2020 declined by$555 million compared to the first nine months of fiscal 2019. The first nine months of fiscal 2019 included$56 million of revenue for our Specialty Fluids business. The remaining$499 million decline in net sales was driven by lower volumes primarily in Reinforcement Materials and Purification Solutions ($285 million ), a less favorable price and product mix (combined$162 million ), and the unfavorable impact from foreign currency translation ($38 million ). The less favorable price and product mix was due to lower prices in Reinforcement Materials due to the pass through of lower feedstock costs and a weaker product mix in the Performance Chemicals segment due to the more competitive pricing and weaker product mix in the fumed metal oxides product line inChina andEurope and the less favorable product mix in our specialty carbons product line from lower demand in automotive applications. The lower volumes were driven by our Reinforcement Materials segment due to weak automotive and tire demand and the impact of the COVID-19 pandemic on demand. The lower volumes in the Purification Solutions segment was due to lower sales in mercury removal and other industrial gas and air applications, due to historically low natural gas prices, and lower demand for automotive applications related to impacts from COVID-19. Gross profit decreased by$101 million in the third quarter of fiscal 2020 compared to the third quarter of fiscal 2019. Excluding the impact of the divestiture of our Specialty Fluids business, the gross profit decline was primarily due to lower volumes from Reinforcement Materials due to declining demand from weaker automotive and tire production related to the impacts of the COVID-19 pandemic on demand. Gross profit decreased by$151 million in the first nine months of fiscal 2020 compared to the first nine months of fiscal 2019. Excluding the impact of the divestiture of our Specialty Fluids business, the gross profit decline was primarily due to lower volumes in Reinforcement Materials and Purification Solutions and lower unit margins in the Performance Chemicals segments.
Selling and Administrative Expenses
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(Inmillions)
Selling and administrative expenses $ 52 $ 65$ 230 $ 208 Selling and administrative expenses decreased by$13 million in the third quarter of fiscal 2020 compared to the same period of fiscal 2019, primarily due to a decrease in the accrual for incentive compensation and other cost reduction activities in the current fiscal year. Selling and administrative expense increased by$22 million in the first nine months of fiscal 2020 compared to the same period of fiscal 2019, primarily due to the$50 million charge related to a legal settlement recorded during the second quarter of fiscal 2020, partially offset by a decrease in the accrual for incentive compensation and other cost reduction activities in the current fiscal year.
Research and Technical Expenses
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(Inmillions)
Research and technical expenses $ 13 $ 16 $ 41 $ 47
33
-------------------------------------------------------------------------------- Research and technical expenses decreased by$3 million and$6 million in the third quarter and the first nine months of fiscal 2020, respectively, compared to the same periods of fiscal 2019, due to cost reduction activities in the current fiscal year.
Interest and Dividend Income, Interest Expense and Other Income (Expense)
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(Inmillions)
Interest and dividend income $ 1 $ 2 $
7 $ 6
Interest expense $ (13 ) $ (14 ) $ (41 ) $ (43 )
Other income (expense) $ (3 ) $ - $ (6 ) $ (6 )
Interest and dividend income decreased $1 million in the third quarter of fiscal
2020 compared to the same period of fiscal 2019, primarily due to lower interest
rates. For the nine months ended June 30, 2020 , Interest and dividend income
increased $1 million primarily due to interest earned from higher interest rates
on cash deposits in South America .
Interest expense decreased $1 million in the third quarter of fiscal 2020
compared to the same period of fiscal 2019 primarily due to lower interest
rates. For the nine months ended June 30, 2020 , interest expense decreased $2
million as compared to the same period of fiscal 2019, primarily due to lower
average debt balances.
Other income (expense) changed by $3 million in the third quarter of fiscal 2020
compared to the third quarter of fiscal 2019, primarily due to the unfavorable
impact of foreign currency translation. Other income (expense) remained
consistent in the first nine months of fiscal 2020 compared to the same period
of fiscal 2019.
(Provision) Benefit for Income Taxes and Reconciliation of Effective Tax Rate to
Operating Tax Rate
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(Dollars inmillions)
(Provision) benefit for income taxes $ 5$ (30 ) $ (9 )$ (43 ) Effective tax rate 51 % 43 % 17 % 23 % Impact of discrete tax items(1): Unusual or infrequent items - % (22 )% 11 % 3 % Items related to uncertain tax positions (27 )% - % 16 % 2 % Other discrete tax items 11 % 4 % 3 % - % Impact of certain items (6 )% (2 )% (18 )% (5 )% Operating tax rate 29 % 23 % 29 % 23 %
(1) For the three and nine months ended
items included a net discrete tax benefit of
respectively. For the three and nine months ended
of discrete tax items included a net discrete tax expense of
a net discrete tax benefit of
discrete tax items for the periods ended June 30, 2020 and 2019 were as
follows:
(a) Unusual or infrequent items during the three and nine months ended June
30, 2020 consisted of the net tax impact of
legislation (net tax benefit of a nil amount and
infrequent items during the three and nine months ended
consisted of the net tax impacts of the Tax Cuts and Jobs Act of 2017 (net
tax expense of
allowances on beginning of year tax balances, excludible foreign exchange
gains and losses in certain jurisdictions, impacts related to stock
compensation deductions, and the tax impacts of a pension settlement;
(b) Items related to uncertain tax positions during the three and nine months
ended
accruals for uncertain tax positions due to the expiration of statutes of
limitations, the accrual of interest on uncertain tax positions, the
accrual of an uncertain tax position (fiscal 2020 only) and the settlement
of tax audits;
(c) Other discrete tax items during the three and nine months ended
2020 and 2019 included net tax impacts as a result of changes in non-
tax laws, return to provision adjustments related to tax return filings,
and other items.
34
-------------------------------------------------------------------------------- For fiscal year 2020, the Operating tax rate is expected to be in the range of 29% to 30%. We are not providing a forward-looking reconciliation of the operating tax rate range with an effective tax rate range because, without unreasonable effort, we are unable to predict with reasonable certainty the matters we would allocate to "certain items," including unusual gains and losses, costs associated with future restructurings, acquisition-related expenses and litigation outcomes. These items are uncertain, depend on various factors, and could have a material impact on the effective tax rate in future periods. We fileU.S. federal and state and non-U.S. income tax returns in jurisdictions with varying statutes of limitations. We are under audit in a number of jurisdictions. It is possible that some of these audits will be resolved in fiscal 2020 and could impact our anticipated effective tax rate. We have filed our tax returns in accordance with the tax laws, in all material respects, in each jurisdiction and maintain tax reserves for uncertain tax positions. Equity in Earnings of Affiliated Companies and Net Income (Loss) Attributable to Noncontrolling Interests Three Months Ended June 30 Nine Months Ended June 30 2020 2019 2020 2019 (In
millions)
Equity in earnings of affiliated companies, net of tax $ 1 $ 1 $ 2 $ 1
Net income (loss) attributable to
noncontrolling interests, net of tax $ 1 $ 8 $ 10 $ 22 Equity in earnings of affiliated companies, net of tax, remained consistent in the third quarter of fiscal 2020 compared to the same period of fiscal 2019. Equity in earnings of affiliated companies, net of tax, increased by$1 million in the first nine months of fiscal 2020 compared to the same period of fiscal 2019. The$2 million of income in the first nine months of fiscal 2020 relates to income from our equity affiliates inIndia andMexico . In fiscal 2019, this income was consistent with fiscal 2020, but also included losses from our equity affiliate inVenezuela , which has since been impaired. Net income (loss) attributable to noncontrolling interests, net of tax, decreased by$7 million in the third quarter of fiscal 2020 and$12 million in the first nine months of fiscal 2020 compared to the same periods of fiscal 2019, primarily due to the lower profitability from our joint ventures inChina andCzech Republic .
Net Income Attributable to
In the third quarter and first nine months of fiscal 2020, we reported net income (loss) attributable toCabot Corporation of$(6) million and$34 million or$(0.12) and$0.59 per diluted common share, respectively. This compares to net income (loss) attributable toCabot Corporation of$32 million and$124 million , or$0.55 and$2.08 per diluted common share, respectively, in the third quarter and first nine months of fiscal 2019. The net loss in the third quarter of fiscal 2020 is primarily due to lower Segment EBIT due to the impact of the COVID-19 pandemic on demand. The lower net income in the first nine months of fiscal 2020 is primarily due to lower Segment EBIT due to the impact of the COVID-19 pandemic on demand and a$50 million charge related to a legal settlement recorded in the second quarter of fiscal 2020. The net income (loss) attributable toCabot Corporation for the third quarter and first nine months of fiscal 2019 includes impairment charges associated with our divested Specialty Fluids business which did not recur in fiscal 2020.
Third quarter of Fiscal 2020 versus Third quarter of Fiscal 2019-By Business Segment
Income (loss) before income taxes and equity in earnings of affiliated companies, certain items, other unallocated items, and Total segment EBIT for the three and nine months endedJune 30, 2020 and 2019 are set forth in the table below. The details of certain items and other unallocated items are shown below and in Note N of our Notes to the Consolidated Financial Statements. Three Months Ended June 30 Nine Months Ended June 30 2020 2019 2020 2019 (In millions) Income (loss) before income taxes and equity in earnings of affiliated companies$ (11 ) $ 69 $ 51$ 188 Less: Certain items (7 ) (14 ) (74 ) (61 ) Less: Other unallocated items (22 ) (29 ) (74 ) (80 ) Total segment EBIT $ 18$ 112 $ 199 $ 329 35
-------------------------------------------------------------------------------- In the third quarter of fiscal 2020, Income (loss) before income taxes and equity in earnings of affiliated companies decreased by$80 million and Total segment EBIT decreased by$94 million . Included in the third quarter of fiscal 2019 is$2 million of EBIT related to our Specialty Fluids business, which we divested in the third quarter of fiscal 2019. Excluding the Specialty Fluids impact, Total Segment EBIT decreased$92 million . The decrease in Total segment EBIT is driven by lower volumes in each of our three segments and lower margins in Reinforcement Materials and Performance Chemicals, partially offset by lower fixed costs. Lower volumes in Reinforcement Materials ($75 million ) were primarily due to weaker automotive and tire demand and lower volumes in Performance Chemicals ($7 million ) were primarily due to weaker automotive demand, in each case related to the impacts from the COVID-19 pandemic. Lower volumes in Purification Solutions ($8 million ) were due to weaker demand in mercury removal applications and the impact of the COVID-19 pandemic on the demand for automotive applications. Lower margins in Reinforcement Materials ($17 million ) were primarily due to the rapid decline of global feedstock costs, which resulted in a temporary pricing and cost mismatch, and regional mix, partially offset by lower raw material costs. Lower margins in Performance Chemicals ($9 million ) were primarily due to lower pricing in our fumed metal oxides product line and a less favorable product mix in our specialty carbons product line. Lower fixed costs ($32 million ) were driven by lower production volumes and other cost reduction actions. In the first nine months of fiscal 2020, Income (loss) before income taxes and equity in earnings of affiliated companies decreased$137 million and total Segment EBIT decreased by$130 million . Included in the first nine months of fiscal 2019 is$24 million of EBIT related to our Specialty Fluids business, which we divested in the third quarter of fiscal 2019. Excluding the Specialty Fluids impact, Total segment EBIT decreased$106 million . The decrease in Total segment EBIT was driven by lower volumes in Reinforcement Materials and Purification Solutions and lower margins in Performance Chemicals, partially offset by lower fixed costs. Lower volumes in Reinforcement Materials ($101 million ) were primarily due to weaker automotive and tire demand and the impacts of the COVID-19 pandemic on demand while lower volumes in Purification Solutions ($20 million ) were due to lower volumes in mercury removal applications and the impact of the COVID-19 pandemic on demand for automotive applications. Lower fixed costs ($30 million ) were driven by lower production volumes and other cost reduction actions. The decrease in Income (loss) before income taxes and equity earnings of affiliated companies also reflects a$50 million charge related to a legal settlement entered into during the nine months of fiscal 2020.
Certain Items
Details of the certain items for the third quarter and first nine months of fiscal 2020 and fiscal 2019 are as follows:
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(Inmillions)
Legal and environmental matters and reserves$ (1 ) $ -$ (51 ) $ (1 ) Global restructuring activities (Note K) (3 ) (4 ) (16 ) (15 ) Employee benefit plan settlements (2 ) - (5 ) 3 Acquisition and integration-related charges (1 ) (1 ) (3 ) (5 ) Specialty Fluids loss on sale and asset impairment charge (Note C) - (8 ) (1 ) (28 ) Indirect tax settlement credits - - 3 - Equity affiliate investment impairment charge - - - (11 ) Other - (1 ) (1 ) (4 ) Total certain items, pre-tax (7 ) (14 ) (74 ) (61 ) Tax-related certain items: Tax impact of certain items 2 1 12 4 Discrete tax items 2 (14 ) 15 10 Total tax-related certain items 4 (13 ) 27 14 Total certain items, after tax$ (3 ) $ (27 )$ (47 ) $ (47 ) 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 toCabot Corporation , and (2) subtracting the tax expense or benefit on "adjusted earnings". Adjusted earnings is defined as the pre-tax income attributable toCabot Corporation excluding certain items. The tax expense or benefit on adjusted earnings is calculated by applying the operating tax rate, as defined under the heading "Definition of Terms and Non-GAAP Financial Measures", to adjusted earnings. 36 -------------------------------------------------------------------------------- Other Unallocated Items Three Months Ended June 30 Nine Months Ended June 30 2020 2019 2020 2019 (In millions) Interest expense$ (13 ) $ (14 ) $ (41 ) $ (43 ) Unallocated corporate costs (10 ) (14 ) (32 ) (39 ) General unallocated income (expense) 2 - 1 3
Less: Equity in earnings of affiliated
companies, net of tax 1 1 2 1 Total other unallocated items$ (22 ) $ (29 ) $ (74 ) $ (80 ) 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 ongoing corporate projects. The balances of General unallocated income (expense) consist of gains (losses) arising from foreign currency transactions, net of other foreign currency risk management activities, the profit or loss related to the corporate adjustment for unearned revenue, and the impact of including the full operating results of a contractual joint venture in Purification Solutions segment EBIT.
Reinforcement Materials
Sales and EBIT for Reinforcement Materials for the third quarter and first nine months of fiscal 2020 and 2019 were as follows:
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(Inmillions)
Reinforcement Materials Sales
931 $ 1,363
Reinforcement Materials EBIT $ (5 ) $ 72 $ 103 $ 195
Sales in Reinforcement Materials decreased by $264 million in the third quarter
of fiscal 2020 compared to the same period of fiscal 2019, primarily due to
lower volumes ($195 million ), a less favorable price and product mix (combined
$56 million ), and the unfavorable impact from foreign currency translation ($13
million ). The lower volumes were primarily due to weaker automotive and tire
demand resulting from the impact of the COVID-19 pandemic. The less favorable
pricing was primarily due to the pass-through of lower feedstock prices.
In the first nine months of fiscal 2020, sales in Reinforcement Materials
decreased by $432 million when compared to the first nine months of fiscal 2019.
The decrease was primarily driven by lower volumes ($273 million ), a less
favorable price and product mix (combined $133 million ), and the unfavorable
impact from foreign currency translation ($26 million ). The lower volumes were
primarily due to weaker automotive and tire demand and the impacts of the
COVID-19 pandemic on demand. The less favorable price and product mix was due to
the pass-through of lower feedstock prices.
EBIT in Reinforcement Materials decreased $77 million in the third quarter of
fiscal 2020 compared to the same period of fiscal 2019. During the third quarter
of fiscal 2020, the segment had 42% lower volumes ($75 million ), lower unit
margins ($18 million ), and an unfavorable impact from foreign currency
translation ($4 million ), partially offset by lower fixed costs ($20 million ).
The lower volumes were primarily due to weaker tire and automotive demand
resulting from the impacts of COVID-19. Unit margins were negatively impacted by
slower turns of inventory and lower energy center revenue as a result of reduced
sales volumes and lower feedstock prices offset by favorable pricing from 2020
tire customer agreements. Lower fixed costs were driven by lower production
volumes and other cost reduction actions.
EBIT in Reinforcement Materials decreased $92 million in the first nine months
of fiscal 2020 compared to the same period of fiscal 2019. The decrease was
driven by lower volumes ($101 million ), lower unit margins ($6 million ), and an
unfavorable impact from foreign currency translation ($5 million ), which were
partially offset by lower fixed costs ($20 million ). Lower volumes were
primarily due to weaker automotive and tire demand and the impacts from
COVID-19. Unit margins were negatively impacted by slower turns of inventory and
lower energy center revenue as a result of reduced sales volumes and lower
feedstock prices offset by favorable pricing from 2020 tire customer agreements.
Lower fixed costs were driven by lower production volumes and other cost
reduction actions.
37
--------------------------------------------------------------------------------Performance Chemicals
Sales and EBIT for Performance Chemicals for the third quarter and first nine months of fiscal 2020 and 2019 were as follows:
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(In millions)
Performance Additives Sales $ 151 $ 172 $ 489 $ 518
Formulated Solutions Sales 69 79 218 218
Performance Chemicals Sales
707 $ 736
Performance Chemicals EBIT $ 21 $ 37 $ 93 $ 111
Sales in Performance Chemicals decreased by $31 million in the third quarter of
fiscal 2020 compared to the same period of fiscal 2019, primarily due to a less
favorable price and product mix (combined $15 million ), lower volumes ($12
million ), and the unfavorable impact from foreign currency translation ($4
million ). The less favorable price and product mix was primarily due to a more
competitive pricing environment and weaker product mix in the fumed metal oxides
product line in China and Europe and weaker product mix in our specialty carbons
product line from lower demand in automotive applications. The lower volumes
were driven by the specialty carbons and specialty compounds product lines due
to lower demand in automotive applications driven by the impact of COVID-19 on
demand.
In the first nine months of fiscal 2020, sales in Performance Chemicals
decreased $29 million when compared to the same period of fiscal 2019. The
decrease was primarily due to a less favorable price and product mix (combined
$46 million ) and the unfavorable impact from foreign currency translation ($10
million ), partially offset by higher volumes ($27 million ). The less favorable
price and product mix was primarily due to a more competitive pricing
environment and weaker product mix in the fumed metal oxides product line in
China and Europe and weaker product mix in our specialty carbons product line
from lower demand in automotive applications. The higher volumes were primarily
due to higher demand in the specialty carbons and specialty compounds product
lines in the first two quarters of the fiscal year.
EBIT in Performance Chemicals decreased by $16 million in the third quarter of
fiscal 2020 compared to the third quarter of fiscal 2019 primarily due to lower
unit margins ($9 million ) driven by a more competitive pricing environment and
weaker product mix in the fumed metal oxides product line in China and Europe
and lower volumes ($7 million ) in the specialty carbons and specialty compounds
product lines due to lower demand in automotive applications driven by the
impact of COVID-19 on demand.
EBIT in Performance Chemicals decreased by $18 million in the first nine months
of fiscal 2020 when compared to the same period of fiscal 2019 primarily due to
lower unit margins ($15 million ), and the unfavorable impact of inventory
comparisons ($10 million ), partially offset by higher volumes ($10 million ).
Lower unit margins were due to a more competitive pricing environment and weaker
product mix in the fumed metal oxides product line in China and Europe and
weaker product mix in our specialty carbons product line due to lower demand in
automotive applications. The higher volumes were driven by our specialty carbons
and specialty compounds product lines due to higher demand in the specialty
carbons and specialty compounds product lines in the first two quarters of the
fiscal year and higher volumes aligned with new capacity in our fumed metal
oxides product line.
Purification Solutions
Sales and EBIT for Purification Solutions for the third quarter and first nine months of fiscal 2020 and 2019 were as follows:
Three Months Ended June 30 Nine Months Ended June 30
2020 2019 2020 2019
(In millions)
Purification Solutions Sales $ 63 $ 73 $ 186 $ 210
Purification Solutions EBIT $ 2 $ 1 $ 3 $ (1 )
Sales in Purification Solutions decreased by $10 million in the third quarter of
fiscal 2020 compared to the same period of fiscal 2019 due to lower volumes ($15
million ), partially offset by improved pricing and a more favorable product mix
(combined $5 million ). The lower volumes were primarily due to lower sales in
mercury removal, other industrial gas and air applications and automotive
applications impacted by lower demand due to COVID-19.
Sale in Purification Solutions decreased $24 million in the first nine months of
fiscal 2020 when compared to the same period of fiscal 2019 due to lower volumes
($39 million ) and the unfavorable impact from foreign currency translation ($2
million ), partially offset by improved pricing and a more favorable product mix
(combined $17 million ). The lower volumes were primarily due to lower sales in
mercury removal, other industrial gas and air applications and automotive
applications impacted by lower demand due to COVID-19.
38
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EBIT in Purification Solutions increased by $1 million in the first quarter of
fiscal 2020 compared to the third quarter of fiscal 2019 due to higher unit
margins ($3 million ), and lower fixed costs ($6 million ) as a result of prior
year restructuring activities and an insurance recovery of approximately $1
million , partially offset by lower volumes ($8 million ). The higher unit margins
were primarily due to an improved product mix and higher prices. The lower
volumes were primarily due to lower sales in mercury removal, other industrial
gas and air applications and automotive applications impacted by lower demand
due to COVID-19.
EBIT in Purification Solutions improved by $4 million in the first nine months
of fiscal 2020 when compared to the same period of fiscal 2019 due to higher
unit margins ($13 million ) and, lower fixed costs ($11 million ) as a result of
prior year restructuring activities, partially offset by lower volumes ($20
million ). The higher unit margins were primarily due to an improved product mix
and higher prices while the lower volumes were primarily due to lower sales in
mercury removal, other industrial gas and air applications and automotive
applications impacted by lower demand due to COVID-19.
Specialty Fluids
We divested our Specialty Fluids business onJune 28, 2019 . Refer to our fiscal 2019 10-K filing for further details. Sales and EBIT for Specialty Fluids for the third quarter and first nine months of fiscal 2020 and 2019 were as follows: Three Months Ended June 30 Nine Months Ended June 30 2020 2019 2020 2019 (In millions) Specialty Fluids Sales $ - $ 13 $ - $ 56 Specialty Fluid EBIT $ - $ 2 $ - $ 24 Cash Flows and Liquidity Overview Our liquidity position, as measured by cash and cash equivalents plus borrowing availability, decreased by$97 million during the first nine months of fiscal 2020, which was largely attributable to capital expenditures, the acquisition ofShenzhen Sanshun Nano New Materials Co., Ltd ("SUSN"), share repurchases and cash dividends, partially offset by lower net working capital. As ofJune 30, 2020 , we had cash and cash equivalents of$162 million and borrowing availability under our revolving credit agreements of$1.2 billion .
We have access to borrowings under the following three credit agreements:
• $1 billion unsecured revolving credit agreement (the "JPM Credit
Agreement") with JPMorgan Chase Bank, N.A ., as Administrative Agent,
Citibank, N.A ., as Syndication Agent, and the other lenders party
thereto, which matures in October 2022 . The JPM Credit Agreement
provides liquidity for working capital and general corporate purposes
and supports our commercial paper program.
•
Agreement") with
lenders party thereto, which matures in
Credit Agreement provides liquidity for working capital and general
corporate purposes for certain of our Canadian subsidiaries.
• €300 million unsecured revolving credit agreement (the "Euro Credit
Agreement", and together with the JPM Credit Agreement and the Canadian
Credit Agreement, the "Credit Agreements"), with Wells Fargo Bank,
National Association , as Administrative Agent, and the other lenders
party thereto, which matures in May 2024 or earlier upon maturity of the
JPM Credit Agreement. Borrowings under the Euro Credit Agreement may be
used for the repatriation of earnings of our foreign subsidiaries to the
owing to us or any of our subsidiaries and for working capital and
general corporate purposes.
At our election, loans under the Credit Agreements bear interest at LIBOR plus
an applicable margin of between 0.68% and 1.20%, depending on our credit
ratings, or at the prime rate plus an applicable margin of between 0.00% and
0.20%, depending on our credit ratings, and at similar applicable rates for
foreign currency borrowings.
39
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As of June 30, 2020 , we were in compliance with our debt covenants under the
Credit Agreements, which, with limited exceptions, generally require us to
comply on a quarterly basis with a leverage test requiring consolidated total
debt not to exceed consolidated EBITDA (earnings before interest, taxes,
depreciation and amortization) for the four quarters then ending by more than
3.50 to 1.00. Because of the uncertainty of the overall financial impact of the
COVID-19 pandemic and to increase our financial flexibility, we amended the
Credit Agreements as of June 8, 2020 to, among other things: (a) set the
consolidated total debt to consolidated EBITDA ratio at 4.50 to 1.00 for the
fiscal quarters ending September 30, 2020 through June 30, 2021 , and (b) reduce
the lien basket for other permitted liens securing Indebtedness (as defined in
the Credit Agreements) in an aggregate amount at any time outstanding to 5% of
Consolidated Tangible Net Worth (as defined in the Credit Agreements), at any
time through and including June 30, 2021 . As part of these amendments, we agreed
to pay a 10 basis point fee on the consenting lenders' commitments under the JPM
Credit Agreement and the Euro Credit Agreement.
A significant portion of our business occurs outside the U.S. and our cash
generation does not always align geographically with our cash needs. The vast
majority of our cash and cash equivalent holdings tend to be held outside the
U.S. Cash held by foreign subsidiaries is generally used to finance the
subsidiaries' operational activities and future investments. We typically issue
commercial paper throughout the year to manage our short-term U.S. cash needs.
During the second quarter of fiscal 2020, one of our short-term credit ratings
was downgraded, which temporarily decreased our access to, and increased our
cost to borrow through, the commercial paper market, and we instead borrowed
under our revolving credit agreements. During the third quarter of fiscal 2020,
the commercial paper market stabilized and we are currently using a combination
of commercial paper and revolving credit facility borrowings to meet our U.S.
cash needs. We generally reduce our commercial paper balance and, if applicable,
borrowings under the Credit Agreements, at quarter-end using cash derived from
customer collections, settlement of intercompany balances and short-term
intercompany loans. In the event that additional funds are needed in the U.S. ,
we expect to be able to repatriate funds or to access additional debt under our
revolving credit facilities. As of June 30, 2020 , our borrowings on the JPM
Credit Agreement totaled $75 million , and we had $13 million of commercial paper
outstanding. As of June 30, 2020 , our borrowings under the Euro Credit Agreement
totaled $144 million , and there were no borrowings outstanding under the
Canadian Credit Agreement.
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.
In light of the uncertain economic environment created by the COVID-19 pandemic,
among other actions we have taken to preserve our liquidity position, we have
deferred capital spending where possible and delayed spending on some of our
growth projects. With these decisions, we currently expect our capital
expenditures for fiscal 2020 to be approximately $200 million in the aggregate
to be used primarily for sustaining and compliance capital projects at our
operating facilities as well as for growth projects in Performance Chemicals. In
addition, during the second quarter of fiscal 2020, we suspended our share
repurchase activity, and we do not anticipate repurchasing our shares for the
remainder of fiscal 2020.
Although we cannot predict the duration or scope of the COVID-19 pandemic and
its impact on our customers and suppliers, we are actively managing the business
to maintain cash flow and we anticipate sufficient liquidity from (i) cash on
hand; (ii) cash flows from operating activities; and (iii) cash available from
our revolving credit facilities to meet our operational and capital investment
needs and financial obligations for the foreseeable future.
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$278 million in the first nine months of fiscal 2020 compared to$166 million of cash provided by operating activities during the same period of fiscal 2019. Cash provided by operating activities in the first nine months of fiscal 2020 was driven primarily by our net income of$44 million , a decrease in Accounts and notes receivable of$172 million , the non-cash impact of depreciation and amortization of$117 million and a decrease in our Inventories of$74 million , partially offset by a decrease in Accounts payable and accrued liabilities of$68 million , an increase in Prepaid expenses and other assets of$25 million and the non-cash impact of a deferred tax benefit of$20 million . 40 -------------------------------------------------------------------------------- Cash provided by operating activities in the first nine months of fiscal 2019 was driven primarily by our net income of$146 million , the non-cash impacts of depreciation and amortization of$110 million , the loss on the sale of the Specialty Fluids business of$28 million and the impairment of our investment in our Venezuelan equity affiliate of$11 million . Partially offsetting these factors were a decrease in Accounts payable and accrued liabilities of$65 million , a decrease in Income taxes payable of$24 million , a decrease in Other liabilities of$27 million and the non-cash impact of a deferred tax benefit of$20 million .
In addition to the factors noted above, the following other elements of operations have a bearing on operating cash flows:
Restructurings - As ofJune 30, 2020 , we had$9 million of total restructuring costs in accrued expenses in the Consolidated Balance Sheets related to certain of our global restructuring activities. In the first nine months of fiscal 2020, we paid$13 million related to these restructuring activities, and we expect to make additional cash payments of approximately$4 million in fiscal 2020 and$11 million thereafter. Legal Matters - As ofJune 30, 2020 , we had a$21 million reserve for existing and future respirator claims that we expect to pay over multiple years. During the second quarter of fiscal 2020, we settled a large group of respirator claims for$65.2 million . We paid$32.6 million related to these settled claims during the third quarter of fiscal 2020, and the remaining$32.6 million payable will be paid in the first quarter of fiscal 2021. We also have other lawsuits, claims and contingent liabilities arising in the ordinary course of business.
Cash Flows from Investing Activities
Investing activities consumed$252 million of cash in the first nine months of fiscal 2020 compared to$33 million of cash consumed during the same period of fiscal 2019. In the first nine months of fiscal 2020, investing activities primarily consisted of$162 million of capital expenditures for sustaining and compliance capital projects at our operating facilities as well as capacity expansion capital expenditures in Reinforcement Materials and Performance Chemicals,$84 million , net of cash acquired for the SUSN acquisition inApril 2020 and$8 million for the plant that we acquired fromNSCC inSeptember 2018 . In the nine months endedJune 30, 2019 , investing activities consumed$33 million of cash, which was primarily driven by$155 million of capital expenditures for sustaining and compliance capital projects at our operating facilities as well as capacity expansion capital expenditures in Reinforcement Materials and Performance Chemicals, partially offset by proceeds from the sale of the Specialty Fluids business of$130 million , net of cash held in escrow of$5 million .
Cash Flows from Financing Activities
Financing activities consumed$37 million of cash in the first nine months of fiscal 2020 compared to$146 million of cash consumed during the same period of fiscal 2019. In the first nine months of fiscal 2020, financing activities primarily consisted of the repayment of$15 million of other long-term debt, share repurchases of$44 million , dividend payments to stockholders of$60 million , dividend payments to noncontrolling interests of$26 million and the repayment of$20 million of commercial paper, partially offset by the net proceeds from borrowings under our revolvers of$125 million . In the first nine months of fiscal 2019, financing activities primarily consisted of share repurchases of$144 million , dividend payments to stockholders of$60 million , the repayment of$75 million of long-term debt, the repayment of$176 million of commercial paper, and the redemption of$25 million of preferred stock held by our former NHUMO joint venture partner, partially offset by the proceeds from the issuance of our registered notes and borrowing under our European revolver in the aggregate of$344 million .
Off-Balance Sheet Arrangements
As of
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--------------------------------------------------------------------------------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 and the factors we expect to impact our results of operations, including how we expect the COVID-19 pandemic to impact demand for our products, our results of operations and our cash flows and our related mitigation efforts; growth in the battery market; when we expect the NSCC Carbon plant upgrades to be completed; the amount and the timing of the contingent consideration we expect to pay related to the SUSN acquisition; the amount and timing of the charge to earnings we will record and the cash outlays we will make in connection with our reorganization and the closing of certain manufacturing facilities, restructuring initiatives and under our transformation plan for our Purification Solutions business; our estimated future amortization expenses for our intangible assets; when we expect to make payments under the settlement agreement we entered into settling certain respirator liability claims; the timing of expected payments from our reserve for existing and future respirator claims; the amount of any future gain or loss we may record upon the settlement, and the timing of the completion, of certain defined benefit obligations and pension plan terminations; 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, share repurchases, and future cash outlays associated with long-term contractual obligations; our expected tax rate for fiscal 2020; and the possible outcome of legal 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 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, our actual results could differ materially from those expressed in the forward-looking statements. Importantly, as we cannot predict the duration or scope of the COVID-19 pandemic, the negative impact to our results cannot be estimated. Factors that will influence the impact on our business and operations include the duration and extent of the pandemic, the extent of imposed or recommended containment and mitigation measures, and the general economic consequences of the pandemic. 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 our forward-looking statements: changes in raw material costs; lower than expected demand for our products; changes in environmental requirements in theU.S. ; 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; unanticipated disruptions or delays in plant operations or development projects; 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; negative or uncertain worldwide or regional economic conditions and market opportunities, including from trade relations or global health matters; 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. These other factors and risks are discussed more fully in our 2019 10-K, our Quarterly Report for the quarterly period endedMarch 31, 2020 and in our subsequentSEC filings.
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