Critical Accounting Policies
The preparation of our consolidated 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 policies and estimates. 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. The estimates that we believe are critical to the preparation of the consolidated financial statements are presented below.
Revenue Recognition and Accounts Receivable
We recognize 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. We generally are able to ensure that products meet customer specifications prior to shipment. If we are 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. The following table shows the relative size of the revenue recognized in each of our reportable segments. Three months ended December 31 2013 2012 Reinforcement Materials 59 % 59 % Performance Materials 25 % 24 % Purification Solutions 9 % 12 % Advanced Technologies 7 % 5 % We derive the substantial majority of revenues from the sale of products in Reinforcement Materials and Performance Materials. Revenue from these products is typically recognized when the product is shipped and title and risk of loss have passed to the customer. We offer certain 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. We periodically review the assumptions underlying estimates of discounts and volume rebates and adjust revenues accordingly. 32
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Revenue in Purification Solutions is typically recognized when the product is shipped and title and risk of loss have passed to the customer. For major activated carbon injection systems projects, revenue is recognized using the percentage-of-completion method. Revenue in Advanced Technologies, excluding the Specialty Fluids Business, is typically recognized when the product is shipped and title and risk of loss have passed to the customer. Depending on the nature of the contract with the customer, a portion of the segment's revenue may be recognized using proportional performance. We have technology and licensing agreements with one customer that are accounted for as multiple element arrangements. Revenue is recognized ratably over the term of the agreements, limited by the cumulative amounts that become due, some of which are through 2022. A significant portion of the revenue in the Specialty Fluids Business, included in Advanced Technologies, arises 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. We also generate revenues from cesium formate sold outside of a rental process and revenue is recognized upon delivery of the fluid. We maintain 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 an historical and prospective basis. Customer account balances are charged against the allowance when it is probable the receivable will not be recovered. There is no off-balance sheet credit exposure related to customer receivable balances.
Intangible Assets and Goodwill
We record 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 separate businesses included within Performance Materials and Advanced Technologies are considered separate reporting units. Goodwill balances relative to these segments are recorded in the Fumed Metal Oxides reporting unit within Performance Materials and the Security Materials reporting unit within Advanced Technologies. For the purpose of the goodwill impairment test, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value amount and as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. Alternatively, we may elect to proceed directly to the two-step goodwill impairment test. 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. If based on the quantitative evaluation the fair value of the reporting unit is less than its carrying amount, we perform 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 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 our reporting units decline because of reduced operating performance, market declines, or other indicators of impairment, or as a result of changes in the discount rate, charges for impairment may be necessary. We use 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 (i) assumptions used in the valuation model; and (ii) determination of the intangible assets' useful lives. We estimate 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. We review definite-lived intangible assets for impairment when indication of potential impairment exists, such as a significant reduction in cash flows 33
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associated with the assets. Actual cash flows arising from a particular intangible asset could vary from projected cash flows which could imply different carrying values from those established at the dates of acquisition and which could result in impairment of such asset. We evaluate indefinite-lived intangible assets for impairment annually or when events occur or circumstances change that may reduce the fair value of the asset below its carrying amount. The annual review is performed as of
May 31. We may first perform a qualitative assessment to determine whether it is necessary to perform the quantitative impairment test or bypass the qualitative assessment and proceed directly to performing the quantitative impairment test. The quantitative impairment test is based on discounted estimated future cash flows. The assumptions used to estimate fair value include management's best estimates of future growth rates and discount rates over an estimate of the remaining operating period at the unit of accounting level. Our intangible assets are primarily comprised of trademarks, customer relationships, patented and unpatented technology and other intellectual property. Finite lived intangible assets are amortized over their estimated useful lives. Long-lived Assets Our long-lived assets primarily include property, plant and equipment, 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. An asset impairment is recognized when the carrying value of the asset is not recoverable based on the probability-weighted undiscounted estimated future cash flows to be generated by the asset. Our estimates reflect management's assumptions about selling prices, production and sales volumes, costs and market conditions over an estimate of the remaining operating period. If an impairment is indicated, the asset is written down to 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. The key inputs to the discounted cash flow would be the same as the undiscounted cash flow noted above, with the addition of the discount rate used. In circumstances when an asset does not have separate identifiable cash flows, an impairment charge is recorded when we no longer intend to use the asset.
To test for impairment of assets we generally use 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.
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.
Litigation and Contingencies
We are involved in litigation in the ordinary course of business, including personal injury and environmental litigation. After consultation with counsel, as appropriate, we accrue a liability for litigation when it is probable that a liability has been incurred and the amount can be reasonably estimated. The estimated reserves are recorded based on our best estimate of the liability associated with such matters or the low end of the estimated range of liability if we are unable to identify a better estimate within that range. Our best estimate is determined through the evaluation of various information, including claims, settlement offers, demands by government agencies, estimates performed by independent third parties, identification of other responsible parties and an assessment of their ability to contribute, and our prior experience. Litigation is highly uncertain and there is always the possibility of an unusual result in any particular case that may reduce our earnings and cash flows. The most significant reserves that we have established are for environmental remediation and respirator litigation claims. The amount accrued for environmental matters reflects our assumptions about remediation requirements at the contaminated sites, the nature of the remedies, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites, and the number and financial viability of other potentially responsible parties. A portion of the reserve for environmental matters is recognized on a discounted basis, which requires the use of an estimated discount rate and estimates of future cash flows associated with the liability. These liabilities can be affected by the availability of new information, changes in the assumptions on which the accruals are based, unanticipated government enforcement action or changes in applicable government laws and regulations, which could result in higher or lower costs. 34
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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 and the amount accrued is recognized on a discounted basis. 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 silica and non-malignant asbestos 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 the entity from which we acquired the safety respiratory products business or the indemnity provided by its former owner, (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 these existing and future claims. Accordingly, the actual amount of these liabilities for existing and future claims could be different than the reserved amount. Further, if the timing of our actual payments made for respirator claims differs significantly from our estimated payment schedule, and we determine that we can no longer reasonably predict the timing of such payments, we could then be required to record the reserve amount on an undiscounted basis on our Consolidated Balance Sheets, causing an immediate impact to earnings.
Our business operations are global in nature, and we are subject to taxes in numerous jurisdictions. Tax laws and tax rates vary substantially in these jurisdictions and are subject to change based on the political and economic climate in those countries. We file our tax returns in accordance with our interpretations of each jurisdiction's tax laws.
Significant judgment is required in determining our worldwide provision for income taxes and recording the related tax assets and liabilities. In the ordinary course of our business, there are operational decisions, transactions, facts and circumstances, and calculations which make the ultimate tax determination uncertain. Furthermore, our tax positions are periodically subject to challenge by taxing authorities throughout the world. We have recorded reserves on uncertain tax position for taxes and associated interest and penalties that may become payable in future years as a result of audits by tax authorities. Any significant impact as a result of changes in underlying facts, law, tax rates, tax audit, or review could lead to adjustments to our income tax expense, our effective tax rate, and/or our cash flow. We record our 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. The estimated annual effective tax rate may be significantly impacted by nondeductible expenses and our 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. We record benefits for uncertain tax positions based on an assessment of whether the position is more likely than not to be sustained by the taxing authorities. If this threshold is not met, no tax benefit of the uncertain tax position is recognized. If the threshold is met, the tax benefit that is recognized is the largest amount that is greater than 50% likely of being realized upon ultimate settlement. This analysis presumes the taxing authorities' full knowledge of the positions taken and all relevant facts, but does not consider the time value of money. We also accrue for interest and penalties on these uncertain tax positions and include such charges in the income tax provision in the Consolidated Statements of Operations. Additionally, we have established valuation allowances against a variety of deferred tax assets, including net operating loss carry forwards, foreign tax credits, and other income tax credits. Valuation allowances take into consideration our ability to use these deferred tax assets and reduce the value of such items to the amount that is deemed more likely than not to be recoverable. Our ability to utilize these deferred tax assets is dependent on achieving our forecast of future taxable operating income over an extended period of time. We review our forecast in relation to actual results and expected trends on a quarterly basis. Failure to achieve our operating income targets may change our assessment regarding the recoverability of our net deferred tax assets and such change could result in a valuation allowance being recorded against some or all of our net deferred tax assets. An increase in a valuation allowance would result in additional income tax expense, while a release of valuation allowances in periods when these tax attributes become realizable would reduce our income tax expense. 35
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Our consolidated financial statements detail specific charges relating to restructuring activities as well as the actual spending that has occurred against the resulting accruals. Our restructuring charges are estimates based on our preliminary assessments of (i) severance and other employee benefits to be granted to employees, which are based on known benefit formulas and identified job grades, (ii) environmental remediation, and (iii) asset impairment and accelerated depreciation. Because these accruals are estimates, they are subject to change as a result of subsequent information that may come to our attention while executing the restructuring plans. These changes in estimates would then be reflected in our consolidated financial statements.
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 we used the first-in, first-out ("FIFO") method instead of the LIFO method for such inventories, the value of those inventories would have been
$55 millionhigher as of both December 31, 2013and September 30, 2013. The cost of Specialty Fluids inventories is determined using the average cost method. The cost of other U.S. and non-U.S. inventories is determined using the FIFO method. In periods of rapidly rising or declining raw material costs, the inventory method we employ can have a significant impact on our profitability. Under our current LIFO method, when raw material costs are rising, our most recent higher priced purchases are the first to be charged to cost of sales. If, however, we were using a FIFO method, our purchases from earlier periods, which were at lower prices, would instead be the first charged to cost of sales. The opposite result could occur during a period of rapid decline in raw material costs. We review inventory for both potential obsolescence and potential loss of value periodically. In this review, we make assumptions about the future demand for and market value of our inventory and based on these assumptions estimate the amount of any obsolete, unmarketable or slow moving inventory. We write down the value of our inventories by an amount equal to the difference between the cost of the inventory and its estimated market value. Historically, such write-downs have not been significant. If actual market conditions are less favorable than those projected by management at the time of the assessment, however, additional inventory write-downs may be required, which could reduce our gross profit and our earnings. Results of Operations
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 various types and grades, or mix, of products sold in a particular business or segment during the period, and the positive or negative impact of that mix on the revenue or profitability of the business 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 the cost of goods sold ("COGS") ("liquidation impact"). The discussion under the heading "Provision 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 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 the 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 understand what our tax rate on current operations would be without the impact of these items which we do not believe are reflective of the underlying business results. 36
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Total segment EBIT is a non-GAAP performance measure, and should not be considered an alternative for Income from continuing operations before taxes, the most directly comparable GAAP financial measure. In calculating Total segment EBIT, we make certain adjustments such as excluding certain items, meaning items that management does not consider representative of our fundamental segment results, as well as items that are not allocated to our business segments, such as interest expense and other corporate costs. Our Chief Operating Decision Maker uses segment EBIT to evaluate the operating results of each segment and to allocate resources to the segments. We believe Total segment EBIT provides useful supplemental information for our investors as it is an important indicator of the Company's operational strength and performance. 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. A reconciliation of Total segment EBIT to Income from continuing operations before income taxes and equity in earnings of affiliated companies is provided in Note P of our consolidated financial statements.
Cabot is organized into four reportable business segments: Reinforcement Materials, Performance Materials, Advanced Technologies and Purification Solutions. Cabot is also organized for operational purposes into three geographic regions: the
Our analysis of financial condition and operating results should be read with our consolidated financial statements and accompanying notes.
During the first quarter of fiscal 2014, Income from continuing operations before income taxes and equity in earnings of affiliated companies increased compared to the first quarter of fiscal 2013 largely due to higher volumes and a gain recognized on our pre-existing equity investment in our carbon black joint venture in
Mexicowith Grupo Kuo S.A.B. de C.V. ("KUO"), NHUMO, S.A. de C.V.("NHUMO"), from our acquisition during the first quarter of fiscal 2014 of KUO's common stock interest in NHUMO. See Note C to our consolidated financial statements for details of the NHUMO transaction.
First Quarter Fiscal 2014 versus First Quarter Fiscal 2013-Consolidated
Net Sales and other operating revenues and Gross Profit
Three months ended December 31 2013 2012 (Dollars in millions) Net sales and other operating revenues
$ 899 $ 820Gross profit $ 179 $ 147The $79 millionincrease in net sales from the first quarter of fiscal 2013 to the first quarter of fiscal 2014 was due primarily to higher volumes ( $107 million) partially offset by lower prices and unfavorable product mix (combined $32 million).
Gross profit increased by
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Selling and Administrative Expenses
Three months ended December 31 2013 2012 (Dollars in millions) Selling and administrative expenses
$ 77 $ 73Selling and administrative expenses increased by $4 millionin the first quarter of fiscal 2014 when compared to the same period of fiscal 2013. The increase was principally driven by higher expenses related to the addition of NHUMO and a higher level of accrued expense related to incentive compensation.
Research and Technical Expenses
Three months ended December 31 2013 2012 (Dollars in millions) Research and technical expenses
$ 16 $ 19Research and technical expenses decreased $3 millionin the first quarter of fiscal 2014 when compared to the same period of fiscal 2013. The decrease was driven by lower costs from restructuring-related activities undertaken in the prior year. 38
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Interest and Dividend Income, Interest Expense and Other Income
Three months ended December 31 2013 2012 (Dollars in millions) Interest and dividend income $ 1
$ 1Interest expense $ 14 $ 16Other income $ 35 $ 1
Interest and dividend income was consistent in the first quarter of fiscal 2014 as compared to the same period in fiscal 2013.
Interest expense decreased by
$2 millionin the first quarter of fiscal 2014 when compared to the same period in fiscal 2013 due to the maturity of long-term debt in the fourth quarter of fiscal 2013 that was refinanced with commercial paper carrying a lower interest rate.
Other income in the first quarter of fiscal 2014 increased by
Provision for Income Taxes and Reconciliation of Effective Tax Rate to Operating Tax Rate Three months ended December 31 2013 2012 (Dollars in millions) Provision for income taxes
$ 24 $ 19Effective tax rate 22 % 47 % Impact of discrete tax items: Unusual or infrequent items (1 )%
Items related to uncertain tax positions 1 %
Other discrete tax items (1 )%
Impact of certain items 7 % - % Operating tax rate 28 % 27 % During the first quarter of fiscal 2014, we recorded a tax provision of
$24 million, resulting in an effective tax rate of 22%. This amount included a net discrete tax charge of $1 million. During the first quarter of fiscal 2013, we recorded a tax provision of $19 million, resulting in an effective tax rate of 47%. This amount included a net discrete tax charge of $3 million. The decrease in the effective tax rate in the first quarter of fiscal 2014 is primarily due to a non-taxable gain of $29 millionrecognized on the Company's pre-existing investment in NHUMO as a result of the NHUMO transaction. This gain is reported as a certain item. See Note C of the consolidated financial statements for details of the transaction. The operating tax rate for the first quarter of fiscal 2014 was 28%. The operating tax rate for the first quarter of fiscal 2013 was 27%. The increase in the operating tax rate in the first quarter of fiscal 2014 is primarily due to a change in our geographic mix of earnings. We are currently under audit in a number of jurisdictions outside of the U.S. It is possible that some of these audits will be resolved in fiscal 2014, which may impact our tax expense and effective tax rate going forward. We expect our operating tax rate for fiscal 2014 to be between 26% and 28%. 39
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Equity in Earnings of Affiliated Companies and Net Income Attributable to Noncontrolling Interests, net of tax
Three months ended December 31 2013 2012 (Dollars in millions) Equity in earnings of affiliated companies, net of tax
$ 2 $ 6
Equity in earnings of affiliated companies, net of tax, decreased
Net income attributable to noncontrolling interests increased
$2 millionin the first quarter of fiscal 2014 as compared to the same period of fiscal 2013 due to higher profitability of our joint ventures.
Net Income Attributable to
In the first quarter of fiscal 2014, we reported net income attributable to
First Quarter Fiscal 2014 versus First Quarter Fiscal 2013-By Business Segment
Total segment EBIT, certain items, other unallocated items and Income from continuing operations before income taxes and equity in earnings of affiliated companies for the three months ended
December 31, 2013and 2012 are set forth in the table below. The details of certain items and other unallocated items are shown below and in Note P of our consolidated financial statements. Three months ended December 31 2013 2012 (Dollars in millions) Total segment EBIT $ 113 $ 89Certain items 24 (20 ) Other unallocated items (29 ) (28 )
Income from continuing operations before income taxes and equity in earnings of affiliated companies
In the first quarter of fiscal 2014, total segment EBIT increased by
$24 millionwhen compared to the same period of fiscal 2013. The increase was principally driven by higher volumes ( $44 million) partially offset by higher fixed costs ( $20 million) associated with new carbon black capacity and higher maintenance costs in the Purification Solutions segment. 40
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Details of the certain items for the first quarter of fiscal 2014 and 2013 are as follows: Three months ended
December 312013 2012 (Dollars in millions)
Global restructuring activities
$ (5 )$
Acquisition and integration-related charges (5 )
Foreign currency gain on revaluations 6
Gain on existing investment in NHUMO 29
Environmental and legal reserves (1 )
Total certain items, pre-tax 24
Tax-related certain items
Tax impact of certain items 1
Tax impact of certain foreign exchange losses -
Discrete tax items (1 )
Total tax-related certain items -
Total certain items after tax
Certain items for the first quarter of fiscal 2014 include charges related to restructuring initiatives, acquisition and integration-related charges, foreign currency gain on revaluations, a gain recognized on our existing equity investment in NHUMO, environmental matters and tax certain items. Details of restructuring activities are included in Note L of the consolidated financial statements. Acquisition and integration-related charges include legal and professional fees, the incremental value of inventory as a result of purchase accounting adjustments, and other expenses related to the completion of the acquisitions and the integrations of Purification Solutions and NHUMO. Details of the gain recognized on our existing equity investment in NHUMO are included in Note C of the consolidated financial statements. Tax certain items include discrete tax items, which are unusual and infrequent and the tax impact of certain foreign exchange losses. Other Unallocated Items Three months ended December 31 2013 2012 (Dollars in millions) Interest expense
$ (14 ) $ (16 )Equity in earnings of affiliated companies (2 )
Unallocated corporate costs (13 )
General unallocated income -
Total other unallocated items
$ (29 )$
Costs from total other unallocated items increased by
$1 millionin the first quarter of fiscal 2014 as compared to the same period in fiscal 2013. Interest expense decreased $2 millionin the first quarter of fiscal 2014 when compared to the same period in fiscal 2013 due to the maturity of long-term debt in the fourth quarter of fiscal 2013 that was refinanced with commercial paper carrying a lower interest rate. General unallocated income decreased by $3 millionprimarily due to the COGS impact of LIFO accounting from changes in carbon black raw material costs that resulted in an unfavorable comparison. 41
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Sales and EBIT for Reinforcement Materials for the first quarter of fiscal 2014 and fiscal 2013 are as follows:
Three months ended December 31 2013 2012 (Dollars in millions) Reinforcement Materials Sales
$ 517 $ 475Reinforcement Materials EBIT $ 64 $ 50In the first quarter of fiscal 2014, sales in Reinforcement Materials increased by $42 millionwhen compared to the first quarter of fiscal 2013. The increase was principally driven by the impact of higher volumes ( $72 million) partially offset by a less favorable price and product mix (combined $22 million) and the unfavorable impact of foreign currency translation ( $9 million). EBIT in Reinforcement Materials increased by $14 millionin the first quarter of fiscal 2014 when compared to the same period of fiscal 2013. The increase was principally driven by 15% higher volumes ( $23 million) partially offset by higher fixed costs ( $9 million) primarily associated with new carbon black capacity.
Sales and EBIT for Performance Materials for the first quarter of fiscal 2014 and fiscal 2013 are as follows:
Three months ended December 31 2013 2012 (Dollars in millions) Specialty Carbons and Compounds Sales
$ 148 $ 132Fumed Metal Oxides Sales 69 64 Performance Materials Sales $ 217 $ 196Performance Materials EBIT $ 34 $ 27In the first quarter of fiscal 2014, sales for Performance Materials increased by $21 millionwhen compared to the first quarter of fiscal 2013. The increase was due to higher volumes ( $24 million) and the favorable impact of foreign currency translation ( $2 million) partially offset by an unfavorable price and product mix (combined $6 million). Volumes in Specialty Carbons and Compounds increased by 16% and volumes in Fumed Metal Oxides increased by 5%. EBIT in Performance Materials increased by $7 millionin the first quarter of fiscal 2014 when compared to the same quarter of fiscal 2013 due to higher volumes ( $13 million) partially offset by a less favorable price and product mix ( $5 million). 42
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Sales and EBIT for Advanced Technologies for the first quarter of fiscal 2014 and 2013 are as follows: Three months ended December 31 2013 2012 (Dollars in millions) Inkjet Colorants
$ 15 $ 16Aerogel 5 5 Security Materials 1 1 Elastomer Composites 16 8 Specialty Fluids 28 8 Advanced Technologies Sales $ 65 $ 38Advanced Technologies EBIT $ 24 $ 7
Sales in Advanced Technologies increased by
EBIT in Advanced Technologies increased by
$17 millionin the first quarter of fiscal 2014 when compared to the same period of fiscal 2013 due to higher volumes ( $16 million) and higher royalties and technology payments in Elastomer Composites ( $5 million) partially offset by higher costs ( $3 million) in the Specialty Fluids business. Purification Solutions
Sales and EBIT for Purification Solutions for the first quarter of fiscal 2014 and fiscal 2013 are as follows:
Three months ended December 31 2013 2012 (Dollars in millions) Purification Solutions Sales
$ 77 $ 93Purification Solutions EBIT $ (9 ) $ 5Sales in Purification Solutions decreased by $16 millionin the first quarter of fiscal 2014 when compared to the same period of fiscal 2013 due to lower volumes ( $17 million) offset by favorable prices and product mix (combined $1 million). EBIT in Purification Solutions decreased by $14 millionin the first quarter of fiscal 2014 when compared to the same period of fiscal 2013 due to lower volumes ( $8 million) and higher fixed costs ( $8 million) related to higher maintenance costs and a higher allocation of certain functional and indirect costs. These items were partially offset by favorable pricing and product mix (combined $1 million.) Cash Flows and Liquidity Overview Our liquidity position, as measured by cash and cash equivalents plus borrowing availability, decreased by $139 millionduring the first quarter of fiscal 2014 due to an increase in working capital, the NHUMO transaction, and capital expenditures. At December 31, 2013, we had cash and cash equivalents of $105 million, and current availability under our revolving credit agreement of approximately $359 million. Our revolving credit agreement contains affirmative, negative and financial covenants and events of default customary for financings of this type. The financial covenants in the revolving credit agreement include interest coverage, debt-to-EBITDA and subsidiary debt to total capitalization ratios. As of December 31, 2013, we were in compliance with all applicable covenants. 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. As of December 31, 2013, our U.S. dollar cash and cash equivalent holdings by region were: Asia Pacific $41 million, Europe $28 million, and the Americas $36 million, which included $8 millionin the U.S. 43
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January 2013, we initiated a commercial paper program allowing us to issue notes of various tenors up to 364 days. The commercial paper program is backed by our committed revolving credit facility, and the aggregate borrowings under both the commercial paper program and revolving credit agreement cannot exceed the $750 millionlimit on the revolving credit agreement. To date the interest on the commercial paper notes has been lower than the interest that we would have paid if we had instead borrowed under our revolving credit agreement. The outstanding balance of commercial paper of $390 millionas of December 31, 2013is included within the Notes payable caption on the Consolidated Balance Sheets.
At the closing of the NHUMO transaction in
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. Our liquidity derived 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.
Our Consolidated Statements of Cash Flows have been presented to include discontinued operations with continuing operations. Therefore, unless noted otherwise, the following discussion of our cash flows and liquidity position include both continuing and discontinued operations.
January 2012, we completed the sale of our Supermetals Business, which we classified as discontinued operations beginning in the fourth quarter of fiscal 2011 when we entered into the sale and purchase agreement for its sale. In connection with the sale, we received $175 millionon the closing date and notes for additional minimum consideration totaling approximately $277 millionpayable at various dates through the second quarter of fiscal 2014. Through December 31, 2013, Cabot received payments of $62 millionunder the GAM Notes that became due. The carrying value of the GAM Notes at December 31, 2013was $215 million, which is equivalent to the contractual amount due on March 31, 2014. The carrying value of the GAM Notes was presented as Notes receivable from sale of business on the Consolidated Balance Sheets.
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 used in 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
Cash used in operating activities in the first three months of fiscal 2014 was driven primarily by net income of
$86 millionplus $51 millionof depreciation and amortization and $17 millionof dividends from equity affiliates. These sources of cash were partially offset by a net increase in working capital (inventories plus accounts and notes receivable, less accounts payable and accrued liabilities). Our working capital increase during the first three months of fiscal 2014 was driven primarily by higher accounts receivable, higher inventories and lower accounts payable and accrued liabilities due to the timing and payout of certain corporate accruals. Cash used in operating activities in the first three months of fiscal 2013 was driven primarily by an increase in working capital (Inventories plus Accounts and notes receivable, less Accounts payable and accrued liabilities) and a decrease in income taxes payable. Partially offsetting these uses of cash were net income and depreciation and amortization. Our working capital increase during the first quarter of fiscal 2013 was driven by higher inventory, lower accounts payable and accrued liabilities due to the timing and payout of certain corporate accruals, and lower accounts receivable due to lower volumes. 44
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Cash Flows from Investing Activities
In the three months ended
December 31, 2013, investing activities consumed $119 millionof cash and were primarily driven by capital expenditures of $42 millionand cash paid in the NHUMO transaction of $80 million. For the three months ended December 31, 2012, cash flows from investing activities were primarily driven by capital expenditures partially offset by $19 millionof cash received from the notes receivable from the sale of the Supermetals business in the three months ended December 31, 2012. During the three months ended December 31, 2013, capital expenditures were primarily related to sustaining and compliance capital projects at our operating facilities, site development at our mine in Marshall, Texas, to support the future raw materials supply for the Purification Solutions business, investments in energy recovery technology, and capital spending required for process technology and product differentiation projects. Capital expenditures for the remainder of fiscal 2014 are expected to be between $150 millionto $200 million. Our planned capital spending program for the remainder of fiscal 2014 is primarily for sustaining and compliance capital projects at our operating facilities, investments in energy related projects, and site-development initiatives.
Cash Flows from Financing Activities
Financing activities provided
$155 millionprimarily related to net inflows of $149 millionfrom our commercial paper program. In the first three months of fiscal 2014, our overall debt balance increased by $167 millionprimarily driven by the acquisition of NHUMO, capital expenditures and working capital increases.
Financing activities provided
We own 49% of an operating 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, 2013, these subsidiaries carried the operating affiliate investment of $23 millionand held 20 million bolivars( $3 million) in cash. During the three months ended December 31, 2013and 2012, the operating affiliate declared dividends of 11 million bolivars( $2 million) and 4 million bolivars( $1 million), respectively, to our wholly owned subsidiaries, which were paid in U.S. dollars and repatriated. The Venezuelan bolivars held by Cabot's wholly owned subsidiaries may only be exchanged for foreign currencies through certain Venezuelan government controlled channels. The channels available are the Venezuelan central bank ("CADIVI"), and Venezuelan government and government-backed bond offerings. The bond offerings use a bidding process, where companies and individuals requiring U.S. dollars place a request for a fixed sum, and CADIVI then determines how to allocate the pool of U.S. dollars in that issuance. We closely monitor our ability to convert our bolivar holdings into U.S. dollars, as we intend to convert substantially all bolivars held by our wholly owned subsidiaries in Venezuelato U.S. dollars as soon as practical. Any future change in the CADIVI official rate or opening of additional parallel markets could lead us to change the exchange rate we use and result in gains or losses on the bolivar denominated assets held by our wholly owned subsidiaries. 45
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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, 2013. Payments Due by Fiscal Year Remainder of Fiscal 2014 2015 2016 2017 2018 Thereafter Total (Dollars in millions) Reinforcement Materials $ 265 $ 296 $ 228 $ 183 $ 178 $ 2,793 $ 3,943Performance Materials 32 39 33 30 30 236 400 Advanced Technologies 2 2 1 1 1 - 7 Purification Solutions 20 16 9 9 9 16 79 Total $ 319 $ 353 $ 271 $ 223 $ 218 $ 3,045 $ 4,429
Off-balance sheet arrangements
Cabot has 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 concerning the receipt of the cash proceeds due to us from the sale of our Supermetals Business; 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 2014; the recoverability of our equity affiliate investment in
Venezuela; 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, including at our mine in Manitoba, as planned; the timing of implementation of environmental regulations; 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 a reserve for our share of liability for respirator claims; and the outcome of pending litigation. Other factors and risks are discussed in our 2013 10-K. 46
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Recently Issued Accounting Pronouncements - Not Yet Adopted
July 2013, the FASB issued a new standard related to the "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists". The standard requires, unless certain conditions exist, an unrecognized tax benefit or a portion of an unrecognized tax benefit be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, similar to a tax loss or a tax credit carryforward. This standard is applicable for fiscal years beginning after December 15, 2013, and for interim periods within those years. Accordingly, we will adopt this standard beginning October 1, 2014, in the beginning of the first quarter of our 2015 fiscal year. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements and we do not expect the impact to be material.