10-K 1 d230919d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

  x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2011

or

 

  ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                        to                         

Commission file number 1-5667

Cabot Corporation

(Exact name of Registrant as specified in its charter)

 

Delaware   04-2271897

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

Two Seaport Lane, Suite 1300  
Boston, Massachusetts   02210
(Address of Principal Executive Offices)   (Zip Code)

(617) 345-0100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common stock, $1.00 par value per share

  New York Stock Exchange

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

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

Large accelerated filer  x                        Accelerated filer  ¨

Non-accelerated filer  ¨  (Do not check if a smaller reporting company)     Smaller reporting company  ¨

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

As of the last business day of the Registrant’s most recently completed second fiscal quarter (March 31, 2011), the aggregate market value of the Registrant’s common stock held by non-affiliates was $3,010,984,478. As of November 15, 2011, there were 63,904,198 shares of the Registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive proxy statement for its 2012 Annual Meeting of Shareholders are incorporated by reference into Part III of this annual report on Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I   

ITEM 1.

  

Business

     3   

ITEM 1A.

  

Risk Factors

     14   

ITEM 1B.

  

Unresolved Staff Comments

     19   

ITEM 2.

  

Properties

     20   

ITEM 3.

  

Legal Proceedings

     22   

ITEM 4.

  

(Removed and Reserved)

     24   
PART II   

ITEM 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     26   

ITEM 6.

  

Selected Financial Data

     27   

ITEM 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     30   

ITEM 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

     51   

ITEM 8.

  

Financial Statements and Supplementary Data

     54   

ITEM 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     114   

ITEM 9A.

  

Controls and Procedures

     114   

ITEM 9B.

  

Other Information

     115   
PART III   

ITEM 10.

  

Directors, Executive Officers and Corporate Governance

     116   

ITEM 11.

  

Executive Compensation

     116   

ITEM 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     116   

ITEM 13.

  

Certain Relationships and Related Transactions, and Director Independence

     116   

ITEM 14.

  

Principal Accounting Fees and Services

     116   
PART IV   

ITEM 15.

  

Exhibits, Financial Statement Schedules

     117   

Signatures

     121   

Exhibit Index

     123   

 

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Information Relating to Forward-Looking Statements

This annual report on Form 10-K contains “forward-looking statements” under the Federal securities laws. These forward-looking statements include statements relating to our future business performance and overall prospects; demand for our products; when we expect the sale of our Supermetals Business to close; when we expect commissioning of the rubber blacks facility in Hebei Province, China we are constructing with our joint venture partner to occur; when we expect additional capacity at our rubber blacks operations in Argentina and Brazil to become available; when we expect commissioning to occur of the fumed silica manufacturing operations we are expanding in Jiangxi Province, China with our joint venture partner; when we expect our fumed silica capacity expansion plans in Barry, Wales to be completed; when we expect additional capacity at our Inkjet facility in Haverhill, Massachusetts to be available; our expectations regarding the life of our pollucite ore reserves; the anticipated effect of the time lag in price adjustments that remain in certain of our carbon black supply contracts; the sufficiency of our cash on hand, cash provided from operations and cash available under our credit facilities to fund our cash requirements; anticipated capital spending, including environmental-related capital expenditures; cash requirements and uses of available cash, including future cash outlays associated with long-term contractual obligations, restructurings, contributions to employee benefit plans, environmental remediation costs and future respirator liabilities; exposure to interest rate and foreign exchange risk; future benefit plan payments we expect to make; our expected tax rate for fiscal 2012; our ability to recover deferred tax assets; 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 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 and difficult to predict. If known or unknown risks materialize, or should underlying assumptions prove inaccurate, our actual results could differ materially from past results and from those expressed in the forward-looking statements. Important factors that could cause our actual results to differ materially from those expressed in our forward-looking statements are described in Item 1A in this report.

We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Investors are advised, however, to consult any further disclosures we make on related subjects in our 10-Q and 8-K reports filed with the Securities and Exchange Commission (the “SEC”).

PART I

 

Item 1. Business

General

Cabot is a global specialty chemicals and performance materials company headquartered in Boston, Massachusetts. Our principal products are rubber and specialty grade carbon blacks, fumed metal oxides, inkjet colorants, aerogels and cesium formate drilling fluids. Cabot and its affiliates have manufacturing facilities and operations in the United States and approximately 20 other countries. Cabot’s business was founded in 1882 and incorporated in the State of Delaware in 1960. The terms “Cabot”, “Company”, “we”, and “our” as used in this report refer to Cabot Corporation and its consolidated subsidiaries.

Our strategy is to deliver earnings growth through leadership in performance materials. We intend to achieve this goal by focusing on margin improvement, capacity expansion and emerging market growth, developing new products and businesses and actively managing our portfolio of businesses.

 

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Our products are generally based on technical expertise and innovation in one or more of our three core competencies: making and handling very fine particles; modifying the surfaces of very fine particles to alter their functionality; and designing particles to impart specific properties to a composite. We focus on creating particles with the composition, morphology, surface functionalities and formulations to support our customers’ existing and emerging applications.

We are organized into four business segments: the Core Segment; the Performance Segment; the New Business Segment; and the Specialty Fluids Segment. For operational purposes, we are also organized into three geographic regions: The Americas; Europe, Middle East and Africa; and Asia Pacific. The business segments are discussed in more detail later in this section. Financial information about our business segments appears in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 below (“MD&A”) and in Note V of the Notes to our Consolidated Financial Statements in Item 8 below (“Note V”). Financial information about our sales and long-lived assets in certain geographic areas appears in Note V. Our internet address is www.cabot-corp.com. We make available free of charge on or through our internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after electronically filing such material with, or furnishing it to, the SEC.

Discontinued Operations

Supermetals Business

During fiscal 2011, we entered into an agreement to sell our Supermetals Business to Global Advanced Metals Pty Ltd. (“GAM”) for a minimum of approximately $400 million in total cash consideration. The transaction is subject to regulatory approval and other customary closing conditions and is expected to close by the end of calendar year 2011. Results of operations for the Supermetals Business are reported as a discontinued operation for fiscal 2011 and for all prior periods presented.

The Supermetals Business produces tantalum, niobium (columbium) and their alloys. Tantalum, which accounts for substantially all of this Business’s sales, is produced in various forms. Electronics is the largest application for tantalum powder, which is used to make capacitors for computers, networking devices, wireless phones, electronics for automobiles and other devices. Tantalum, niobium and their alloys are also produced in wrought form for applications such as the production of superalloys and chemical process equipment and for various other industrial and aerospace applications, including fiber optic filters, sodium vapor lamps, turbine blades and aerospace propulsion systems. In addition, the Supermetals Business sells the starting metals (high-purity grade tantalum powders, plates and ingots) used to manufacture finished tantalum sputtering targets used in thin film applications, including semiconductors, inkjet heads, magnetics and flat panel displays. The Business has manufacturing facilities in Boyertown, Pennsylvania and Kawahigashi-machi, Japan.

Tantalum ore is the principal raw material used in this Business. The Business has not purchased or sourced any material containing tantalum, including coltan, from the Democratic Republic of the Congo. An independent audit conducted by a third party auditor assigned by the Electronics Industry Citizenship Coalition and Global e-Sustainability Initiative (as part of the Conflict-Free Smelter Validation Program) confirmed that our tantalum supply chain is free of conflict minerals. As part of the audit, we demonstrated that we have a documented conflict minerals policy, a mechanism in place for tracing material back to the mine of origin, and documentation demonstrating that 100% of purchased materials are from non-conflict sources.

 

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Core Segment

Rubber Blacks Business

Products

Carbon black is a form of elemental carbon that is manufactured in a highly controlled process to produce particles and aggregates of varied structure and surface chemistry, resulting in many different performance characteristics for a wide variety of applications. Rubber grade carbon blacks are used to enhance the physical properties of the systems and applications in which they are incorporated.

Our rubber blacks products are used in tires and industrial products. Rubber blacks have traditionally been used in the tire industry as a rubber reinforcing agent and are also used as a performance additive. In industrial products such as hoses, belts, extruded profiles and molded goods, rubber blacks are used to improve the physical performance of the product.

Sales and Customers

Sales of rubber blacks products are made by Cabot employees and through distributors and sales representatives. Sales to three major tire customers represent a material portion of the Rubber Blacks Business’s total net sales and operating revenues. The loss of any of these customers could have a material adverse effect on the Rubber Blacks Business.

Under appropriate circumstances, we have entered into supply contracts with certain customers, many of which have durations of at least one year. Many of these contracts provide for sales price adjustments to account for changes in relevant feedstock indices and, in some cases, changes in other relevant costs (such as the cost of natural gas). In fiscal 2011, approximately half of our rubber blacks volume was sold under supply contracts in effect during the fiscal year. The majority of the volumes sold under these contracts are sold to customers in North America and Western Europe.

Much of the rubber blacks we sell is used in automotive products and, therefore, our financial results may be affected by the cyclical nature of the automotive industry. However, a large portion of the market for our products is in replacement tires that historically have been less subject to automotive industry cycles.

Competition

We are one of the leading manufacturers of carbon black in the world. We compete in the manufacture of carbon black primarily with three companies with a global presence and a significant number of other companies which have a regional presence. Competition for products within the Rubber Blacks Business is based on product performance, quality, reliability, service, technical innovation, price, and logistics. We believe our technological leadership, global manufacturing presence, operations and logistics excellence and customer service provide us with a competitive advantage.

Raw Materials

The principal raw material used in the manufacture of carbon black is a portion of the residual heavy oils derived from petroleum refining operations and from the distillation of coal tars and the production of ethylene throughout the world. Natural gas is also used in the production of carbon black. Raw material costs generally are influenced by the availability of various types of carbon black feedstock and natural gas, and related transportation costs. Importantly, movements in the market price for crude oil typically affect carbon black feedstock costs.

 

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Operations

We own, or have a controlling interest in, and operate plants that produce rubber blacks in Argentina, Brazil, Canada, China, Colombia, the Czech Republic, France, Indonesia, Italy, Japan, Malaysia, The Netherlands, and the United States. Our equity affiliates operate carbon black plants in Mexico and Venezuela. The following table shows our ownership interest as of September 30, 2011 in rubber blacks operations in which we own less than 100%:

 

Location

  

Percentage Interest

Shanghai, China

   70% (consolidated subsidiary)

Tianjin, China

   70% (consolidated subsidiary)

Xingtai City, China

   60% (consolidated subsidiary)

Valasske Mezirici (Valmez), Czech Republic

   52% (consolidated subsidiary)

Cilegon and Merak, Indonesia

   85% (consolidated subsidiary)

Port Dickson, Malaysia

   51% (consolidated subsidiary)

Tampico, Mexico

   40% (equity affiliate)

Valencia, Venezuela

   49% (equity affiliate)

We continue to expand the manufacturing capacity of our Rubber Blacks Business in emerging markets. In fiscal 2009, we completed construction of and began operating two additional rubber blacks production units at our carbon black plant in Tianjin, China, increasing our capacity at that facility by 150,000 metric tons. During fiscal 2010 and 2011 we announced plans to expand capacity at our rubber blacks facilities in Indonesia, increasing our overall capacity in Indonesia by approximately 50%. In addition, during fiscal 2011, we began projects at our rubber blacks facilities in Argentina and Brazil, which will increase our total rubber blacks capacity in South America over the next three years by approximately 20%. Finally, we entered into a joint venture with Risun Chemicals Company, Ltd. for the construction and operation of a rubber blacks manufacturing facility in Xingtai City, Hebei Province, China. The facility will produce approximately 130,000 metric tons of carbon black annually, with the potential to expand annual capacity to 300,000 metric tons. We expect commissioning of this facility in calendar year 2013.

We also plan to add additional rubber blacks capacity at our existing plants in Europe, increasing our rubber blacks capacity in Europe by approximately 10%.

As part of our 2009 global restructuring plan, over the course of fiscal 2009 and 2010 we closed our manufacturing operations in Stanlow, U.K., and in Berre, France. In fiscal 2010, we also closed our manufacturing operations in Thane, India following a broad reaching analysis of our manufacturing assets, including their cost structure, ability to expand and a variety of other factors.

Performance Segment

The Performance Segment is comprised of two product lines: specialty grades of carbon black and thermoplastic concentrates (referred to together as “performance products”); and fumed silica, fumed alumina and dispersions thereof (referred to together as “fumed metal oxides”). In each product line, we design, manufacture and sell materials that deliver performance in a broad range of customer applications across the automotive, construction and infrastructure, and electronics and consumer products sectors.

Products

Carbon black is a form of elemental carbon that is manufactured in a highly controlled process to produce particles and aggregates of varied structure and surface chemistry, resulting in many different performance characteristics for a wide variety of applications. Our specialty grades of carbon black are used to impart color, provide rheology control, enhance conductivity and static charge control, provide UV protection, enhance mechanical properties, and provide chemical flexibility through surface treatment. These products are used in a wide variety of applications, such as inks, coatings, cables, pipes, toners and

 

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electronics. In addition, we manufacture and source thermoplastic concentrates and compounds (which we refer to as “masterbatch products”) that are marketed to the plastics industry.

Fumed silica is an ultra-fine, high-purity particle used as a reinforcing, thickening, abrasive, thixotropic, suspending or anti-caking agent in a wide variety of products produced for the automotive, construction, microelectronics, and consumer products industries. These products include adhesives, sealants, cosmetics, inks, toners, silicone rubber, coatings, polishing slurries and pharmaceuticals. Fumed alumina, also an ultra-fine, high-purity particle, is used as an abrasive, absorbent or barrier agent in a variety of products, such as inkjet media, lighting, coatings, cosmetics and polishing slurries.

Sales and Customers

Sales of these products are made by Cabot employees and through distributors and sales representatives. Under appropriate circumstances, we have entered into long-term supply arrangements (those with an initial term longer than one year) with certain customers for sales of our products. In fiscal 2011, sales under these contracts accounted for approximately 15% of the Performance Segment’s revenue. For the performance products line of business, these contracts are with a broad number of customers. In contrast, sales under long-term contracts with two customers account for a substantial portion of the revenue of the fumed metal oxides line of business. The majority of volume sold under long-term contracts in the Performance Segment is sold to customers located in North America and Western Europe.

Competition

We are one of the leading manufacturers of carbon black in the world. We compete in the manufacture of carbon black primarily with three companies with a global presence and a significant number of other companies which have a regional presence. We are also a leading producer of masterbatch products in Europe, the Middle East and Asia. We are a leading producer and seller of fumed silica and compete primarily with three companies with a global presence and at least four other companies which have a regional presence.

Competition for these products is based on product performance, quality, reliability, service, technical innovation and price. We believe our technological leadership, global manufacturing presence, operations excellence and customer service provide us with a competitive advantage.

Raw Materials

The principal raw material used in the manufacture of carbon black is a portion of the residual heavy oils derived from petroleum refining operations and from the distillation of coal tars and the production of ethylene throughout the world. Natural gas is also used in the production of carbon black. Raw material costs generally are influenced by the availability of various types of carbon black feedstock and natural gas, and related transportation costs. Importantly, movements in the market price for crude oil typically affect carbon black feedstock costs.

Other than carbon black feedstock, the primary materials used for our masterbatch products are thermoplastic resins and mineral fillers. Raw materials for these concentrates are, in general, readily available.

Raw materials for the production of fumed silica are various chlorosilane feedstocks. We purchase feedstocks and for some customers convert their feedstock to product on a fee-basis (so called “toll conversion”). We also purchase aluminum chloride as feedstock for the production of fumed alumina. We have long-term procurement contracts or arrangements in place for the purchase of fumed silica feedstock, which we believe will enable us to meet our raw material requirements for the foreseeable future. In addition, we buy some raw materials in the spot market to help ensure flexibility and minimize costs.

 

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Operations

We own, or have a controlling interest in, and operate plants that produce specialty grades of carbon black in China, The Netherlands and the United States. Our masterbatch products are produced in facilities that we own, or have a controlling interest in, located in Belgium, China and the UAE. We also own, or have a controlling interest in, manufacturing plants that produce fumed metal oxides in the United States, China, the United Kingdom, and Germany. An equity affiliate operates a fumed metal oxides plant in Mettur Dam, India. The following table shows our ownership interest as of September 30, 2011 in these segment operations in which we own less than 100%:

 

Location

  

Percentage Interest

Tianjin, China (performance products)

   90% (consolidated subsidiary)

Jiangxi Province, China (fumed metal oxides)

   90% (consolidated subsidiary)

Mettur Dam, India (fumed metal oxides)

   50% (equity affiliate)

We continue to expand the manufacturing capacity of our Performance Products and Fumed Metal Oxides Businesses in emerging markets. During fiscal 2007, we commissioned a specialty carbon black manufacturing unit at our plant in Tianjin with an annual capacity of approximately 20,000 metric tons. In addition, during fiscal 2011 we commissioned a masterbatch manufacturing plant at our carbon black plant in Tianjin, China. This new plant has an annual capacity of approximately 45,000 metric tons that may be expanded to 80,000 metric tons in the future. In addition, in fiscal 2010 we commenced manufacturing operations at our recently acquired masterbatch facility in Dubai.

We also continue to expand our fumed silica capacity in China. We are increasing the annual capacity at our joint venture’s fumed silica manufacturing facility in Jiangxi Province to approximately 15,000 metric tons. We expect commissioning of the first phase of this expansion in the first quarter of fiscal 2012 and commissioning of the remainder of this expansion in the first half of calendar year 2012.

We also plan to expand production capacity by 25% at our fumed silica facility in Barry, Wales. The expansion is expected to be completed in calendar year 2012.

As part of our 2009 global restructuring plan, over the course of fiscal 2009 and 2010 we closed our masterbatch manufacturing operations in Dukinfield, U.K. and our carbon black manufacturing operations in Stanlow, U.K. and in Berre, France. In fiscal 2011, we closed our masterbatch manufacturing facility in Grigno, Italy.

New Business Segment

Our New Business Segment is comprised of the Inkjet Colorants, Aerogel, Cabot Superior MicroPowders and Cabot Elastomer Composites Businesses. During the fourth quarter of fiscal 2011, we made changes in our business organizational and financial reporting structure. As part of these changes, our Cabot Elastomer Composites Business became part of our New Business Segment to enable the Business to have a stronger focus on the penetration of elastomer composite products in non-tire applications. In addition, corporate business development costs related to new technology efforts in areas such as energy storage and discharge in battery applications, solar energy applications, and graphenes in composite materials are no longer included in the Segment’s results and are now included in unallocated corporate costs. We made this change because these efforts support the entire Company. A discussion of each of the Businesses in our New Business Segment follows.

 

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Inkjet Colorants Business

Products

We produce and sell aqueous inkjet colorants primarily to the inkjet printing market. Our inkjet colorants are high-quality pigment-based black and other colorant dispersions we manufacture by surface treating specialty grades of carbon black and other pigments. The dispersions are used in aqueous inkjet inks to impart color (optical density or chroma) with improved durability (waterfastness, lightfastness and rub resistance) while maintaining high printhead reliability. Our inkjet colorants are produced for various inkjet printing applications, including small office and home office, corporate office, and commercial and industrial printing, as well as for other niche applications that require a high level of dispersibility and colloidal stability.

Sales and Customers

Sales of inkjet colorants are made by Cabot employees to inkjet printer manufacturers and to suppliers of inkjet inks in the inkjet cartridge aftermarket. Many of our commercialized products have been developed through joint research and development initiatives with inkjet printer manufacturers. These initiatives have led to the development of exclusive differentiated products for these inkjet customers.

Competition

Our inkjet colorants are designed to replace traditional pigment dispersions and dyes used in inkjet printing applications. Competitive products for inkjet colorants are organic dyes and other dispersed pigments manufactured and marketed by large chemical companies and small independent producers. Competition is based on product performance, technical innovation, quality, reliability, service and price. We believe our commercial strengths include technical innovation, product performance and service.

Raw Materials

Raw materials for inkjet colorants include carbon black sourced from our carbon black plants, organic pigments and other treating agents available from various sources. We believe that all raw materials to produce inkjet colorants are in adequate supply.

Operations

Our inkjet colorants are manufactured at our facility in Haverhill, Massachusetts. During fiscal 2011, we announced plans to double the capacity of our color pigment dispersion and polymer product lines at our facility in Haverhill during fiscal 2012.

Aerogel Business

Products

Cabot’s aerogel is a hydrophobic, silica-based particle with a high surface area that is used in a variety of thermal insulation and specialty chemical applications. In the construction industry, the product is used in insulative composite building products and translucent skylight, window, wall and roof systems for insulating eco-daylighting applications. In the oil and gas industry, aerogel is used to insulate subsea pipelines. In the specialty chemicals industry, the product is used to provide matte finishing, insulating and thickening properties for use in a variety of applications. We continue to focus on application and market development activities for use of aerogel in these and other new applications.

Sales and Customers

Sales of aerogel products are made principally by Cabot employees. A large portion of our product sales are made to engineering procurement and installation companies for use in subsea pipe-in-pipe

 

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insulation applications in both the Gulf of Mexico and North Sea, and to regional building and construction companies and distributors for construction, eco-daylighting and specialty chemical applications.

Competition

Although the manufacturing processes used are different, in premium insulation applications, our aerogel products compete principally with aerogel products manufactured by Aspen Aerogel, Inc. and non-aerogel insulation products manufactured by primarily regional companies throughout the world.

Competition is based on product performance, price, quality, reliability and service. We believe our commercial strengths include technical innovation, product performance, quality and service.

Raw Materials

The principal raw materials for the production of aerogels are silica sol and/or sodium silicate, which we believe are in adequate supply.

Operations

We manufacture our aerogel products at our facility in Frankfurt, Germany using a unique and patented manufacturing process. Finished products for use in the oil and gas industry are fabricated at a facility in Billerica, Massachusetts.

Cabot Superior MicroPowders Business (“CSMP”)

The principal area of commercial focus for CSMP is in developing covert taggants for a broad range of anti-counterfeiting security applications, including brand security, currency, tax stamps, identification and fuel markers. Covert taggants are invisible, unique markers that are added to products to determine their authenticity through the use of custom detectors or readers. Our taggants are manufactured using a proprietary process, which produces highly uniform materials with unique signatures. Development and manufacturing activities are conducted primarily at our facilities in Albuquerque, New Mexico and Mountain View, California.

Cabot Elastomer Composites Business (“CEC”)

In addition to the carbon black we make using conventional carbon black manufacturing methods, we have developed elastomer composite products that are compounds of natural latex rubber and carbon black made by a patented liquid phase process. We believe these compounds improve abrasion/wear resistance, reduce fatigue and reduce rolling resistance compared to natural rubber/carbon black compounds made by conventional methods. Our CEC products are targeted for tire, defense, mining, automotive and aerospace applications. We manufacture our CEC products at our facility in Port Dickson, Malaysia.

Specialty Fluids Segment

Products

Our Specialty Fluids Segment produces and markets cesium formate as a drilling and completion fluid for use primarily in high pressure and high temperature oil and gas well construction. Cesium formate products are solids-free, high-density fluids that have a low viscosity, enabling safe and efficient well construction and workover operations. The fluid is resistant to high temperatures, minimizes damage to producing reservoirs and is readily biodegradable in accordance with the testing guidelines set by the Organization for Economic Cooperation and Development. In a majority of applications, cesium formate is blended with other formates or products.

 

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Sales, Rental and Customers

Sales of our cesium formate products are made to oil and gas operating companies directly by Cabot employees and sales representatives and indirectly through oil field service companies. We generally rent cesium formate to our customers for use in drilling operations on a short-term basis. After completion of a job, the customer returns the fluid to Cabot and it is reprocessed for use in subsequent well operations. Any fluid that is lost during use and not returned to Cabot is paid for by the customer. On occasion we also make sales of cesium formate outside of a rental process.

A large portion of our fluids have been used for drilling and completion of wells in the North Sea, where we have been supplying cesium formate-based fluids for both reservoir drilling and completion activities on large gas and condensate field projects in the Norwegian Continental Shelf. Although we have expanded the use of our fluids to drilling operations outside of the North Sea, an important portion of our business continues to be with a limited number of customers for drilling and completion operations in the North Sea.

Competition

Formate fluids, which were introduced to the market in the mid-1990s, are a relatively small but growing part of the drilling and completion fluids market and compete mainly with traditional drilling fluid technologies. Competition in the well fluids business is based on product performance, quality, reliability, service, technical innovation and price, and proximity of inventory to customers’ drilling operations. We believe our commercial strengths include our unique product offerings and their performance, and our customer service.

Raw Materials

The principal raw material used in this business is pollucite (cesium ore), which we obtain primarily from our mine in Manitoba, Canada. We own a substantial portion of the world’s known pollucite reserves, ensuring us an adequate supply of our principal raw material. Considering our current production rates, our current estimate of reserve levels in the mine and inventory on hand, we expect our supply to last at least 10 years. The process of estimating mineral reserves is inherently uncertain and requires making subjective engineering, geological, geophysical and economic assumptions. Accordingly, there is likely to be variability in the estimated reserve life of the ore body over time.

Most jobs for which cesium formate is used require a large volume of the product. Accordingly, the Specialty Fluids Segment maintains a large inventory of fluid.

Operations

We have a mine and a cesium formate manufacturing facility in Manitoba, Canada, as well as fluid blending and reclamation facilities in Aberdeen, Scotland and in Bergen and Kristiansund, Norway. In addition, fluid is warehoused at various locations around the world to support existing and potential operations.

Patents and Trademarks

We own and are a licensee of various patents, which expire at different times, covering many of our products as well as processes and product uses. Although the products made and sold under these patents and licenses are important to Cabot, the loss of any particular patent or license would not materially affect our business, taken as a whole. We sell our products under a variety of trademarks, the loss of any one of which would not materially affect our business, taken as a whole.

 

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Seasonality

Our businesses are generally not seasonal in nature, although we may experience some regional seasonal declines during holiday periods.

Backlog

We do not consider backlog to be a significant indicator of the level of future sales activity. In general, we do not manufacture our products against a backlog of orders. Production and inventory levels are based on the level of incoming orders as well as projections of future demand. Therefore, we believe that backlog information is not material to understanding our overall business and is not a reliable indicator of our ability to achieve any particular level of revenue or financial performance.

Employees

As of September 30, 2011, we had approximately 4,100 employees. Some of our employees in the United States and abroad are covered by collective bargaining or similar agreements. We believe that our relations with our employees are generally satisfactory.

Research and Development

Cabot develops new and improved products and higher efficiency processes through Company-sponsored research and technical service activities, including those initiated in response to customer requests. Our expenditures for such activities generally are spread among our businesses and are shown in the consolidated statements of operations. Further discussion of our research and technical expenses incurred in each of our last three fiscal years appears in MD&A below.

Safety, Health and Environment (“SH&E”)

Cabot has been named as a potentially responsible party under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (the “Superfund law”) and comparable state statutes with respect to several sites primarily associated with our divested businesses. (See “Legal Proceedings” below.) During the next several years, as remediation of various environmental sites is carried out, we expect to spend against our $6 million environmental reserve for costs associated with such remediation. Adjustments are made to the reserve based on our continuing analysis of our share of costs likely to be incurred at each site. Inherent uncertainties exist in these estimates due to unknown conditions at the various sites, changing governmental regulations and legal standards regarding liability, and changing technologies for handling site investigation and remediation. While the reserve represents our best estimate of the costs we expect to incur, the actual costs to investigate and remediate these sites may exceed the amounts accrued in the environmental reserve. While it is always possible that an unusual event may occur with respect to a given site and have a material adverse effect on our results of operations in a particular period, we do not believe that the costs relating to these sites, in the aggregate, are likely to have a material adverse effect on our financial position. Furthermore, it is possible that we may also incur future costs relating to environmental liabilities not currently known to us or as to which it is currently not possible to make an estimate.

Our ongoing operations are subject to extensive federal, state, local, and foreign laws, regulations, rules, and ordinances relating to safety, health, and environmental matters (“SH&E Requirements”). These SH&E Requirements include requirements to obtain and comply with various environmental-related permits for constructing any new facilities and operating all of our existing facilities. We have expended and will continue to expend considerable sums to construct, maintain, operate, and improve facilities for safety, health and environmental protection and to comply with SH&E Requirements. We spent approximately $36 million in environmental-related capital expenditures at existing facilities in fiscal 2011 and anticipate spending approximately $27 million for such matters in fiscal 2012.

 

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In recognition of the importance of compliance with SH&E Requirements to Cabot, our Board of Directors has a Safety, Health, and Environmental Affairs Committee. The Committee, which is comprised of independent directors, meets at least three times a year and provides oversight and guidance to Cabot’s safety, health and environmental management programs. In particular, the Committee reviews Cabot’s environmental reserve, safety, health and environmental risk assessment and management processes, environmental and safety audit reports, performance metrics, performance as benchmarked against industry peer groups, assessed fines or penalties, site security and safety issues, health and environmental training initiatives, and the SH&E budget. The Committee also consults with our outside and internal advisors regarding management of Cabot’s safety, health and environmental programs.

The International Agency for Research on Cancer (“IARC”) classifies carbon black as a Group 2B substance (known animal carcinogen, possible human carcinogen). We have communicated IARC’s classification of carbon black to our customers and employees and have included that information in our material safety data sheets and elsewhere, as appropriate. We continue to believe that the available evidence, taken as a whole, indicates that carbon black is not carcinogenic to humans, and does not present a health hazard when handled in accordance with good housekeeping and safe workplace practices as described in our material safety data sheets.

The California Office of Environmental Health Hazard Assessment (“OEHHA”) published a notice adding “carbon black (airborne, unbound particles of respirable size)” to the California Safe Drinking Water and Toxic Enforcement Act, commonly referred to as Proposition 65, in 2003. Proposition 65 requires businesses to warn individuals before they knowingly or intentionally expose them to chemicals subject to its requirements, and it prohibits businesses from knowingly discharging or releasing the chemicals into water or onto land where they could contaminate drinking water. We worked with the International Carbon Black Association, as well as various customers and carbon black user groups, to ensure our compliance with the requirements associated with the Proposition 65 listing of carbon black, which became effective in February 2004. OEHHA is reportedly considering certain changes that may result in removing the “airborne, unbound particles of respirable size” qualifying language from its listing of carbon black. If this change is adopted by OEHHA, it would result in increased labeling and other requirements for our customers under Proposition 65.

The European Commission (“EC”) developed a new European Union (“EU”) regulatory framework for chemicals called REACH (Registration, Evaluation and Authorization of Chemicals), which became effective in June 2007. REACH applies to all existing and new chemical substances produced or imported into the EU in quantities greater than one metric ton a year. Manufacturers or importers of these chemical substances are required to submit specified health, safety, risk and use information about the substance to the European Chemical Agency. We completed the registrations under REACH for both carbon black and fumed silica in February 2010, and for cesium formate in April 2009. We are working to complete other substance dossiers for the 2013 registration deadline. We are also working with the manufacturers and importers of our raw materials, including our feedstocks, to ensure their registration prior to the applicable deadlines. In addition, the EC has adopted a harmonized definition of “nanomaterial” to be used in the EU to identify materials for which special provisions may apply, such as risk assessment and ingredient labeling. The EC definition is broad and would apply to many of our existing products, including carbon black, fumed silica and alumina. It is unknown at this time what the implications of this new classification may be for Cabot with respect to existing products as well as potential new products.

Environmental agencies worldwide are increasingly implementing regulations and other requirements resulting in more restrictive air emission limits globally, particularly as they relate to nitrogen oxide and sulphur dioxide emissions. In addition, global efforts to reduce greenhouse gas emissions impact the carbon black industry as carbon dioxide is emitted in the carbon black manufacturing process. In December 2005, the EC published a directive that includes carbon black manufacturing in the combustion sector and in Phase II of the Emissions Trading Scheme, which establishes a maximum allowable emission credit for each ton of CO 2 emitted, for the period 2008 to 2012. The EC is developing allowable emission credits for

 

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Phase III of the Emissions Trading Scheme, which will apply for the period 2013 to 2020. Various EU member states have included carbon black facilities in their national allocation plans and a number of our carbon black plants in Europe were required to comply with the Emission Trading Scheme beginning in calendar year 2008. We generally expect to purchase credits where necessary to respond to allocation shortfalls. There are also ongoing discussions in other regions and countries, including the U.S., Canada, China, and Brazil, regarding greenhouse gas emission reduction programs, but those programs have not yet been fully defined and their impact on us cannot be estimated at this time. Finally, Cabot’s U.S. carbon black facilities began reporting their greenhouse gas emissions under the U.S. Environmental Protection Agency’s new rule for the Mandatory Reporting of Greenhouse Gases in calendar year 2011.

Various U.S. agencies and international bodies have adopted security requirements applicable to certain manufacturing and industrial facilities and marine port locations. These security-related requirements involve the preparation of security assessments and security plans in some cases, and in other cases the registration of certain facilities with specified governmental authorities. We closely monitor all security-related regulatory developments and believe we are in compliance with all existing requirements. Compliance with such requirements is not expected to have a material adverse effect on our operations.

Foreign and Domestic Operations and Export Sales

A significant portion of our revenues and operating profits is derived from overseas operations. The profitability of our segments is affected by fluctuations in the value of the U.S. dollar relative to foreign currencies. (See MD&A and the Geographic Information portion of Note V for further information relating to sales and long-lived assets by geographic area.) Currency fluctuations, nationalization and expropriation of assets are risks inherent in international operations. We have taken steps we deem prudent in our international operations to diversify and otherwise to protect against these risks, including the use of foreign currency financial instruments to reduce the risk associated with changes in the value of certain foreign currencies compared to the U.S. dollar. (See the risk management discussion contained in “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A below and Note L of the Notes to the Company’s Consolidated Financial Statements).

 

Item 1A.

Risk Factors

In addition to factors described elsewhere in this report, the following are important factors that could cause our actual results to differ materially from those expressed in our forward-looking statements. It is not possible, however, to predict or identify all such factors. Accordingly, investors should not consider the following to be a complete discussion of all potential risks or uncertainties.

Negative or uncertain worldwide or regional economic conditions may adversely impact our business.

Our operations and performance are affected by worldwide and regional economic conditions. In periods of significant market turmoil and financial market uncertainty, we may experience pricing pressure on products and services and reduced business activity at a regional or global level. An economic downturn may reduce demand for our products, which could decrease our revenues and could have an adverse effect on our financial condition and cash flows. In addition, during periods of economic uncertainty, our customers may temporarily pursue inventory reduction measures that exceed declines in the actual underlying demand.

Our Rubber Blacks Business is sensitive to changes in industry capacity utilization. As a result, we may experience pricing pressure when capacity utilization in this Business decreases, which could affect our financial performance.

Plant capacity expansions may be delayed and/or not achieve the expected benefits.

Our ability to complete capacity expansions as planned may be delayed or interrupted by the need to obtain environmental and other regulatory approvals, availability of labor and materials, unforeseen hazards

 

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such as weather conditions, and other risks customarily associated with construction projects. In addition, our ability to expand capacity in emerging regions depends in part on economic and political conditions in these regions and, in some cases, on our ability to establish operations, construct additional manufacturing capacity or form strategic business alliances. Moreover, the cost of expanding capacity in our Rubber Blacks, Performance Products, Fumed Metal Oxides and Inkjet Businesses could have a negative impact on the financial performance of these businesses until capacity utilization is sufficient to absorb the incremental costs associated with the expansion.

As a chemical manufacturing company, our operations have the potential to cause environmental or other damage as well as personal injury.

The operation of a chemical manufacturing business as well as the sale and distribution of chemical products involve safety, health and environmental risks. For example, the production and/or processing of carbon black, fumed metal oxides, aerogel and other chemicals involve the handling, transportation, manufacture or use of certain substances or components that may be considered toxic or hazardous within the meaning of applicable federal, state, local and foreign laws, regulations, rules and ordinances relating to safety, health and environmental matters. The transportation of chemical products and other activities associated with our manufacturing processes have the potential to cause environmental or other damage as well as injury or death to employees or third parties. We could incur significant expenditures in connection with such operational risks.

Our operations are subject to extensive safety, health and environmental requirements, which could increase our costs and/or reduce our profit.

Our ongoing operations are subject to extensive federal, state, local and foreign laws, regulations, rules and ordinances relating to safety, health and environmental matters (“SH&E Requirements”), many of which provide for substantial monetary fines and criminal sanctions for violations. These SH&E Requirements include requirements to obtain and comply with various environmental-related permits for constructing any new facilities and operating all of our existing facilities. In June 2009, we received an information request from the U.S. Environmental Protection Agency (“EPA”) as part of an EPA national initiative focused on the U.S. carbon black manufacturing sector. The information request relates to our Pampa, Texas facility’s compliance with certain regulatory and permitting requirements under the Clean Air Act, including the New Source Review (“NSR”) construction permitting requirements. We responded to EPA’s information request in August 2009 and are in discussions with EPA. Based on how EPA has handled similar NSR initiatives with other industrial sectors, it is anticipated that EPA will seek to require us to employ additional technology control devices or approaches with respect to emissions at certain U.S. facilities and/or seek a civil penalty from us.

We believe that our ongoing operations comply with current SH&E Requirements in a manner that should not materially adversely affect our earnings or cash flow. We cannot be certain, however, that significant costs or liabilities will not be incurred with respect to SH&E Requirements and our operations. Moreover, we are not able to predict whether future changes or developments in SH&E Requirements will affect our earnings or cash flow in a materially adverse manner.

Any failure to realize benefits from acquisitions, alliances or joint ventures could adversely affect future financial results.

As part of our strategies for growth and improved profitability, we have made and may continue to make acquisitions and investments and enter into joint ventures. The success of acquisitions of new technologies, companies and products, or arrangements with third parties is not always predictable and we may not be successful in realizing our objectives as anticipated. We may not be able to integrate any acquired businesses successfully into our existing businesses, make such businesses profitable, or realize anticipated cost savings or synergies, if any, from these acquisitions, which could adversely affect our business.

 

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We are exposed to political or country risk inherent in doing business in some countries.

Sales outside of the U.S. constituted a majority of our revenues in fiscal 2011. Our operations in some countries may be subject to the following risks: changes in the rate of economic growth; unsettled political or economic conditions; possible expropriation or other governmental actions; social unrest, war, terrorist activities or other armed conflict; confiscatory taxation or other adverse tax policies; deprivation of contract rights; trade regulations affecting production, pricing and marketing of products; reduced protection of intellectual property rights; restrictions on the repatriation of income or capital; exchange controls; inflation; currency fluctuations and devaluation; the effect of global health, safety and environmental matters on economic conditions and market opportunities; and changes in financial policy and availability of credit. We have an equity method investment in Venezuela, a country that has established rigid controls over the ability of foreign companies to repatriate cash. Such exchange controls could potentially impact our ability, in both the short and long term, to recover both the cost of our investment and earnings from that investment.

Volatility in the price of energy and raw materials could decrease our margins.

Our manufacturing processes consume significant amounts of energy and raw materials, the costs of which are subject to worldwide supply and demand as well as other factors beyond our control. Dramatic increases in such costs or decreases in the availability of raw materials at acceptable costs could have an adverse effect on our results of operations. For example, movements in the market price for crude oil typically affect carbon black feedstock costs. Significant movements in the market price for crude oil tend to create volatility in our carbon black feedstock costs, which can affect our working capital and results of operations. Certain of our carbon black supply contracts contain provisions that adjust prices to account for changes in a relevant feedstock price index. We attempt to offset the effects of increases in raw material costs through selling price increases in our non-contract sales, productivity improvements and cost reduction efforts. Success in offsetting increased raw material costs with price increases is largely influenced by competitive and economic conditions and could vary significantly depending on the segment served. Such increases may not be accepted by our customers, may not be sufficient to compensate for increased raw material and energy costs or may decrease demand for our products and our volume of sales. If we are not able to fully offset the effects of increased raw material or energy costs, it could have a significant impact on our financial results.

We depend on a group of key customers for a significant portion of our sales. A significant adverse change in a customer relationship or in a customer’s performance or financial position could harm our business and financial condition.

Our success in strengthening relationships and growing business with our largest customers and retaining their business over extended time periods could affect our future results. We have a group of key customers across our businesses that together represent a significant portion of our total net sales and operating revenues. The loss of any of our important customers, or a reduction in volumes sold to them because of a work stoppage or other disruption, could adversely affect our results of operations until such business is replaced or the disruption ends. Any deterioration in the financial condition of any of our customers or the industries they serve that impairs our customers’ ability to make payments to us also could increase our uncollectible receivables and could affect our future results and financial condition.

Our failure to successfully develop new products and technologies that address our customers’ changing requirements or competitive challenges may have a negative effect on our business results.

The end markets into which we sell our products are subject to periodic technological change, ongoing product improvements and changes in customer requirements. Increased competition from existing or newly developed products offered by our competitors or companies whose products offer a similar functionality as our products may negatively affect demand for our products. We work to identify, develop and market

 

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innovative products on a timely basis to meet our customers’ changing requirements and competitive challenges. If we fail to develop new products or keep pace with technological developments, our sales may be negatively impacted and our business results could be adversely affected.

Fluctuations in foreign currency exchange and interest rates could affect our financial results.

We earn revenues, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar. In fiscal 2011, we derived a majority of our revenues from sales outside the United States. Because our consolidated financial statements are presented in U.S. dollars, we must translate revenues, income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other currencies in countries where we operate will affect our results of operations and the value of balance sheet items denominated in foreign currencies. Due to the geographic diversity of our operations, weaknesses in some currencies might be offset by strengths in others over time. In addition, we are exposed to adverse changes in interest rates. We manage both these risks through normal operating and financing activities and, when deemed appropriate, through the use of derivative instruments as well as foreign currency debt. We cannot be certain, however, that we will be successful in reducing the risks inherent in exposures to foreign currency and interest rate fluctuations.

There are also instances where we have direct current exposures to foreign currency movements because settlement back into a different currency is intended. These situations can have a direct impact on our cash flows.

The money we spend developing new businesses and technologies may not result in a proportional increase in our revenues or profits.

We cannot be certain that the costs we incur investing in new businesses and technologies will result in a proportional increase in revenues or profits. In addition, the timely commercialization of products that we are developing may be disrupted or delayed by manufacturing or other technical difficulties, market acceptance or insufficient market size to support a new product, competitors’ new products, and difficulties in moving from the experimental stage to the production stage. These disruptions or delays could affect our future business results.

Our tax rate is dependent both upon the jurisdiction where our earnings arise and the tax laws in those jurisdictions.

Our future tax rates may be adversely affected by a number of factors, including the enactment of tax legislation currently being considered in the U.S.; other changes in tax laws or the interpretation of such tax laws; changes in the estimated realization of our net deferred tax assets; the jurisdictions in which profits are determined to be earned and taxed; the repatriation of non-U.S. earnings for which we have not previously provided for U.S. income and non-U.S. withholding taxes; adjustments to estimated taxes upon finalization of various tax returns; increases in expenses that are not deductible for tax purposes, including impairment of goodwill in connection with acquisitions; changes in available tax credits; and the resolution of issues arising from tax audits with various tax authorities. Losses for which no tax benefits can be recorded could materially impact our tax rate and its volatility from one quarter to another. Any significant change in our jurisdictional earnings mix or in the tax laws in those jurisdictions could impact our future tax rates and net income in those periods.

Regulations requiring a reduction of greenhouse gas emissions will likely impact the carbon black industry, including our carbon black operations.

Carbon dioxide is emitted in the carbon black manufacturing process. In December 2005, the European Commission (“EC”) published a directive that includes carbon black manufacturing in the combustion

 

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sector and in Phase II of the Emissions Trading Scheme for the period 2008 to 2012. The EC is developing allowable emission credits for Phase III of the Emissions Trading Scheme, which will apply for the period 2013 to 2020. Various European Union member states have included carbon black facilities in their national allocation plans and we have taken actions to comply with applicable CO2 emission requirements. However, there can be no assurance that we will be able to purchase emissions credits if our carbon black operations generate more CO2 than our allocations permit or that the cost of such credits will be acceptable to us. There are also ongoing discussions in other regions and countries, including the U.S., Canada, China and Brazil, regarding greenhouse gas emission reduction programs, but those programs have not yet been defined and their potential impact on our manufacturing operations or financial results cannot be estimated at this time.

Litigation or legal proceedings could expose us to significant liabilities and thus negatively affect our financial results.

As more fully described in “Item 3—Legal Proceedings”, we are a party to or the subject of lawsuits, claims, and proceedings, including those involving contract, environmental, and health and safety matters as well as product liability and personal injury claims relating to asbestosis, silicosis, and coal worker’s pneumoconiosis, and exposure to various chemicals. We are also a potentially responsible party in various environmental proceedings and remediation matters wherein substantial amounts are at issue. Adverse rulings, judgments or settlements in pending or future litigation (including contract litigation and liabilities associated with respirator claims) or in connection with environmental remediation activities could cause our results to differ materially from those expressed or forecasted in any forward-looking statements.

Our restructuring activities and cost saving initiatives may not achieve the results we anticipate.

We have undertaken and will continue to undertake cost reduction initiatives and organizational restructurings to optimize our asset base, improve operating efficiencies and generate cost savings. We cannot be certain that we will be able to complete these initiatives as planned or that the estimated operating efficiencies or cost savings from such activities will be fully realized or maintained over time. In addition, when we close manufacturing facilities, we may not be successful in migrating our customers from those closed facilities to our other facilities.

We may be required to impair or write off certain assets if our assumptions about future sales and profitability prove incorrect.

In analyzing the value of our inventory, property, plant and equipment, investments and intangible assets, we have made assumptions about future sales (pricing and volume), costs and cash generation. These assumptions are based on management’s best estimates and if the actual results differ significantly from these assumptions, we may not be able to realize the value of the assets recorded as of September 30, 2011, which could lead to an impairment or write-off of certain of these assets in the future.

On occasion we enter into derivative contracts with financial counterparties. The effectiveness of these contracts is dependent on the ability of these financial counterparties to perform their obligations and their nonperformance could harm our financial condition.

We have entered into interest rate swap contracts, foreign currency derivatives and forward commodity contracts as part of our financial strategy. The effectiveness of our hedging programs using these instruments is dependent, in part, upon the counterparties to these contracts honoring their financial obligations. If any of our counterparties are unable to perform their obligations in the future, we could be exposed to increased earnings and cash flow volatility due to an instrument’s failure to hedge a financial risk.

 

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We may be subject to information technology systems failures, network disruptions and breaches of data security.

Information technology systems failures, including risks associated with upgrading our systems, network disruptions and breaches of data security could disrupt our operations by impeding our processing of transactions, our ability to protect customer or company information and our financial reporting. Our computer systems, including our back-up systems, could be damaged or interrupted by power outages, computer and telecommunications failures, computer viruses, internal or external security breaches, events such as fires, earthquakes, floods, tornadoes and hurricanes, and/or errors by our employees. Although we have taken steps to address these concerns by implementing sophisticated network security and internal control measures, there can be no assurance that a system failure or data security breach will not have a material adverse effect on our financial condition and results of operations.

The continued protection of our patents and other proprietary intellectual property rights are important to our success.

Our patent and other intellectual property rights are important to our success and competitive position. We own various patents and other intellectual property rights in the U.S. and other countries covering many of our products, as well as processes and product uses. In addition, we are a licensee of various patents and intellectual property rights belonging to others in the U.S. and other countries. Because the laws and enforcement mechanisms of some countries may not allow us to protect our proprietary rights to the same extent as we are able to in the U.S., the strength of our intellectual property rights will vary from country to country.

Irrespective of our proprietary intellectual property rights, we may be subject to claims that our products, processes or product uses infringe the intellectual property rights of others. These claims, even if they are without merit, could be expensive and time consuming to defend and if we were to lose such claims, we could be subject to injunctions and/or damages, or be required to enter into licensing agreements requiring royalty payments and/or use restrictions. Licensing agreements may not be available to us, and if available, may not be available on acceptable terms.

Natural disasters could affect our operations and financial results.

We operate facilities in areas of the world that are exposed to natural hazards, such as floods, windstorms and earthquakes. Such events could disrupt our supply of raw materials or otherwise affect production, transportation and delivery of our products or affect demand for our products.

 

Item 1B. Unresolved Staff Comments

None.

 

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Item 2. Properties

Cabot’s corporate headquarters are in leased office space in Boston, Massachusetts. We also own or lease office, manufacturing, storage, distribution, marketing and research and development facilities in the United States and in foreign countries. The locations of our principal manufacturing and/or administrative facilities are set forth in the table below. Unless otherwise indicated, all the properties are owned.

 

Location by Region

  Core
Segment
  Performance
Segment
  New Business
Segment
  Specialty Fluids
Segment

Americas Region

       

Mountain View, CA*

      X  

Alpharetta, GA*(1)

  X   X   X   X

Tuscola, IL

    X    

Canal, LA

  X   X    

Ville Platte, LA

  X      

Billerica, MA

  X   X   X  

Billerica, MA (plant)*

      X  

Haverhill, MA

      X  

Midland, MI

    X    

Albuquerque, NM (2 plants)*

      X  

Pampa, TX

  X   X    

Campana, Argentina

  X      

Maua, Brazil

  X   X    

Sao Paulo, Brazil*(1)

  X   X   X   X

Cartagena, Colombia

  X      

Lac du Bonnet, Manitoba**

        X

Sarnia, Ontario

  X   X    

 

(1) 

Regional shared service center

*

Leased premises

** Building(s) owned by Cabot on leased land

 

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Location by Region

   Core
Segment
   Performance
Segment
   New Business
Segment
   Specialty Fluids
Segment

EMEA Region

           

Loncin, Belgium

      X      

Leuven, Belgium*(1)

   X    X    X    X

Pepinster, Belgium

      X      

Valasske Mezirici (Valmez), Czech Republic**

   X         

Port Jerome, France**

   X         

Frankfurt, Germany*

         X   

Rheinfelden, Germany

      X      

Ravenna, Italy

   X         

Bergen, Norway*

            X

Kristiansund, Norway*

            X

Aberdeen, Scotland*

            X

Schaffhausen, Switzerland*

   X    X    X    X

Botlek, The Netherlands**

   X    X      

Dubai, United Arab Emirates*

      X      

Barry, Wales**

      X      

Asia Pacific Region

           

Hong Kong, China**

      X      

Jiangxi Province, China**

      X      

Tianjin, China**

   X    X      

Shanghai, China*(1)

   X    X    X    X

Shanghai, China** (plant)

   X         

Mumbai, India*

   X    X      

Cilegon, Indonesia**

   X         

Jakarta, Indonesia*

   X    X      

Merak, Indonesia

   X         

Ichihara, Japan

   X         

Shimonoseki, Japan**

   X    X      

Tokyo, Japan*

   X    X    X   

Port Dickson, Malaysia**

   X       X   

 

(1) 

Regional shared service center

*

Leased premises

** Building(s) owned by Cabot on leased land

During fiscal 2011, we entered into an agreement to sell our Supermetals Business. The Business has manufacturing facilities in Boyertown, Pennsylvania and Kawahigashi-machi, Japan, which are not reflected in the table above.

We conduct research and development for our various businesses primarily at facilities in Billerica, MA; Albuquerque, NM; Mountain View, CA; Pampa, TX; Pepinster, Belgium; Frankfurt and Rheinfelden, Germany; and Port Dickson, Malaysia.

Our existing manufacturing plants, together with announced capacity expansion plans, will generally have sufficient production capacity to meet current requirements and expected near-term growth. These plants are generally well maintained, in good operating condition and suitable and adequate for their intended use. Our administrative offices and other facilities are generally suitable and adequate for their intended purposes.

 

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Item 3. Legal Proceedings

Cabot is a party in various lawsuits and environmental proceedings wherein substantial amounts are claimed. The following is a description of the significant proceedings pending on September 30, 2011, unless otherwise specified.

Environmental Proceedings

In June 2009, Cabot received an information request from the United States Environmental Protection Agency (“EPA”) regarding Cabot’s carbon black manufacturing facility in Pampa, Texas. The information request relates to the Pampa facility’s compliance with certain regulatory and permitting requirements under the Clean Air Act, including the New Source Review (“NSR”) construction permitting requirements. EPA has indicated that this information request is part of an EPA national initiative focused on the U.S. carbon black manufacturing sector. Cabot responded to EPA’s information request in August 2009 and is in discussions with EPA. Based upon how EPA has handled similar NSR initiatives with other industrial sectors, it is anticipated that EPA will seek to require Cabot to employ additional technology control devices or approaches with respect to emissions at certain U.S. facilities and/or seek a civil penalty from Cabot.

Cabot is one of fourteen companies, collectively the Ashtabula River Cooperating Group II (“ARCG II”), which participated in the remediation of the Ashtabula River in Ohio. Our liability at this site is associated with the former Cabot Titania business, which operated two manufacturing facilities in Ashtabula in the 1960s and early 1970s. The ARCG II is part of a public/private partnership (the Ashtabula River Partnership) established to conduct dredging and environmental restoration of the Ashtabula River. In addition to funding provided by the ARCG II and the State of Ohio, the federal government also provided funding toward the project under the Great Lakes Legacy Act and the Water Resources Development Act. Dredging of the river was completed in 2008 and the landfill that was constructed to contain all of the dredged materials was capped in 2009. The ARCG II also is in the process of finalizing a settlement with the Ashtabula River Natural Resource Trustees for alleged natural resource damages to the river. The Consent Decree memorializing this settlement is expected to be filed with the court in late calendar year 2011 or early calendar year 2012.

In 1986, Cabot sold a beryllium manufacturing facility in Reading, Pennsylvania to NGK Metals, Inc. (“NGK”). In doing so, we agreed to share with NGK the costs of certain environmental remediation of the Reading plant site. After the sale, the EPA issued an order to NGK pursuant to the Resource Conservation and Recovery Act (“RCRA”) requiring NGK to address soil and groundwater contamination at the site. Soil remediation at the site has been completed and the groundwater remediation activities are ongoing pursuant to the RCRA order. We are contributing to the costs of the groundwater remediation activities pursuant to the cost-sharing agreement with NGK. Cabot and NGK are also pursuing legal claims against the United States for cost recovery and participation in future remediation activities based on the United States’ previous involvement at the site, beginning in World War II and continuing thereafter.

Cabot continues to perform certain sampling and remediation activities at a former manufacturing site in Gainesville, Florida that was sold in the 1960s. The activities are pursuant to a formal Record of Decision and 1991 Consent Decree with EPA. Cabot installed a groundwater treatment system at the site in the early 1990s, and that system is still in operation. Cabot continues to work cooperatively with EPA, the Florida Department of Environmental Protection and the local authorities on this matter.

As of September 30, 2011, we had a $6 million reserve on both a discounted and undiscounted basis for environmental remediation costs at various sites. The operation and maintenance component of this reserve was $3 million on both a discounted and undiscounted basis. The $6 million reserve represents our current best estimate of costs likely to be incurred for remediation based on our analysis of the extent of cleanup required, alternative cleanup methods available, abilities of other responsible parties to contribute and our interpretation of laws and regulations applicable to each of our sites.

 

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Other Proceedings

Respirator Liabilities

We have exposure in connection with a safety respiratory products business that a subsidiary acquired from American Optical Corporation (“AO”) in an April 1990 asset purchase transaction. The subsidiary manufactured respirators under the AO brand and disposed of that business in July 1995. In connection with its acquisition of the business, the subsidiary agreed, in certain circumstances, to assume a portion of AO’s liabilities, including costs of legal fees together with amounts paid in settlements and judgments, allocable to AO respiratory products used prior to the 1990 purchase by the Cabot subsidiary. In exchange for the subsidiary’s assumption of certain of AO’s respirator liabilities, AO agreed to provide to the subsidiary the benefits of: (i) AO’s insurance coverage for the period prior to the 1990 acquisition and (ii) a former owner’s indemnity of AO holding it harmless from any liability allocable to AO respiratory products used prior to May 1982.

Generally, these respirator liabilities involve claims for personal injury, including asbestosis, silicosis and coal worker’s pneumoconiosis, allegedly resulting from the use of respirators that are claimed to have been negligently designed or labeled. Neither Cabot, nor its past or present subsidiaries, at any time manufactured asbestos or asbestos-containing products. Moreover, not every person with exposure to asbestos, silica or coal mine dust giving rise to a claim used a form of respiratory protection. At no time did this respiratory product line represent a significant portion of the respirator market. In addition, other parties, including AO, AO’s insurers, and another former owner and its insurers (collectively, the “Payor Group”), are responsible for significant portions of the costs of these liabilities, leaving Cabot’s subsidiary with a portion of the liability in only some of the pending cases.

The subsidiary transferred the business to Aearo Corporation (“Aearo”) in July 1995. Cabot agreed to have the subsidiary retain certain liabilities allocable to respirators used prior to the 1995 transaction so long as Aearo paid, and continues to pay, Cabot an annual fee of $400,000. Aearo can discontinue payment of the fee at any time, in which case it will assume the responsibility for and indemnify Cabot against the liabilities allocable to respirators manufactured and used prior to the 1995 transaction. We anticipate that we will continue to receive payment of the $400,000 fee from Aearo and thereby retain these liabilities for the foreseeable future. We have no liability in connection with any products manufactured by Aearo after 1995.

As of September 30, 2011 and 2010, there were approximately 42,000 and 45,000 claimants, respectively, in pending cases asserting claims against AO in connection with respiratory products. Cabot has contributed to the Payor Group’s defense and settlement costs with respect to a percentage of pending claims depending on several factors, including the period of alleged product use. In order to quantify our estimated share of liability for pending and future respirator liability claims, we engaged, through counsel, the assistance of Hamilton, Rabinovitz & Alschuler, Inc. (“HR&A”), a leading consulting firm in the field of tort liability valuation. The methodology developed by HR&A addresses the complexities surrounding our potential liability by making assumptions about future claimants with respect to periods of asbestos, silica and coal mine dust exposure and respirator use. Using those and other assumptions, HR&A estimated the number of future asbestos, silica and coal mine dust claims that would be filed and the related costs that would be incurred in resolving both currently pending and future claims. On this basis, HR&A then estimated the net present value of the share of these liabilities that reflected our period of direct manufacture and our contractual obligations. Based on the HR&A estimates, we have recorded on a net present value basis an $11 million reserve ($16 million on an undiscounted basis) to cover our estimated share of liability for pending and future respirator claims. Cash payments related to this liability were $5 million in fiscal 2011 and $2 million in each of fiscal 2010 and 2009.

Our current estimate of the cost of our share of existing and future respirator liability claims is based on facts and circumstances existing at this time. Developments that could affect our estimate include, but are not limited to, (i) significant changes in the number of future claims, (ii) changes in the rate of dismissals without payment of pending silica and non-malignant asbestos claims, (iii) significant changes in

 

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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 members of the Payor Group, (viii) a change in the availability of AO’s insurance coverage or the indemnity provided by AO’s former owner, (ix) changes in the allocation of costs among the Payor Group and (x) a determination that our assumptions regarding the contractual obligations on which we have estimated our share of liability are inaccurate. 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.

Other Matters

We have various other lawsuits, claims and contingent liabilities arising in the ordinary course of our business. These include a number of claims asserting premises liability for asbestos exposure and claims in respect of our divested businesses. In our opinion, although final disposition of some or all of these other suits and claims may impact our financial statements in a particular period, they should not, in the aggregate, have a material adverse effect on our financial position.

 

Item 4. (Removed and Reserved)

Executive Officers of the Registrant

Set forth below is certain information about Cabot’s executive officers. Ages are as of November 29, 2011.

Patrick M. Prevost, age 56, joined Cabot in January 2008 as President and Chief Executive Officer. Mr. Prevost has also been a member of Cabot’s Board of Directors since January 2008. Prior to joining Cabot, since October 2005, Mr. Prevost served as President, Performance Chemicals, of BASF AG, an international chemical company. Prior to that, he was responsible for BASF Corporation’s Chemicals and Plastics business in North America. Prior to joining BASF in 2003, he held senior management positions at BP and Amoco.

Eduardo E. Cordeiro, age 44, is Executive Vice President and Chief Financial Officer. Mr. Cordeiro joined Cabot in 1998 as Manager of Corporate Planning and served in that position until January 2000. Mr. Cordeiro was Director of Finance and Investor Relations from January 2000 to March 2002, Corporate Controller from March 2002 to July 2003, General Manager of the Fumed Metal Oxides Business from July 2003 to January 2005, General Manager of the Supermetals Business from January 2005 to May 2008, and responsible for Corporate Strategy from May 2008 until February 2009, when he became Cabot’s Chief Financial Officer. Mr. Cordeiro also co-managed CSMP from November 2004 to May 2008. Mr. Cordeiro was appointed Vice President in March 2003 and Executive Vice President in March 2009.

David A. Miller, age 52, joined Cabot in September 2009 as Executive Vice President, General Manager of Cabot’s Core Segment and General Manager of the Americas region. Prior to joining Cabot, Mr. Miller held a variety of management positions in BP’s chemical business in North America, Europe and Asia. Most recently, Mr. Miller served as President, Aromatics Asia, Europe and Middle East from January 2007 to July 2009, President, Global Purified Terephthalic Acid from October 2005 to January 2007, and Senior Vice President, Olefins and Derivatives China & Asia Operations (Innovene division) from January 2004 to October 2005.

Brian A. Berube, age 49, is Vice President and General Counsel. Mr. Berube joined Cabot in 1994 as an attorney in Cabot’s law department and became Deputy General Counsel in June 2001. Mr. Berube was

 

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appointed Vice President in March 2002 at which time he was also named Business General Counsel. Mr. Berube has been General Counsel since March 2003.

Sean D. Keohane, age 44, is Vice President and General Manager of the Performance Segment. Mr. Keohane joined Cabot in August 2002 as Global Marketing Director. Mr. Keohane was General Manager of the Performance Products Business from October 2003 until May 2008, when he was named General Manager of the Performance Segment. He was appointed Vice President in March 2005. Before joining Cabot, Mr. Keohane worked for Pratt & Whitney, a division of United Technologies, in a variety of leadership positions.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Cabot’s common stock is listed for trading (symbol CBT) on the New York Stock Exchange. As of November 15, 2011, there were 983 holders of record of Cabot’s common stock. The tables below show the high and low sales price for Cabot’s common stock for each of the fiscal quarters ended December 31, March 31, June 30, and September 30 and the quarterly cash dividend paid on Cabot’s common stock for the past two fiscal years.

Stock Price and Dividend Data

 

     Quarters Ended  
     December 31      March 31      June 30      September 30  

Fiscal 2011

           

Cash dividends per share

   $ 0.18      $ 0.18      $ 0.18      $ 0.18  

Price range of common stock:

           

High

   $ 38.89       $ 47.11       $ 48.77       $ 43.42   

Low

   $ 32.19       $ 38.03       $ 36.92       $ 23.75   

Fiscal 2010

           

Cash dividends per share

   $ 0.18      $ 0.18      $ 0.18      $ 0.18  

Price range of common stock:

           

High

   $ 27.52      $ 32.23      $ 34.00      $ 33.20  

Low

   $ 20.95      $ 24.13      $ 23.84      $ 22.95  

Issuer Purchases of Equity Securities

The table below sets forth information regarding Cabot’s purchases of its equity securities during the quarter ended September 30, 2011:

 

Period

  Total Number
of Shares
Purchased(1)
    Average
Price Paid
per Share
    Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs(1)
    Maximum Number (or
Approximate Dollar
Value) of Shares that
May Yet Be Purchased
Under the Plans or
Programs(1)
 

July 1, 2011—July 31, 2011

    1,223      $ 39.44            —        4,311,122   

August 1, 2011—August 31, 2011

    228,905      $ 34.26        226,200        4,084,922   

September 1, 2011—September 30, 2011

    1,341,167      $ 31.77        1,338,900        2,746,022   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

    1,571,295          1,565,100     

 

(1) 

On May 11, 2007, we publicly announced that the Board of Directors authorized us to repurchase five million shares of our common stock on the open market or in privately negotiated transactions. On September 14, 2007, the Board of Directors increased the share repurchase authorization to 10 million shares (the “2007 Authorization”). This authorization does not have a set expiration date. In the fourth quarter of 2011 we repurchased 1,565,100 shares under this authorization.

In addition to the 2007 Authorization, in certain circumstances the Board has authorized us to repurchase shares of restricted stock purchased by recipients of certain long-term incentive awards after such shares vest to satisfy tax withholding obligations and associated loan repayment liabilities. The shares are repurchased from employees at fair market value. During the fourth quarter of fiscal 2011, we repurchased 6,195 shares from employees under this authorization.

 

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Item 6. Selected Financial Data

In the fourth quarter of fiscal 2011, Cabot entered into an agreement to sell its Supermetals Business. This transaction is subject to regulatory approval and other customary closing conditions and is expected to close by the end of calendar year 2011. Because of this sale agreement, the results of the Supermetals Business are now presented as discontinued operations, and the assets and liabilities associated with the sale are now presented as assets and liabilities held for sale for all periods presented in the table below.

 

     Years Ended September 30  
         2011             2010             2009             2008             2007      
    (Dollars in millions, except per share amounts and ratios)  

Consolidated Net Income (Loss)

         

Net sales and other operating revenues

  $ 3,102     $ 2,716     $ 2,108     $ 3,001     $ 2,388  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    558       510       217       459       455  

Selling and administrative expenses

    249       241       205       238       241  

Research and technical expenses

    66       65       66       68       59  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations(1)

    243       204       (54     153       155  

Net interest expense and other charges(2)

    (40     (38     (45     (52     (20
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

    203       166       (99     101       135  

(Provision) benefit for income taxes(3)

    (6     (30     21       (10     (25

Equity in earnings of affiliated companies

    8       7       5       8       12  

Income (loss) from discontinued operations, net of tax

    53       26       (2     7       22  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    258       169       (75     106       144  

Net income attributable to noncontrolling interests, net of tax

    22       15       2       20       15  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to Cabot Corporation

  $ 236     $ 154     $ (77   $ 86     $ 129  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Common Share Data

         

Diluted net income (loss) attributable to Cabot Corporation:

         

Income (loss) from continuing operations

  $ 2.77     $ 1.94     $ (1.21   $ 1.21     $ 1.56  

Income (loss) from discontinued operations

    0.80       0.41       (0.04     0.11       0.31  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to Cabot Corporation

  $ 3.57     $ 2.35     $ (1.25   $ 1.32     $ 1.87  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Dividends

  $ 0.72     $ 0.72     $ 0.72     $ 0.72     $ 0.72  

Closing prices

  $ 24.78     $ 32.57     $ 23.11     $ 31.78     $ 35.53  

Weighted-average diluted shares outstanding—millions(4)

    65.4       64.3       62.8       62.8       66.2  

Shares outstanding at year end—millions

    63.9       65.4       65.3       65.3       65.3  

Consolidated Financial Position

         

Current assets

  $ 1,449     $ 1,335     $ 1,060     $ 1,228     $ 1,063  

Current assets held for sale

    106       103       140       180       212  

Net property, plant, and equipment

    1,036       937       972       1,035       976  

Other assets

    511       471       462       363       341  

Non-current assets held for sale

    39       40       42       52       44  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 3,141     $ 2,886     $ 2,676     $ 2,858     $ 2,636  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Current liabilities

  $ 644     $ 523     $ 455     $ 574     $ 520  

Current liabilities held for sale

    12       16       22       27       27  

Long-term debt

    556       600       623       586       503  

Other long-term liabilities

    307       324       334       308       314  

Non-current liabilities held for sale

    6       6       5       4       2  

Cabot Corporation stockholders’ equity

    1,487       1,302       1,134       1,249       1,194  

Noncontrolling interests

    129       115       103       110       76  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and stockholders’ equity

  $ 3,141     $ 2,886     $ 2,676     $ 2,858     $ 2,636  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Working capital(5)

  $ 899     $ 899     $ 723     $ 807     $ 728  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Selected Financial Ratios

         

Adjusted return on invested capital(6)

    16     14     2     8     11

Net debt to capitalization ratio(7)

    20     16     22     30     25

 

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(1) 

Income (loss) from operations includes certain items. For fiscal 2011, certain items include charges of $18 million for the Company’s global restructuring activities and $1 million for environmental reserves and legal settlements. For fiscal 2010, certain items include charges of $46 million for the Company’s global restructuring activities, $3 million for environmental reserves and legal settlements, $2 million for a long-lived asset impairment, and a $2 million addition in the reserve for respirator claims. For fiscal 2009, certain items include charges of $87 million for the Company’s global restructuring activities, $4 million for executive transition costs, and $1 million for the write-down of impaired investments. For fiscal 2008, certain items include charges of $16 million for the closure of our carbon black facility in Waverly, West Virginia, $5 million for the Company’s 2008 global restructuring plan, $4 million for executive transition costs, $3 million for environmental reserves and legal settlements, $2 million related to the closure of a former carbon black facility, and $2 million for debt issuance costs, offset by a gain of $18 million for the sale of land in Altona, Australia and a $2 million reduction in the reserve for respirator claims. For fiscal 2007, certain items include charges of $15 million for legal and environmental reserves and settlements and $11 million for restructuring activities.

(2) 

Net interest expense and other charges for fiscal 2011, 2009 and 2008 include foreign currency losses of $6 million, $15 million and $14 million, respectively. Net interest expense and other charges for fiscal 2010 and 2007 include foreign currency gains of less than $1 million and $9 million, respectively.

(3) 

The Company’s tax rate for fiscal 2011 was a provision of 3% which includes net tax benefits of $24 million from the repatriation of high taxed income, $10 million from the settlements of various tax audits, $2 million from the renewal of the U.S. research and experimentation (“R&E”) credit and $2 million for investment incentive tax credits recognized in China. The Company’s tax rate for fiscal 2010 was a provision of 18% which includes net tax benefits of $15 million from the settlements of various tax audits and $2 million for investment incentive tax credits. The Company’s tax rate for fiscal 2009 was a benefit of 21%, which includes $12 million of net tax benefits resulting from settlements of various tax audits and tax credits during the year. The Company’s tax rate for fiscal 2008 was a provision of 10%, which includes approximately $11 million of net tax benefits resulting from settlements of various tax audits and tax credits during the year. The Company’s tax rate for fiscal 2007 was a provision of 19%, which includes $3 million in tax benefits resulting from the settlement of various tax audits during the year.

(4) 

The weighted-average diluted shares outstanding for fiscal 2009 excludes approximately 4 million shares as those shares would have had an antidilutive effect due to the Company’s net loss position.

(5) 

Working capital is total current assets, including current assets held for sale, less total current liabilities, including current liabilities held for sale.

 

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(6) 

Adjusted return on invested capital (“Adjusted ROIC”) is a non-GAAP financial measure that management believes is useful to investors as a measure of performance and the effectiveness of our use of capital. We use Adjusted ROIC as one measure to monitor and evaluate performance. ROIC is not a measure of financial performance under GAAP and may not be defined and calculated by other companies in the same manner. Adjusted ROIC, which excludes items that management considers to be unusual and not representative of the Company’s segment results, is calculated as follows.

Numerator (four quarter rolling):

Net income (loss) attributable to Cabot Corporation

Less the after-tax impact of:

Noncontrolling interest in net income

Interest expense

Interest income

Certain items

Denominator:

Previous five quarter average invested capital calculated as follows:

Total Cabot Corporation stockholders’ equity

 

  Plus:     Noncontrolling interests’ equity

Long-term debt

Current portion of long-term debt

Notes payable to banks

 

  Less:    Cash and cash equivalents

Less the four quarter rolling impact of after tax certain items.

 

(7) 

Net debt to capitalization ratio is calculated by dividing total debt (the sum of short-term and long-term debt less cash and cash equivalents) by the sum of total stockholder’s equity plus noncontrolling interest.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and related disclosure of contingent assets and liabilities. We consider an accounting estimate to be critical to the financial statements if (i) the estimate is complex in nature or requires a high degree of judgment and (ii) different estimates and assumptions were used, the results could have a material impact on the consolidated financial statements. On an ongoing basis, we evaluate our 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 and Notes Receivable

We recognize revenue when persuasive evidence of a sales arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectability is probable. 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 shipping 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 revenue when billed to customers or included in the sales price. Shipping and handling costs are included in cost of sales.

The following table shows the relative size of the revenue recognized in each of our reportable segments.

 

     Years ended September 30  
     2011     2010     2009  

Core Segment

     65     63     63

Performance Segment

     29     30     31

New Business Segment

     4     4     3

Specialty Fluids Segment

     2     3     3

We derive the substantial majority of revenues from the sale of products in our Core and Performance Segments. 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 the estimates of discounts and volume rebates and adjust revenues accordingly.

Revenue in the New Business Segment 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.

The majority of the revenue in the Specialty Fluids Segment 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. On occasion we also make sales of cesium formate outside of a rental process and revenue is recognized upon delivery of the fluid.

 

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We maintain allowances for doubtful accounts based on an assessment of the collectibility 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. Changes in the allowance during fiscal 2011 and 2010 were not material. There is no off-balance sheet credit exposure related to customer receivable balances.

Inventory Valuation

The cost of most raw materials, work in process and finished goods inventories in the U.S. is determined by the last-in, first-out (“LIFO”) method. Total U.S. inventories utilizing this cost flow assumption was $32 million at both September 30, 2011 and 2010. These inventories represent 8% and 10% of total worldwide inventories at the respective year-ends. 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 $53 million and $35 million higher as of September 30, 2011 and 2010, respectively. The cost of other U.S. and all non-U.S. inventories is determined using the average cost method or 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.

At certain times, we may decrease inventory levels to the point where layers of inventory recorded under the LIFO method that were purchased in preceding years are liquidated. The inventory in these layers may be valued at an amount that is different than our current costs. If there is a liquidation of an inventory layer, there may be an impact to our cost of sales and net income for that period. If the liquidated inventory is at a cost lower than our current cost, there would be a reduction in our cost of sales and an increase to our net income during the period. Conversely, if the liquidated inventory is at a cost higher than our current cost, there will be an increase in our cost of sales and a reduction to our net income during the period.

During fiscal 2009 inventory quantities were reduced at our U.S. Rubber Blacks and Performance Products sites, leading to liquidations of LIFO inventory quantities. These LIFO layer liquidations resulted in a decrease of cost of goods sold of $5 million and an increase in consolidated net income of $3 million ($0.06 per diluted common share) for fiscal 2009. No such reductions occurred in either fiscal 2011 or 2010.

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 the 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 inventory and the 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.

Stock-based Compensation

We have issued restricted stock, restricted stock units, and stock options under our equity compensation plans. The fair value of restricted stock and restricted stock units is the market price of our stock on the day of the grant. The fair value is recognized as expense over the service period, which generally represents the vesting period. The vesting of certain restricted stock units is dependent on certain performance based criteria. We evaluate the likelihood of achievement of such performance objectives each quarter and record stock-based compensation based on this assessment. There are no other significant estimates involved in recording compensation costs for restricted stock units with the exception of estimates we make around the probability of forfeitures. Changes in the forfeiture assumptions could impact our earnings but would not impact our cash flows.

 

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We use the Black-Scholes option pricing model to calculate the fair value of stock options issued under our equity compensation plans. In determining the fair value of stock options, we make a variety of assumptions and estimates, including discount rates, volatility measures, expected dividends and expected option lives. Changes to such assumptions and estimates can result in different fair values and could therefore impact our earnings. Such changes would not impact our cash flows.

Goodwill and Long-Lived Assets

Goodwill is comprised of the cost 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, or when events or changes in the business environment indicate that the carrying value of the reporting unit may exceed its fair value. The annual review is performed as of March 31st of each year.

For the reporting units that carry goodwill balances, our impairment test consists of a comparison of each reporting unit’s carrying value to its estimated fair value. A reporting unit, for the purpose of the impairment test, is at or below the operating segment level. We have three reporting units that carry goodwill balances: Rubber Blacks, Fumed Metal Oxides, and Security Materials. The estimated fair value of a reporting unit is primarily based on discounted estimated future cash flows. We validate this model by considering other factors such as the fair value of comparable companies to our reporting units, and also perform a reconciliation of the fair value of all our reporting units to our overall market capitalization. The assumptions used to estimate the discounted cash flows are based on our best estimates of future growth rates, operating cash flows, capital expenditures, discount rates and market conditions over an estimate of the remaining operating period at the reporting unit level. The discount rate is based on the weighted average cost of capital that is determined by evaluating the risk free rate of return, cost of debt, and expected equity premiums. If an impairment exists, a loss is recorded to write-down the value of goodwill to its implied fair value. As a result of the test completed for March 31, 2011, the estimated fair value substantially exceeded the carrying value of our reporting units.

As of September 30, 2011, our goodwill balance is allocated between three reporting units: Rubber Blacks, $27 million, Fumed Metal Oxides, $11 million, and Security Materials, $2 million. There have been no goodwill impairment charges during the periods presented in these financial statements.

Our long-lived assets primarily include property, plant and equipment, long-term investments, assets held for rent and sale and intangible assets. We review the carrying values of long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of an asset may not be recoverable. Such circumstances would include, but are not limited to, a significant decrease in the market price of the long-lived asset, a significant adverse change in the way the asset is being used, a decline in the physical condition of the asset or a history of operating or cash flow losses associated with the use of the asset. In the recent past, impairments have generally been recognized when we determine that we will restructure certain operations.

To test for impairment of assets we generally use a probability-weighted estimate of the future undiscounted net cash flows of the assets or asset grouping over the remaining life of the asset to determine if the asset is recoverable. If we determine that the asset is not recoverable, we determine if there is a potential impairment loss by calculating the fair value of the asset using a probability-weighted discounted estimate of future cash flows. The discount rate is based on the weighted average cost of capital that is determined by evaluating the risk free rate of return, cost of debt, and expected equity premiums. To the extent the carrying value exceeds the fair value of the asset or asset group, an impairment loss is recognized in the statement of operations in that period.

 

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Financial Instruments

Our financial instruments consist primarily of cash and cash equivalents, accounts and notes receivables, investments, accounts payable and accrued liabilities, short-term and long-term debt, and derivative instruments. The carrying values of our financial instruments approximate fair value with the exception of our long-term debt that has not been designated as part of a fair value hedge. The non-hedged long-term debt is recorded at amortized cost. The fair values of our financial instruments are based on quoted market prices, if such prices are available. In situations where quoted market prices are not available, we rely on valuation models to derive fair value. For interest rate swaps and cross currency swaps, we use standard models with market-based inputs. The significant inputs to these models are interest rate curves for discounting future cash flows. In determining the fair value of the commodity derivatives, the significant inputs to valuation models are quoted market prices of similar instruments in active markets. Such valuation takes into account the ability of the financial counterparty to perform.

We use derivative financial instruments primarily for purposes of hedging exposures to fluctuations in interest rates and foreign currency exchange rates, which exist as part of our on-going business operations. We do not enter into derivative contracts for speculative purposes, nor do we hold or issue any financial instruments for trading purposes. All derivatives are recognized on our Consolidated Balance Sheets at fair value. Where we have a legal right to offset derivative settlements under a master netting agreement with a counterparty, derivatives with that counterparty are presented on a net basis. The changes in the fair value of derivatives are recorded in either earnings or accumulated other comprehensive income, depending on whether or not the instrument is designated as part of a hedge transaction and, if designated as part of a hedge transaction, the type of hedge transaction. The gains or losses on derivative instruments reported in accumulated other comprehensive income are reclassified to earnings in the period in which earnings are affected by the underlying hedged item. The ineffective portion of all hedges is recognized in earnings during the period in which the ineffectiveness occurs.

In accordance with our risk management strategy, we may enter into certain derivative instruments that may not be designated as hedges for accounting purposes. Although these derivatives are not designated as hedges, we believe that such instruments are closely correlated with the underlying exposure, thus managing the associated risk. We record in earnings the gains or losses from changes in the fair value of derivative instruments that are not designated as hedges. Cash movements associated with these instruments are presented in the Consolidated Statements of Cash Flows as Cash Flows from Operating Activities because the derivatives are designed to mitigate risk to our cash flow from operations.

Assets and liabilities measured at fair value, including assets that are part of our defined benefit pension plans, are classified in the fair value hierarchy based on the inputs used for valuation. Assets that are actively traded on an exchange with a quoted price are classified as Level 1. Assets and liabilities that are valued based on quoted prices for similar assets or liabilities in active markets, or standard pricing models using observable inputs are classified as Level 2. As of September 30, 2011, we have no assets or liabilities carried at fair value that are valued using unobservable inputs and, therefore, no assets or liabilities that are classified as Level 3. The sensitivity of fair value estimates is immaterial relative to the assets and liabilities measured at fair value, as well as to our total equity, as of September 30, 2011.

Pensions and Other Postretirement Benefits

We maintain both defined benefit and defined contribution plans for our employees. In addition, we provide certain postretirement health care and life insurance benefits for our retired employees. Plan obligations and annual expense calculations are based on a number of key assumptions. The assumptions, which are specific for each of our U.S. and foreign plans, are related to both the assets we hold to fund our plans (where applicable) and the characteristics of the benefits that will ultimately be provided to our employees. The most significant assumptions relative to our plan assets include the anticipated rates of return on these assets. Assumptions relative to our pension obligations are more varied; they include

 

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estimated discount rates, rates of compensation increases for employees, mortality, employee turnover and other related demographic data. Projected health care and life insurance obligations also rely on the above mentioned demographic assumptions and assumptions surrounding health care cost trends.

We compute our recorded obligations globally in accordance with U.S. generally accepted accounting principles. Under such principles, if actual results differ from what is projected, the differences are generally accumulated and amortized over future periods and could therefore affect the recognized expense and recorded obligation in such future periods. However, cash flow requirements may be different from the amounts of expense that are recorded in the consolidated financial statements. In fiscal 2011, restructuring activities and other employee actions relative to normal operations resulted in certain pension plan curtailments and settlements, which tend to accelerate the recognition of the deferred gains and losses.

Self-Insurance Reserves

We are partially self-insured for certain third-party liabilities globally, as well as workers’ compensation and employee medical benefits in the United States. The third-party and workers’ compensation liabilities are managed through a wholly-owned insurance captive and the related liabilities are included in the consolidated financial statements. The employee medical obligations are managed by a third-party provider and the related liabilities are included in the consolidated financial statements. To limit our potential liabilities for these risks, however, we purchase insurance from third-parties that provides individual and aggregate stop loss protection. The aggregate self-insured liability in fiscal 2011 for combined third party liabilities, U.S. workers’ compensation and employee medical benefits is $6 million, and the retention for medical costs in the United States is at most $200,000 per person per annum. We have accrued amounts equal to the actuarially determined future liabilities. We determine the actuarial assumptions in collaboration with third-party actuaries, based on historical information along with certain assumptions about future events. Changes in assumptions for such matters as legal actions, medical costs and changes in actual experience could cause these estimates to change and impact our earnings and cash flows.

Asset Retirement Obligations

We account for asset retirement obligations by estimating incremental costs for special handling, removal and disposal costs of materials that may or will give rise to conditional asset retirement obligations (“AROs”) and then discount the expected costs back to the current year using a credit adjusted risk-free rate. ARO liabilities and costs are recognized when the timing and/or settlement can be reasonably estimated. If it is unclear when, or if, an ARO will be triggered, we use probability weightings for possible timing scenarios to determine the amounts that should be recognized in our financial statements.

The estimation of AROs is subject to a number of inherent uncertainties including: (a) the timing of when any ARO may be incurred, (b) the ability to accurately identify and reasonably estimate the costs of all materials that may require special handling or treatment, (c) the ability to assess the relative probability of different scenarios that could give rise to an ARO, and (d) other factors outside our control, including changes in regulations, costs and interest rates.

AROs have not been recognized for certain of our facilities because either the present value of the obligation cannot be reasonably estimated due to an indeterminable facility life or we do not have a legal obligation associated with the retirement of those facilities. In most circumstances where AROs have been recorded, the anticipated cash outflows will likely take place far into the future. Accordingly, actual costs and the timing of such costs may vary significantly from our estimates, which may, in turn, impact our earnings. In general, however, when such estimates change, the impact is spread over future years and thus the impact on any individual year is unlikely to be material.

 

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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.

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 respiration 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 our assumptions regarding contractual obligations on which we have estimated our share of liability are inaccurate. 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.

Income Taxes

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

 

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uncertain. Furthermore, our tax positions are periodically subject to challenge by taxing authorities throughout the world. We have recorded reserves 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 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.

Highly Inflationary Environments

We monitor the currencies of countries in which we operate in order to determine if the country should be considered a highly inflationary environment. If and when a currency is determined to be highly inflationary (cumulative inflation of approximately 100 percent or more over a 3-year period), the functional currency of the affected operation would be changed to our reporting currency, the U.S. dollar. Due to cumulative inflation in Venezuela over a three-year period exceeding 100% as of January 1, 2010, the functional currency of our Venezuelan operating entity has changed to the U.S. dollar.

Restructuring Activities

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) costs to vacate certain facilities and (iii) asset impairments. 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.

Significant Accounting Policies

We have other significant accounting policies that are discussed in Note A of the Notes to our Consolidated Financial Statements in Item 8 below. Certain of these policies include the use of estimates, but do not meet the definition of critical because they generally do not require estimates or judgments that are as difficult or subjective to measure. However, these policies are important to an understanding of the consolidated financial statements.

 

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Results of Operations

Definition of Terms

When discussing our income (loss) from operations, we use several terms. The following discussion of results includes information on our reportable segment sales and segment (or business) operating profit (loss) before interest and tax (“EBIT”). In calculating segment EBIT, we exclude certain items, meaning items that are considered by management to be unusual and not representative of segment results. In addition, in calculating segment EBIT, we include Equity in net income of affiliated companies, net of tax, royalties paid by equity affiliates and Net income attributable to noncontrolling interests, net of tax, but exclude Interest expense, foreign currency transaction gains and losses, interest income, dividend income, unearned revenue, the effects of LIFO accounting for inventory, and unallocated general and 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. A reconciliation of segment EBIT to Income (loss) from continuing operations before income taxes and equity in net earnings of affiliated companies is set forth within this section.

The term “LIFO” includes two factors: (i) the impact of current inventory costs being recognized immediately in cost of goods sold (“COGS”) under a last-in first-out method, compared to the older costs that would have been included in COGS under a first-in first-out method (“COGS impact”); and (ii) the impact of reductions in inventory quantities, causing historical inventory costs to flow through COGS (“liquidation impact”). The term “contract lag” refers to the time lag of the feedstock related pricing adjustments in certain of our rubber blacks supply contracts. 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 discussion under the heading “Provision for Income Taxes” includes a discussion of our “operating tax rate”. In calculating our operating tax rate (which is intended to provide the best metric of the Company’s on-going tax rate), we exclude from the recorded tax provision (i) discrete tax items, which are unusual or infrequent, and (ii) the tax impact of certain items. For this calculation, pretax income from continuing operations is also adjusted to exclude the impact of certain items.

Cabot is organized into four business segments: the Core Segment, the Performance Segment, the New Business Segment and the Specialty Fluids Segment. Cabot is also organized for operational purposes into three geographic regions: the Americas; Europe, Middle East and Africa; and Asia Pacific. Discussions of all periods reflect these structures.

Financial results in all periods have been recast to conform to changes made to Income (loss) from discontinued operations, net of tax for our Supermetals Business and our segment reporting structure. The segment reporting structure changes include the reclassification of: i) the Cabot Elastomer Composites Business from the Rubber Blacks Business to the New Business Segment; ii) corporate business development costs related to new technology efforts from the New Business Segment to Unallocated corporate costs; iii) the COGS impact from LIFO accounting from the Rubber Blacks Business and Performance Segment to General unallocated (expense) income; and iv) corporate overhead costs that had been allocated to the Supermetals Business to the remaining Segments.

Our analysis of financial condition and operating results should be read with our Consolidated Financial Statements and accompanying notes. Unless a calendar year is specified, all references to years in this discussion are to our fiscal years ended September 30.

Drivers of Demand and Key Factors Affecting Profitability

Drivers of demand and key factors affecting our profitability differ by Segment. In our Core Segment, demand in the Rubber Blacks Business is influenced on a long term basis primarily by: i) the number of vehicle miles driven globally; ii) the number of original equipment and replacement tires produced; and iii) the number of automotive builds. Over the past several years, the Rubber Blacks Business’ operating results

 

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have been driven by a number of factors, including: i) increases or decreases in sales volumes; ii) changes in raw material costs and our ability to obtain sales price increases for our products commensurate with increases in raw material costs; iii) changes in pricing and product mix; iv) global and regional capacity utilization; v) fixed cost savings achieved through restructuring and other cost saving activities; vi) the growth of our volumes and market position in emerging economies; and vii) capacity management and technology investments, including the impact of energy utilization and yield improvement technologies at our manufacturing facilities. Historically, there has been a time lag between when we incur feedstock costs and the time when prices are adjusted under our supply contracts that contain feedstock related pricing formulas. Since 2008, we have been actively renegotiating these contracts in an attempt to reduce this time delay. However, during fiscal 2009, we still had contracts with a time delay in the pricing adjustment and, therefore, experienced an unfavorable impact to segment EBIT. During fiscal 2010, we reduced the percentage of volume subject to this time lag, and the financial impact of the time lag was immaterial to our business results in fiscal 2010 and fiscal 2011.

In our Performance Segment, longer term demand is driven primarily by the construction and infrastructure, automotive, electronics and consumer products industries. In recent years, operating results in the Performance Segment have been driven by: i) our growth in emerging markets; ii) our ability to deliver differentiated products that drive enhanced performance in customers’ applications; and iii) our ability to obtain value pricing for this differentiation.

In our New Business Segment, drivers of demand are specific to the various businesses. In the Inkjet Colorants Business, demand has been driven by a relative increase of printer platforms using our pigments at both new and existing customers and the broader adoption of inkjet technology in office and commercial printing applications. Demand in the Aerogel Business has been driven by the adoption of aerogel products for oil and gas, daylighting, insulation for building and construction and specialty chemical applications. In the Cabot Superior MicroPowders Business, demand has been driven principally by the number of security taggant applications incorporating our unique and proprietary particles. In the Cabot Elastomer Composites Business, demand has been driven by the penetration of our unique compound of natural rubber and carbon black made in a patented liquid phase into applications for the tire, mining and defense industries. Operating results in the New Business Segment have been influenced by: i) our ability to improve the pace of revenue generation in the Segment; ii) our ability to select the highest value opportunities and work with lead users in the appropriate markets; iii) our ability to appropriately size the overall cost platform of the Segment for the opportunities; and iv) the timing of milestone payments in our Cabot Elastomer Composites Business.

In our Specialty Fluids Segment, demand for cesium formate is primarily driven by the level of drilling activity for high pressure oil and gas wells and by the petroleum industry’s acceptance of our product as a drilling and completion fluid for this application. Operating results in the Specialty Fluids Segment have been driven by the size, type and duration of drilling jobs.

Overview of Results for Fiscal 2011

During fiscal 2011, profitability increased compared to fiscal 2010 driven by improved pricing and product mix and benefits from investments in energy centers and yield technology. During fiscal 2011, we entered into an agreement to divest our Supermetals Business. As such, operating results from the Supermetals Business are included in Income (loss) from discontinued operations, net of tax, for all periods presented on the Consolidated Statements of Operations and the assets and liabilities related to this business are categorized as held for sale for all periods presented on the Consolidated Balance Sheets.

 

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Fiscal 2011 compared to Fiscal 2010 and Fiscal 2010 compared to Fiscal 2009—Consolidated

Net Sales and Gross Profit

 

     Years ended September 30  
     2011      2010      2009  
     (Dollars in millions)  

Net sales and other operating revenues

   $ 3,102      $ 2,716      $ 2,108  

Gross profit

   $ 558      $ 510      $ 217  

The $386 million increase in net sales from fiscal 2010 to fiscal 2011 was due primarily to higher selling prices and a favorable product mix ($301 million) and the favorable effect of foreign currency translation ($97 million) partially offset by lower volumes ($8 million). The $608 million increase in net sales from fiscal 2009 to fiscal 2010 was due primarily to higher volumes ($404 million) from stronger demand in our key end markets, higher selling prices and a favorable product mix ($132 million) and the favorable effect of foreign currency translation ($52 million).

Gross profit increased by $48 million in fiscal 2011 when compared to fiscal 2010 principally due to higher unit margins driven by the implementation of strategic value pricing and product mix initiatives and benefits from the investments in energy centers and yield technology that more than offset higher raw material costs. Gross profit increased by $293 million in fiscal 2010 when compared to fiscal 2009 principally due to: i) higher volumes from improved demand in our end markets; ii) higher unit margins driven by the implementation of strategic value pricing and product mix initiatives; and iii) lower charges recorded as cost of sales during fiscal 2010 principally related to restructuring expenses. While there was a significant contract lag and LIFO benefit in fiscal 2009, the impact in fiscal 2010 was minimal. This resulted in an unfavorable year over year comparison for both of these items.

Gross profit percentage may be significantly affected by changes in net sales as a result of increases or decreases in prices based on the price adjustment to customers for increases or decreases in raw material costs. Therefore, we do not use gross profit percentage as an indicator of business performance, but instead we focus on gross profit dollar changes from period to period as a better indicator of business performance.

Selling and Administrative Expenses

 

     Years Ended September 30  
     2011      2010      2009  
     (Dollars in millions)  

Selling and administrative expenses

   $ 249       $ 241      $ 205  

Selling and administrative expenses increased by $8 million in fiscal 2011 when compared to fiscal 2010. The comparative increase is principally due to increased business and business development activity levels that were partially offset by lower restructuring related expenses. Selling and administrative expenses increased by $36 million in fiscal 2010 when compared to fiscal 2009. The comparative increase is principally due to substantially lower spending levels in fiscal 2009 from cost saving measures implemented at the onset of the global economic downturn, higher restructuring related charges and an increase in performance based compensation in fiscal 2010 commensurate with improved operating results.

Research and Technical Expenses

 

     Years Ended September 30  
     2011      2010      2009  
     (Dollars in millions)  

Research and technical expenses

   $ 66       $ 65      $ 66  

Research and technical expenses were $1 million higher in fiscal 2011 when compared to fiscal 2010 as we maintained our investment in new product and process development opportunities across the businesses. Research and technical expenses were lower by $1 million in fiscal 2010 when compared to

 

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fiscal 2009. While maintaining our gross spending levels, we also continued to focus on investing in our highest value new business and process research opportunities during fiscal 2010.

Interest and Dividend Income

 

     Years Ended September 30  
     2011      2010      2009  
     (Dollars in millions)  

Interest and dividend income

   $ 2       $ 2      $ 3  

Interest and dividend income was $2 million in both fiscal 2011 and 2010. Interest and dividend income was $1 million lower in fiscal 2010 when compared to fiscal 2009 primarily due to lower interest rates, partially offset by higher cash balances.

Interest Expense

 

     Years Ended September 30  
     2011      2010      2009  
     (Dollars in millions)  

Interest expense

   $ 39      $ 40      $ 30  

Interest expense decreased by $1 million in fiscal 2011 when compared to fiscal 2010 driven by lower average debt levels in fiscal 2011 as compared to fiscal 2010. Interest expense increased by $10 million in fiscal 2010 when compared to fiscal 2009. The comparative increase was primarily due to higher average interest rates resulting from the issuance of our 5% Notes in the fourth quarter of fiscal 2009.

Other Expense

 

     Years Ended September 30  
     2011      2010      2009  
     (Dollars in millions)  

Other expense

   $ 3      $       $ 18  

Other expense balances are driven by foreign currency movements, including gains or losses on foreign currency transactions and the remeasurement of our foreign currency denominated debt and related derivatives. The $3 million increase in expense from fiscal 2010 to fiscal 2011 was principally driven by an unfavorable comparison of these foreign currency movements. The $18 million decrease in expense from fiscal 2009 to fiscal 2010 was driven by a favorable comparison of these foreign currency movements, which included the write down in fiscal 2009 of the value of bolivars that had accumulated in our holding companies over several years to a parallel exchange rate ($5 million).

(Provision) Benefit for Income Taxes

 

     Years Ended September 30  
     2011     2010     2009  
     (Dollars in millions)  

(Provision) benefit for income taxes

   $ (6   $ (30   $ 21  

Effective tax rate

     3     18     21

In calculating our operating tax rate, we exclude discrete tax items and the impact of certain items on both operating income and the tax provision.

The provision for income taxes was $6 million for fiscal 2011, resulting in an overall 3% tax rate. This amount included discrete tax benefits of $38 million comprised of: i) $24 million related to the repatriation of high tax income in response to recent changes in U.S. tax legislation; ii) $10 million from audit settlements; iii) $2 million from the recognition of investment tax credits in China; and iv) $2 million from the renewal of the U.S. research and experimentation (“R&E”) credit. The operating tax rate for fiscal 2011 was 22%.

 

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The provision for income taxes was $30 million for fiscal 2010, resulting in an overall 18% tax rate. This amount included discrete tax benefits of $15 million related to the settlement of various tax audits and $2 million for investment incentive credits earned, partially offset by a $1 million charge for miscellaneous adjustments. The operating tax rate for fiscal 2010 was 25%.

The benefit for income taxes was $21 million for fiscal 2009, resulting in an overall 21% tax rate. This amount included discrete tax benefits of $12 million comprised of: i) $9 million from audit settlements; ii) $2 million for the renewal of the U.S. R&E credit; and iii) $1 million for investment incentive credits earned. However, the operating tax rate for fiscal 2009 was a charge of 83% due to the fact that the losses for which no tax benefit could be recorded were disproportionately high compared to overall income for the year.

Our anticipated operating tax rate for fiscal 2012 is 24% to 25%. The IRS has not yet commenced the audit of our 2008 and 2009 tax years and certain Cabot subsidiaries are 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 2012 and could impact our anticipated overall tax rate. We have filed our tax returns in accordance with the tax laws in each jurisdiction and maintain tax reserves for uncertain tax positions.

Equity in Net Income of Affiliates and Noncontrolling Interest in Net Income, net of tax

 

     Years Ended September 30  
     2011      2010      2009  
     (Dollars in millions)  

Equity in net income of affiliated companies, net of tax

   $ 8      $ 7      $ 5  

Net income attributable to noncontrolling interests, net of tax

     22        15        2  

Equity in net income of affiliated companies, net of tax, increased by $1 million in fiscal 2011 when compared to fiscal 2010 due primarily to an improvement in profitability at our equity affiliates in Mexico and Venezuela. Equity in net income of affiliated companies, net of tax, increased by $2 million in fiscal 2010 when compared to fiscal 2009 due primarily to an improvement in profitability at our equity affiliate in Mexico as our end markets recovered from the 2009 global economic downturn.

Noncontrolling interest in net income, net of tax, is the means by which the minority shareholders’ portion of the income or loss in our consolidated joint ventures is removed from our consolidated statement of operations. For fiscal 2011, the $7 million increase in net income attributable to noncontrolling interests, net of tax, is due to the improved profitability of our joint ventures in China, the Czech Republic and Malaysia from higher unit margins. In fiscal 2010, the $13 million increase in net income attributable to noncontrolling interests, net of tax, is due to the improved profitability of our joint ventures in China, Indonesia, and Malaysia, from higher volumes and unit margins.

Income (Loss) from Discontinued Operations, net of tax

During fiscal 2011, we entered into an agreement to divest our Supermetals Business. As such, we have reclassified income from continuing operations related to the Supermetals Business to Income (loss) from discontinued operations, net of tax, for each of the last three fiscal years. The $27 million increase in income from discontinued operations from fiscal 2010 to fiscal 2011 was driven by an increase in profitability of the Supermetals Business as a result of improved pricing and product mix. The $28 million increase in income from discontinued operations from fiscal 2009 to fiscal 2010 was driven by an increase in profitability of the Supermetals Business as a result of higher volumes and lower raw material costs. In addition, in each of fiscal 2011 and 2009, we recorded a loss from discontinued operations, net of tax, of less than $1 million associated with other divested businesses. There were no other items included in discontinued operations in fiscal 2010.

 

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Net Income (Loss) Attributable to Cabot Corporation

In fiscal 2011, we reported net income of $236 million ($3.57 per diluted common share). This is compared to net income of $154 million ($2.35 per diluted common share) in fiscal 2010 and net loss of $77 million ($1.25 per diluted common share) in fiscal 2009.

Fiscal 2011 compared to Fiscal 2010 and Fiscal 2010 compared to Fiscal 2009—By Business Segment

Total segment EBIT, certain items, other unallocated items and income (loss) from continuing operations before taxes for fiscal 2011, 2010 and 2009 are set forth in the table below. The details of certain items and other unallocated items are shown below and in Note V of our Consolidated Financial Statements.

 

     Years Ended September 30  
       2011         2010         2009    
     (Dollars in millions)  

Total segment EBIT

   $ 354      $ 314     $ 61  

Certain items

     (19     (53     (92

Other unallocated items

     (132     (95     (68
  

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before taxes

   $ 203     $ 166     $ (99
  

 

 

   

 

 

   

 

 

 

In fiscal 2011, total segment EBIT increased by $40 million when compared to fiscal 2010. The increase was principally driven by higher unit margins ($101 million) from increased prices, a favorable product mix and the benefits from investments in energy centers and yield technology that more than offset higher raw material costs. Higher fixed manufacturing costs ($44 million) from higher maintenance and other plant operating costs, lower volumes ($9 million) in the Rubber Blacks Business and Specialty Fluids Segment, and an increase in selling and administrative costs ($9 million) primarily related to increased headcount to support business activities in the Performance and New Business Segments partially offset this improvement.

In fiscal 2010, total segment EBIT increased by $253 million when compared to fiscal 2009. The increase was principally driven by higher volumes ($177 million) from stronger demand in our end markets and higher unit margins ($100 million) from increased prices, a favorable product mix and the favorable comparison from charges in fiscal 2009 related to older, high cost inventories that did not recur in fiscal 2010. While there was a significant contract lag benefit in fiscal 2009, the impact in fiscal 2010 was minimal. This resulted in an unfavorable year over year comparison ($23 million) for this item.

Certain Items:

In recent years, the costs of various restructuring activities have been recorded as certain items, and thus not included in segment results. These charges principally comprised the certain items that were recorded in fiscal 2011, 2010 and 2009. In fiscal 2009, we implemented a global plan to restructure our operations, which has continued through fiscal 2011. In addition, we closed our masterbatch plant in Grigno, Italy in fiscal 2011 and closed our carbon black facility in Thane, India in fiscal 2010.

Details of the certain items for fiscal 2011, 2010, and 2009 are as follows:

 

     Years Ended September 30  
       2011         2010         2009    
     (Dollars in millions)  

Global restructuring activities

     (18     (46     (87

Environmental reserves and legal settlements

     (1     (3       

Executive transition costs

                   (4

Long-lived asset impairment

            (2       

Reserve for respirator claims

            (2       

Write-down of impaired investments

                   (1
  

 

 

   

 

 

   

 

 

 

Total certain items, pre-tax

   $ (19   $ (53   $ (92
  

 

 

   

 

 

   

 

 

 

 

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Other unallocated items include interest expense, equity in net income of affiliated companies, Unallocated corporate costs, and general unallocated (expense) income. The balances of Unallocated corporate costs are comprised of corporate costs primarily related to managing a public company that are not allocated to the segments and corporate business development costs related to new technology efforts. The balances of General unallocated (expense) income primarily include foreign currency transaction gains (losses), interest income, dividend income, the profit related to unearned revenue, and the COGS impact of LIFO accounting.

Other Unallocated Items:

 

     Years Ended September 30  
       2011         2010         2009    
     (Dollars in millions)  

Interest expense

   $ (39   $ (40   $ (30

Equity in net income of affiliated companies

     (8     (7     (5

Unallocated corporate costs

     (53     (48     (36

General unallocated (expense) income

     (32            3  
  

 

 

   

 

 

   

 

 

 

Total other unallocated items

   $ (132   $ (95   $ (68
  

 

 

   

 

 

   

 

 

 

In fiscal 2011, costs from total other unallocated items increased by $37 million when compared to the same period of fiscal 2010. The increase was driven by an increase in the charge associated with: i) the COGS impact of LIFO accounting ($16 million) due to rising carbon black raw material costs in fiscal 2011; ii) the unfavorable comparative of foreign currency transactions ($7 million); and iii) the unfavorable impact of a change in the net worth tax in Colombia ($3 million). In addition, there were higher costs commensurate with an increase in business activity levels and higher spending for corporate business development activities. In fiscal 2010, costs from total other unallocated items increased by $27 million when compared to the same period of fiscal 2009. The increase was driven by: i) an unfavorable comparison due to a fiscal 2009 benefit from the COGS impact of LIFO accounting ($22 million) from lower carbon black feedstock costs, which did not repeat in fiscal 2010, and ii) an increase in interest expense ($10 million) due to higher average interest rates resulting from the issuance of our 5% Notes in the fourth quarter of fiscal 2009.

Core Segment

Sales and EBIT for the Rubber Blacks Business for fiscal 2011, 2010 and 2009 are as follows:

 

     Years Ended September 30  
     2011      2010      2009  
     (Dollars in millions)  

Rubber Blacks Business Sales

   $ 1,952       $ 1,660       $ 1,283   
  

 

 

    

 

 

    

 

 

 

Rubber Blacks Business EBIT

   $ 183       $ 139      $ 21   
  

 

 

    

 

 

    

 

 

 

In fiscal 2011, sales in the Rubber Blacks Business increased by $292 million when compared to fiscal 2010. The increase was principally driven by higher prices and a favorable product mix ($252 million) and the favorable effect of foreign currency translation ($73 million). Global volumes decreased by 2% in fiscal 2011 relative to fiscal 2010 driven by the closure of our carbon black facility in India. Excluding the impact of the closure of the India facility, global volumes were consistent with the prior year. In fiscal 2010, sales in the Rubber Blacks Business increased by $377 million when compared to fiscal 2009. The increase was principally driven by higher volumes ($246 million), higher prices and a favorable product mix ($94 million) and the favorable effect of foreign currency translation ($45 million). Global volumes increased by 19% in fiscal 2010 relative to fiscal 2009 from increased demand due to a combination of recovery in our end markets and the impact of expanded capacity at our facility in Tianjin, China.

 

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In fiscal 2011, Rubber Blacks EBIT increased by $44 million when compared to fiscal 2010. The increase was principally driven by higher unit margins ($79 million) from higher pricing, a favorable product mix and benefits from investments in energy centers and yield technology that more than offset higher raw material costs. Higher fixed manufacturing costs ($23 million) from higher maintenance and other plant operating costs and lower volumes ($11 million) partially offset these positive factors. In fiscal 2010, Rubber Blacks EBIT increased by $118 million when compared to fiscal 2009. The increase was principally driven by higher volumes ($74 million) and higher unit margins ($72 million) from higher pricing, a favorable product mix and a favorable comparison from charges in fiscal 2009 related to older, high cost inventories that did not recur in the same period of fiscal 2010. While there was a significant contract lag benefit in fiscal 2009, the impact in fiscal 2010 was minimal. This resulted in an unfavorable year over year comparison ($23 million).

Historically, our rubber blacks supply contracts have provided for a price adjustment on the first day of each quarter to account for changes in feedstock related costs and, in some cases, changes in other relevant costs. These feedstock adjustments were based upon the average of a relevant index over a three-month period, and the contracts typically provided for the adjustments to be calculated in the month preceding the quarter. Accordingly, the calculation was typically based upon the average of the three months preceding the month in which the calculation was made. In periods of rapidly fluctuating feedstock costs, this time lag could have a significant impact on the results of the Rubber Blacks Segment. Over the past three years, we have reduced the percentage of our Rubber Blacks volume subject to this time delay from approximately 50% in fiscal 2008 to less than 10% at the end of fiscal 2010 to an insignificant amount at the end of fiscal 2011. Accordingly, we anticipate that the contract lag comparisons discussed above will not be a factor in our operating results in the future.

Performance Segment

Sales and EBIT for the Performance Segment for fiscal 2011, 2010 and 2009 are as follows:

 

     Years Ended September 30  
       2011          2010          2009    
     (Dollars in millions)  

Performance Products Business Sales

   $ 626      $ 531      $ 410  

Fumed Metal Oxides Business Sales

     254        252        210  
  

 

 

    

 

 

    

 

 

 

Segment Sales

   $ 880      $ 783      $ 620  
  

 

 

    

 

 

    

 

 

 

Segment EBIT

   $ 140      $ 125      $ 25  
  

 

 

    

 

 

    

 

 

 

In fiscal 2011, sales for the Performance Segment increased by $97 million when compared to fiscal 2010. The increase was principally driven by higher prices and a favorable product mix ($53 million), higher volumes ($22 million), and the positive impact of foreign currency translation ($21 million). During fiscal 2011, volumes in Performance Products increased by 5% due to higher demand served by new capacity for our masterbatch products. Volumes in Fumed Metal Oxides decreased by 2% due to our strategic value pricing initiative, which resulted in lower volumes sold. In fiscal 2010, sales for the Performance Segment increased by $163 million when compared to fiscal 2009. The increase was principally driven by higher volumes ($122 million), higher prices and a favorable product mix ($34 million) and the positive impact of foreign currency translation ($6 million). During fiscal 2010, volumes in Performance Products and Fumed Metal Oxides increased by 20% and 18%, respectively, principally from the global recovery of our key end markets.

EBIT in the Performance Segment increased by $15 million in fiscal 2011 when compared to fiscal 2010. The increase was principally driven by higher unit margins ($22 million) from higher pricing and a favorable product mix that more than offset the impact of higher raw materials costs and higher volumes

 

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($6 million). Higher fixed manufacturing costs ($14 million) associated with the start-up of new capacity and higher maintenance and other plant operating costs partially offset these positive factors. EBIT in the Performance Segment increased by $100 million in fiscal 2010 when compared to fiscal 2009. The increase was due to higher volumes ($62 million) from global demand recovery, higher prices and a favorable product mix ($36 million) and the positive effect of foreign currency translation ($4 million).

New Business Segment

Sales and EBIT for the New Business Segment for fiscal 2011, 2010 and 2009 are as follows:

 

     Years Ended September 30  
       2011          2010          2009    
     (Dollars in millions)  

Inkjet Colorants Business Sales

   $ 65       $ 57      $ 46  

Aerogel Business Sales

     24         24        15  

Cabot Superior MicroPowders Business Sales

     11        7        4  

Cabot Elastomer Composites Business Sales

     17        17        5  
  

 

 

    

 

 

    

 

 

 

Segment Sales

   $ 117      $ 105      $ 70  
  

 

 

    

 

 

    

 

 

 

Segment EBIT

   $ 9      $ 15      $ (3
  

 

 

    

 

 

    

 

 

 

Sales in the New Business Segment increased by $12 million in fiscal 2011 when compared to fiscal 2010, with revenue increases in the Inkjet Colorants and Cabot Superior MicroPowders Businesses. Revenue increases were driven by higher volumes in the Inkjet Colorants Business and sales of security taggants and incremental revenue resulting from the acquisition of Oxonica Materials Inc. in the Cabot Superior MicroPowders Business. Sales in the New Business Segment increased by $35 million in fiscal 2010 when compared to fiscal 2009, with commercial revenue increases in all businesses within the Segment and higher revenues from joint development and licensing agreements. The commercial revenue improvements were driven by higher volumes in the Inkjet Colorants Business, an increased number of jobs in oil and gas applications in the Aerogel Business, increased sales of security taggants for brand authentication in the Cabot Superior MicroPowders Business, and the timing of payments associated with certain milestones in our Cabot Elastomer Composites Business.

EBIT in the New Business Segment for fiscal 2011 declined by $6 million when compared to fiscal 2010. The decline was driven by the timing of payments associated with certain milestones which more than offset the benefit of higher product sales in our Cabot Elastomer Composites Business. EBIT in the New Business Segment for fiscal 2010 improved by $18 million when compared to fiscal 2009. The improvement was driven by payments associated with the achievement of certain milestones in our Cabot Elastomer Composites Business and increased sales revenue in the Inkjet Colorants, Aerogel and Cabot Superior MicroPowders Businesses.

In the fourth quarter of fiscal 2010, we acquired Oxonica Materials Inc. (“OMI”) from Oxonica Plc for a purchase price of $5 million in cash. OMI (now named Cabot Security Materials, Inc.) is developing surface enhanced raman scattering materials and detection technology, which is expected to expand our portfolio of security technologies within the Cabot Superior MicroPowders Business.

Specialty Fluids Segment

Sales and EBIT for the Specialty Fluids Segment for fiscal 2011, 2010 and 2009 are as follows:

 

     Years Ended September 30  
       2011          2010          2009    
     (Dollars in millions)  

Segment Sales

   $ 69       $ 81      $ 64  
  

 

 

    

 

 

    

 

 

 

Segment EBIT

   $ 22       $ 35      $ 18  
  

 

 

    

 

 

    

 

 

 

 

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During fiscal 2011, sales in the Specialty Fluids Segment were $12 million lower than in fiscal 2010. The decrease was principally due to a less favorable mix of business, including jobs that were smaller and shorter in duration. During fiscal 2010, sales in the Specialty Fluids Segment were $17 million higher than in fiscal 2009. The increase was due principally to a higher level of drilling activity in the North Sea and higher prices.

Fiscal 2011 EBIT decreased by $13 million when compared to fiscal 2010. The decrease was principally due to a less favorable mix of business, including jobs that were smaller and shorter in duration. Fiscal 2010 EBIT increased by $17 million when compared to fiscal 2009. The increase was driven by higher volumes from a strong level of drilling activity in the North Sea and higher pricing. These favorable factors were partially offset by increased operating expenses from the restart of our manufacturing facility in Manitoba, Canada after a temporary suspension of production activity in fiscal 2009.

Cash Flows and Liquidity

Overview

As permitted by U.S. GAAP, 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. Our liquidity position, as measured by cash and cash equivalents plus borrowing availability, decreased by $4 million during fiscal 2011. The decrease was primarily attributable to our decreased cash position, which was offset by an increase in our committed borrowing facilities. At September 30, 2011, we had cash and cash equivalents of $286 million, and current availability under our revolving credit agreement of approximately $521 million.

In August 2011, we entered into a new committed unsecured revolving credit agreement. The credit agreement provides for a $550 million revolving credit facility through August 2016 and replaced our previous credit facility which was scheduled to expire in June 2014. The credit agreement contains an option, subject to the lenders’ approval, to increase the facility to $750 million. All borrowing under the credit agreement will be based on variable interest rates. Amounts committed under the credit agreement can also be utilized to provide letters of credit in certain circumstances. We plan to use the credit agreement for general corporate purposes, which may include working capital, refinancing existing indebtedness, capital expenditures, share repurchases, and acquisitions. The credit agreement contains affirmative, negative and financial covenants and events of default customary for financings of this type. The financial covenants in the credit agreement include interest coverage, debt-to-EBITDA and subsidiary debt to total capitalization ratios. As of September 30, 2011, we were in compliance with all applicable covenants.

We anticipate sufficient liquidity from (i) cash on hand; (ii) cash flows from operating activities; and (iii) cash available from our credit agreement 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.

We generally manage our cash and debt on a global basis to provide for working capital and capital expenditure 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 cash or debt. As of September 30, 2011 our USD equivalent holdings by region were: Asia Pacific $137 million, Europe $87 million, and the Americas $62 million, which included $27 million in the U.S.

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

 

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Cash Flows from Operating Activities

Cash generated 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 $195 million in fiscal 2011 compared to $249 million in fiscal 2010 and $399 million in fiscal 2009.

Cash generated from operating activities in fiscal 2011 was driven primarily by net income of $258 million plus $144 million of depreciation and amortization and $19 million of non-cash compensation, partially offset by a net increase in working capital of $167 million (Inventories plus Accounts and notes receivable, less Accounts payable and accrued liabilities). Our working capital increase in fiscal 2011 was driven principally by higher pricing and raw material costs when compared to fiscal 2010 and is comprised of higher accounts receivable ($111 million) and inventories ($79 million), offset by an increase in accounts payable and accrued liabilities ($23 million). Despite increased revenue, operating cash flows decreased in fiscal 2011 as a result of the corresponding growth of inventories, accounts receivable, and accounts payable.

Cash generated from operating activities in fiscal 2010 was driven primarily by net income of $169 million plus $143 million of depreciation and amortization and $27 million of non-cash compensation, partially offset by a net increase in working capital of $76 million. Our working capital increase in fiscal 2010 was driven principally by higher sales volumes when compared to fiscal 2009 and is comprised of higher accounts receivable ($116 million) and inventories ($7 million), offset by an increase in accounts payable and accrued liabilities ($47 million).

Cash generated from operating activities in fiscal 2009 was due principally to a net decrease in working capital of $356 million. Specifically, we had both a $215 million decrease in accounts receivable primarily attributable to lower sales and improved collections and a decrease of $184 million in inventories as a result of lower feedstock costs and reduced inventory quantities. Offsetting these sources of cash was a decrease in accounts payable and accrued liabilities of $43 million as a result of the timing of raw material deliveries and payments.

In addition to the working capital movements noted above, the following other elements of operations have had a bearing on operating cash flows:

Discontinued Operations—Fiscal 2011 cash flows provided by operating activities include cash flows of $81 million related to the Supermetals Business. These operating cash flows were primarily driven by $53 million of Income from discontinued operations, net of tax, plus approximately $21 million of deferred tax provision and approximately $6 million of depreciation and amortization.

Restructurings—As of September 30, 2011, we had $11 million of total restructuring costs in accrued expenses in the consolidated balance sheet related to our global restructuring activities. We made cash payments of $26 million during fiscal 2011 related to these restructuring plans. We expect to make cash payments related to these restructuring activities of approximately $10 million in fiscal 2012 and $1 million thereafter (which includes the $11 million already accrued in the consolidated balance sheet as of September 30, 2011).

Environmental Reserves and Litigation Matters—We have recorded a $6 million reserve on both a discounted and undiscounted basis as of September 30, 2011 for environmental remediation costs at various sites. These sites are primarily associated with businesses divested in prior years. We anticipate that the expenditures at these sites will be made over a number of years, and will not be concentrated in any one year. Additionally, as of September 30, 2011 we have recorded an $11 million reserve on a discounted basis ($16 million on an undiscounted basis) for respirator claims. These expenditures will also be incurred over several years. We also have other litigation costs arising in the ordinary course of business.

 

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The following table represents the estimated future undiscounted payments related to our environmental and respirator reserves.

 

     Future Payments by Fiscal Year  
     2012      2013      2014      2015      2016      Thereafter      Total  
     (Dollars in millions)  

Environmental

   $ 1      $ 1      $ 1      $ 1      $ 1      $ 1      $ 6  

Litigation—respirator

     2        1        1        1        1        10        16  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3      $ 2      $ 2      $ 2      $ 2      $ 11      $ 22  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We expect that cash on hand and cash provided from operations will be adequate to fund any cash requirements relating to environmental matters or pending litigation costs.

Operating Activities—Other

Venezuela

We own 49% of an operating affiliate in Venezuela, which is accounted for as an equity affiliate, through our wholly owned subsidiaries that carry the investment and receive its dividends. As of September 30, 2011 these subsidiaries carried the operating affiliate investment of $26 million, and held 21 million bolivars ($5 million) in cash and dividends receivable.

An inability to convert the operating affiliate’s earnings into U.S. dollars would be considered an indicator of impairment, requiring a full impairment analysis of our investment and, therefore, we closely monitor our ability to convert our bolivar holdings into U.S. dollars.

The Venezuelan bolivar may only be exchanged for foreign currencies through certain Venezuelan government controlled channels. The channels available are the Venezuelan central bank (“CADIVI”), Venezuelan government and government-backed bond offerings or an officially sanctioned and regulated secondary market (“SITME”). SITME is subject to restrictions which preclude us from utilizing this market to remit dividends. The bond issuance process uses 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 out the pool of U.S. dollars in that issuance.

During fiscal 2011, the operating affiliate declared a dividend of 19 million bolivars to our wholly owned subsidiaries, of which 6 million bolivars was paid in U.S. dollars at an exchange rate of 4.30 bolivars to the U.S. dollar (“B/$”). We also participated in various bond offerings during fiscal 2011, repatriating approximately 4 million bolivars at a rate of 6.55 B/$, which resulted in an exchange loss of less than $1 million, recognized in the first quarter of fiscal 2011. These transactions indicate that there continue to be available mechanisms to convert the operating affiliate’s earnings to U.S. dollars and, therefore, we continue to use the CADIVI official rate of 4.30 B/$ to remeasure our bolivar balances. We still intend to convert substantially all bolivars held by our Venezuelan subsidiaries to U.S. dollars as soon as practical and we continue to monitor for opportunities to convert their bolivars through Venezuelan government, or government backed, bond offerings.

Any future change in the CADIVI official rate or opening of additional parallel markets could lead us to use a different exchange rate and result in gains or losses on our bolivar denominated assets held by our subsidiaries.

Employee Benefit Plans

As of September 30, 2011 we had a consolidated pension obligation, net of the fair value of plan assets, of $162 million, comprised of $83 million for pension benefit plan liabilities and $79 million for postretirement benefit plan liabilities.

 

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The $83 million of underfunded pension benefit plan liabilities is derived as follows:

 

     U.S.     Foreign     Total  
     (Dollars in millions)  

Fair value of plan assets

   $ 103     $ 197     $ 300  

Benefit obligation

     147       236       383  
  

 

 

   

 

 

   

 

 

 

Funded status

   $ (44 )   $ (39 )   $ (83 )
  

 

 

   

 

 

   

 

 

 

In fiscal 2011, we made cash contributions totaling approximately $13 million to our foreign pension benefit plans and none to our U.S. pension plan. For fiscal 2012, we expect to make cash contributions of approximately $8 million to our U.S. pension plan and approximately $12 million to our foreign pension plans.

The $79 million of unfunded postretirement benefit plan liabilities is comprised of $64 million for our U.S. and $15 million for our foreign postretirement benefit plans. These postretirement benefit plans provide certain health care and life insurance benefits for retired employees. Typical of such plans, our postretirement plans are unfunded and, therefore, have no plan assets. We fund these plans as claims or insurance premiums come due. In fiscal 2011, we paid postretirement benefits of $5 million under our U.S. postretirement plans and less than $1 million under our foreign postretirement plans. For fiscal 2012, we expect to make benefit payments of approximately $6 million under our U.S. postretirement plans and $1 million under our foreign postretirement plans.

Cash Flows from Investing Activities

Cash flows from investing activities were primarily driven by capital expenditures and consumed $232 million of cash in fiscal 2011 compared to $112 million of cash in fiscal 2010 and $105 million in fiscal 2009. Capital expenditures in fiscal 2011 of $230 million were primarily related to sustaining and replacement capital for our operating facilities, investments in energy recovery technology, expansion of our manufacturing footprint in the Asia Pacific region and capital spending required for process technology and product differentiation projects.

Cash used in investing activities for fiscal 2011 includes approximately $6 million of additions to property, plant and equipment in the Supermetals Business.

Capital expenditures in fiscal 2010 of $108 million were primarily related to sustaining and replacement capital for our operating facilities, investments in energy recovery technology, the completion of our newly commissioned masterbatch facility in Dubai, expansion of our manufacturing footprint in the Asia Pacific region and capital spending required for process technology and product differentiation projects.

Capital expenditures in fiscal 2009 of $106 million included spending for expansion of rubber blacks capacity at an existing facility in China, new energy centers at other rubber blacks facilities and a new facility in Dubai.

Capital expenditures for fiscal 2012 are expected to be between $200 million to $250 million. Our planned capital spending program for fiscal 2012 is primarily for higher spending for ongoing sustaining and replacement capital as well as investments in energy related projects and capacity expansions.

Cash Flows from Financing Activities

Financing activities consumed $72 million of cash in fiscal 2011 compared to $57 million of cash in fiscal 2010 and $127 million in fiscal 2009. In each year, financing cash flows were primarily driven by changes in debt levels and dividend payments. In addition, in fiscal 2011 we repurchased approximately 1.6 million shares of our common stock on the open market.

The Supermetals Business did not have significant Cash Flows from Financing Activities in fiscal 2011.

 

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Debt

The following table provides a summary of our outstanding long-term debt.

 

     September 30  
         2011             2010      
     (Dollars in millions)  

Variable rate debt

   $ 15     $ 16  

Interest rate swaps—fixed to variable(1)

     58       73  
  

 

 

   

 

 

 

Total variable rate debt

     73       89  

Fixed rate debt, net of discount

     585       606  

Interest rate swaps—fixed to variable(1)

     (58     (73
  

 

 

   

 

 

 

Total fixed rate debt

     527       533  

Unamortized bond discounts

     (2     (2

Capital lease obligations

     15       3  
  

 

 

   

 

 

 

Total debt

     613       623  

Less current portion on long-term debt

     (57     (23
  

 

 

   

 

 

 

Total long-term debt

   $ 556     $ 600  
  

 

 

   

 

 

 

 

(1) 

The face value of debt swapped from fixed rate to variable rate using interest rate swaps is presented above in order to view our effective fixed and variable debt balances.

In fiscal 2011, net proceeds from certain short term financing arrangements totaled $56 million, offset by long-term debt repayments of $21 million. In fiscal 2010, because of our strong operating cash flows and the proceeds obtained in fiscal 2009 from the issuance of the 5% Notes due in 2016, we had little movement in financing cash flows apart from our on-going dividend payments to our shareholders. In fiscal 2009, we issued 5% Notes due in 2016 and repaid other debt. We had $521 million of availability under our credit agreement as of September 30, 2011.

Our long-term total debt, of which $57 million is current, matures at various times over the next twenty-seven years. The weighted-average interest rate on our fixed rate long-term debt was 5.5%, including the effects of the interest rate swaps. The weighted-average interest rate on variable interest rate long-term debt was 3.6% as of September 30, 2011, including the effects of the interest rate swaps.

At September 30, 2011, we have provided standby letters of credit and bank guarantees totaling $37 million, which expire throughout fiscal 2012.

Share repurchases

During fiscal 2011, we repurchased approximately 1.6 million shares of our common stock on the open market for an aggregate purchase price of $50 million. As of September 30, 2011, we had approximately 2.7 million shares available for repurchase under the Board of Directors’ share repurchase authorization. We also repurchased shares of our common stock with an aggregate market value of $9 million from employees to facilitate their payment of taxes and associated loan repayment obligations due on the vesting of long term incentive awards.

Dividend payments

In each of fiscal 2011, 2010 and 2009, we paid cash dividends on our common stock of $0.72 per share. These cash dividend payments totaled $47 million in fiscal 2011, $47 million in fiscal 2010, and $48 million in fiscal 2009.

 

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Off-balance sheet arrangements

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

Contractual Obligations

The following table sets forth our long-term contractual obligations, excluding those attributable to our discontinued operations, which are described in greater detail in Note T in the notes to our Consolidated Financial Statements in Item 8. Variable interest is based on the variable debt outstanding and prevailing variable interest rates as of September 30, 2011, and the table includes the impact of our interest rate swaps that change fixed rates to floating rates.

 

     Payments Due by Fiscal Year  
     2012      2013      2014      2015      2016      Thereafter      Total  
     (Dollars in millions)  

Contractual Obligations(1)

                    

Purchase commitments

   $ 289      $ 276      $ 260      $ 257      $ 371      $ 2,838      $ 4,291  

Long-term debt(2)

     56        182        2                300        57        597  

Capital lease obligations(3)

     1        1        1        1        1        12        17  

Fixed interest on long-term debt

     27        26        19        19        19        20        130  

Variable interest on long-term debt

     2                                                2  

Operating leases

     19        15        12        11        8        29        94  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 394      $ 500      $ 294      $ 288      $ 699      $ 2,956      $ 5,131  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

We are unable to estimate the timing of potential future payments related to our accrual for uncertain tax positions in the amount of $56 million at September 30, 2011.

(2) 

Payment of long-term debt excludes settlements of cross currency swaps.

(3)

Capital lease obligations includes $2 million for a lease committed to in fiscal 2011 as the lease agreement is not effective until fiscal 2012.

Purchase commitments

We have entered into long-term, volume-based purchase agreements primarily for the purchase of raw materials and natural gas with various key suppliers in our Core and Performance Segments. Under certain of these agreements the quantity of material being purchased is fixed, but the price we pay changes as market prices change. For purposes of the table above, current purchase prices have been used to quantify total commitments.

Operating Leases

We have operating leases primarily comprised of leases for transportation vehicles, warehouse facilities, office space, and machinery and equipment.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to changes in interest rates and foreign currency exchange rates because we finance certain operations through long- and short-term borrowings and denominate our transactions in a variety of foreign currencies. Changes in these rates may have an impact on future cash flows and earnings. We manage these risks through normal operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments.

We have policies governing our use of derivative instruments, and we do not enter into financial instruments for trading or speculative purposes.

By using derivative instruments, we are subject to credit and market risk. The derivative instruments are booked to our balance sheet at fair market value and reflect the asset or (liability) position as of

 

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September 30, 2011. If a counterparty fails to fulfill its performance obligations under a derivative contract, our exposure will equal the fair value of the derivative. Generally, when the fair value of a derivative contract is positive, the counterparty owes Cabot, thus creating a payment risk for Cabot. We minimize counterparty credit (or repayment) risk by entering into these transactions with major financial institutions of investment grade credit rating. As of September 30, 2011, the counterparties that we have executed derivatives with were rated between A- and AA-, inclusive, by Standard and Poor’s. Our exposure to market risk is not hedged in a manner that completely eliminates the effects of changing market conditions on earnings or cash flow.

Interest Rate Risk

As of September 30, 2011, we had long-term debt, including the current portion, totaling $613 million, which has both variable and fixed interest rate components. We have entered into interest rate swaps as a hedge to a portion of our underlying debt instruments to effectively change the characteristics of the interest rate without changing the debt instrument. For fixed rate debt, interest rate changes affect the fair value, but do not impact earnings or cash flows. Conversely, for floating rate debt, interest rate changes generally do not affect the fair value, but do impact future earnings and cash flows, assuming other factors are held constant. As most of our long-term debt was issued at fixed rates, we use interest rate swaps as a means to achieve a different fixed-to-floating interest rate mix.

The table below summarizes the principal terms of our interest rate swap transactions, including the notional amount of the swap, the interest rate payment we receive from and pay to our swap counterparty, the term of the transaction, and its fair value at September 30, 2011.

 

Description

   Notional Amount    Receive    Pay    Fiscal Year
Entered into
   Maturity
(Fiscal Year)
   Fair Market
Value at
September 30,
2011

Asset/
(Liability)
                              (USD)

Interest Rate

Swaps—Fixed

to Variable

   USD 35 million    5.25% Fixed    U.S.-6 month
LIBOR + 0.62%
   2003    2013    3 million
   USD 8 million    8.28% Fixed    U.S.-6 month
LIBOR + 3.14%
   2007    2012   
   USD 5 million    8.27% Fixed    U.S.-3 month
LIBOR + 6.38%
   2010    2012   
   USD 5 million    8.27% Fixed    U.S.-3 month
LIBOR + 6.38%
   2010    2012   
   USD 5 million    8.18% Fixed    U.S.-3 month
LIBOR + 6.35%
   2010    2012   

 

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Table of Contents

Foreign Currency Risk

Our international operations are subject to certain risks, including currency exchange rate fluctuations and government actions. Currently, we have issued debt denominated in U.S. dollars and then entered into cross currency swaps that exchange our dollar principal and interest payments into a currency where we expect long-term, stable cash receipts. The following table summarizes the principal terms of our long-term foreign currency swap transactions, including the notional amount of the swap, the interest rate payment we receive from and pay to our swap counterparty, the term of the transaction and its fair market value at September 30, 2011.

 

Description

   Net Notional Amount    Receive    Pay    Fiscal Year
Entered Into
   Maturity
Year
   Fair Market
Value at
September 30,
2011
                              (USD)

Cross Currency Swaps

   USD 140 million
swapped to

EUR 124 million

   5.25% Fixed    5.43% Fixed    2003    2013    (32 million)
   USD 35 million
swapped to

EUR 31 million

   US-6 month
LIBOR
   EUR-6 month
LIBOR
   2003    2013    (8 million)

Foreign currency exposures also relate to assets and liabilities denominated in foreign currencies other than the functional currency of a given subsidiary as well as the risk that currency fluctuations could affect the dollar value of future cash flows generated in foreign currencies. Accordingly, we use short-term forward contracts to minimize the exposure to foreign currency risk. These forward contracts typically have a duration of 30 days. At September 30, 2011, we had $65 million in net notional foreign currency contracts, which were denominated in the Australian dollar, British pound sterling, Canadian dollar, Euro, and Japanese yen. These forwards had a fair value of ($2 million) as of September 30, 2011. Of the $65 million in net notional foreign currency contracts, $12 million related to contracts denominated in Japanese Yen which were designated as a fair value hedge. These hedge contracts had a fair value of ($1 million) at September 30, 2011.

In certain situations where we have a long-term commitment denominated in a foreign currency we may enter into appropriate financial instruments in accordance with our risk management policy to hedge future cash flow exposures.

Commodity Risk

Certain of our carbon black plants in Europe are subject to mandatory greenhouse gas emission trading schemes. Our objective is to ensure compliance with the European Union Emission Trading Scheme, which is based upon a Cap-and-Trade system that establishes a maximum allowable emission credit for each ton of CO2 emitted. European Union Allowances (“EUA”) originate from the individual EU member state’s country allocation process and are issued by that country’s government. A company that has an excess of EUAs based on the CO2 emissions limits may sell EUAs in the Emission Trading Scheme and if they have a shortfall, a company can buy EUAs or Certified Emission Reduction (“CER”) units to comply.

In order to limit the variability in cost to our European operations, we purchased CERs and sold EUAs which settle each December until 2012. The following table provides details of the derivatives held as of September 30, 2011 used to manage commodity risk.

 

Description

 

Net Notional

Amount

 

Net Buyer /

Net Seller

 

Fiscal Year

Entered into

 

Maturity

(Fiscal Year)

 

Fair Market Value
at September 30, 2011

Asset/(Liability)

                    (USD)

EUAs

  EUR 1 million   Net Seller   2008 & 2009   2012   1 million

CERs

  EUR 1 million   Net Buyer   2008 & 2009   2012   (1) million

 

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Table of Contents
Item 8. Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS

 

Description

   Page  

(1)

  

Consolidated Statements of Operations for each of the fiscal years ended September 30, 2011, 2010, and 2009

     55   

(2)

  

Consolidated Balance Sheets at September 30, 2011 and 2010

     56   

(3)

  

Consolidated Statements of Cash Flows for each of the fiscal years ended September 30, 2011, 2010 and 2009

     58   

(4)

  

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income (Loss) for each of the fiscal years ended September 30, 2011, 2010, and 2009

     59   

(5)

  

Notes to the Consolidated Financial Statements

     62   

(6)

  

Report of Independent Registered Public Accounting Firm

     112   

 

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CABOT CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Years Ended September 30  
         2011              2010              2009      
     (In millions, except per share amounts)  

Net sales and other operating revenues

   $ 3,102      $ 2,716      $ 2,108  

Cost of sales

     2,544        2,206        1,891  
  

 

 

    

 

 

    

 

 

 

Gross profit

     558        510        217  

Selling and administrative expenses

     249        241        205  

Research and technical expenses

     66        65        66  
  

 

 

    

 

 

    

 

 

 

Income (loss) from operations

     243        204        (54

Interest and dividend income

     2        2        3  

Interest expense

     (39      (40      (30

Other expense

     (3              (18
  

 

 

    

 

 

    

 

 

 

Income (loss) from continuing operations before income taxes and equity in net earnings of affiliated companies

     203        166        (99

(Provision) benefit for income taxes

     (6      (30      21  

Equity in earnings of affiliated companies, net of tax of $5, $4 and $1

     8        7        5  
  

 

 

    

 

 

    

 

 

 

Income (loss) from continuing operations

     205        143        (73

Income (loss) from discontinued operations, net of tax of $29, $16, and ($1)

     53        26        (2
  

 

 

    

 

 

    

 

 

 

Net income (loss)

     258        169        (75

Net income attributable to noncontrolling interests, net of tax of $4, $3 and $1

     22        15        2  
  

 

 

    

 

 

    

 

 

 

Net income (loss) attributable to Cabot Corporation

   $ 236      $ 154      $ (77
  

 

 

    

 

 

    

 

 

 

Weighted-average common shares outstanding, in millions:

        

Basic

     64.6        63.8        62.8  
  

 

 

    

 

 

    

 

 

 

Diluted

     65.4        64.3        62.8  
  

 

 

    

 

 

    

 

 

 

Income (loss) per common share:

        

Basic:

        

Income (loss) from continuing operations attributable to Cabot Corporation

   $ 2.80      $ 1.96      $ (1.21

Income (loss) from discontinued operations

     0.82        0.41        (0.04
  

 

 

    

 

 

    

 

 

 

Net income (loss) attributable to Cabot Corporation

   $ 3.62      $ 2.37      $ (1.25
  

 

 

    

 

 

    

 

 

 

Diluted:

        

Income (loss) from continuing operations attributable to Cabot Corporation

   $ 2.77      $ 1.94      $ (1.21

Income (loss) from discontinued operations

     0.80        0.41        (0.04
  

 

 

    

 

 

    

 

 

 

Net income (loss) attributable to Cabot Corporation

   $ 3.57      $ 2.35      $ (1.25
  

 

 

    

 

 

    

 

 

 

Dividends per common share

   $ 0.72      $ 0.72      $ 0.72  
  

 

 

    

 

 

    

 

 

 

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

 

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CABOT CORPORATION

CONSOLIDATED BALANCE SHEETS

ASSETS

 

     September 30  
             2011                     2010          
     (In millions, except
share and per share amounts)
 

Current assets:

    

Cash and cash equivalents

   $ 286     $ 387  

Accounts and notes receivable, net of reserve for doubtful accounts of $4 and $4

     659       540  

Inventories

     393       307  

Prepaid expenses and other current assets

     76       71  

Deferred income taxes

     35       30  

Current assets held for sale

     106       103  
  

 

 

   

 

 

 

Total current assets

     1,555       1,438  
  

 

 

   

 

 

 

Property, plant and equipment

     2,967       2,878  

Accumulated depreciation and amortization

     (1,931     (1,941
  

 

 

   

 

 

 

Net property, plant and equipment

     1,036       937  
  

 

 

   

 

 

 

Goodwill

     40       39  

Equity affiliates

     60       61  

Assets held for rent

     46       40  

Deferred income taxes

     261       245  

Other assets

     104       86  

Noncurrent assets held for sale

     39       40  
  

 

 

   

 

 

 

Total assets

   $ 3,141     $ 2,886  
  

 

 

   

 

 

 

 

 

 

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

 

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CABOT CORPORATION

CONSOLIDATED BALANCE SHEETS

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

     September 30  
             2011                     2010          
     (In millions, except
share and per share amounts)
 

Current liabilities:

    

Notes payable to banks

   $ 86     $ 29  

Accounts payable and accrued liabilities

     461       431  

Income taxes payable

     34       34  

Deferred income taxes

     6       6  

Current portion of long-term debt

     57       23  

Current liabilities held for sale

     12       16  
  

 

 

   

 

 

 

Total current liabilities

     656       539  
  

 

 

   

 

 

 

Long-term debt

     556       600  

Deferred income taxes

     8       6  

Other liabilities

     299       318  

Noncurrent liabilities held for sale

     6       6  

Commitments and contingencies (Note T)

    

Stockholders’ equity:

    

Preferred stock:

    

Authorized: 2,000,000 shares of $1 par value

    

Issued and Outstanding: None and none

              

Common stock:

    

Authorized: 200,000,000 shares of $1 par value

    

Issued: 63,894,443 and 65,429,916 shares

    

Outstanding: 63,860,777 and 65,370,220 shares

     64       65  

Less cost of 33,666 and 59,696 shares of common treasury stock

     (1     (2

Additional paid-in capital

     18       46  

Retained earnings

     1,314       1,125  

Deferred employee benefits

     (14     (20

Accumulated other comprehensive income

     106       88  
  

 

 

   

 

 

 

Total Cabot Corporation stockholders’ equity

     1,487       1,302  

Noncontrolling interests

     129       115  
  

 

 

   

 

 

 

Total stockholders’ equity

     1,616       1,417  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 3,141     $ 2,886  
  

 

 

   

 

 

 

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

 

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CABOT CORPORATION

CONSOLIDATED STATEMENT OF CASH FLOWS

 

     Years Ended September 30  
         2011             2010             2009      
     (In millions)  

Cash Flows from Operating Activities:

      

Net income (loss)

   $ 258     $ 169     $ (75

Adjustments to reconcile net income (loss) to cash provided by operating activities:

      

Depreciation and amortization

     144       143       169  

Deferred tax provision

     (25     (2     (51

Impairment charges

            2         

Loss on sale of property, plant and equipment

     2       6       11  

Equity in earnings of affiliated companies

     (8     (7     (5

Non-cash compensation

     19       27       27  

Other non-cash (income) charges, net

     (3     (5     2  

Changes in assets and liabilities:

      

Accounts and notes receivable

     (111     (116     215  

Inventories

     (79     (7     184  

Prepaid expenses and other current assets

     (17     (18     1  

Accounts payable and accrued liabilities

     23       47       (43

Income taxes payable

     1        7       (15

Other liabilities

     (12     (7     (26

Cash dividends received from equity affiliates

     4       6       1  

Other

     (1 )     4       4  
  

 

 

   

 

 

   

 

 

 

Cash provided by operating activities

     195       249       399  
  

 

 

   

 

 

   

 

 

 

Cash Flows from Investing Activities:

      

Additions to property, plant and equipment

     (230     (108     (106

Investment in equity affiliate

     (2            (3

Acquisition of business, net of cash acquired

            (5       

Proceeds from sales of property, plant and equipment

     6       6       2  

(Increase) decrease in assets held for rent

     (6     2       2  

Settlement of derivatives

            (7       
  

 

 

   

 

 

   

 

 

 

Cash used in investing activities

     (232     (112     (105
  

 

 

   

 

 

   

 

 

 

Cash Flows from Financing Activities:

      

Borrowings under financing arrangements

     71       37       25  

Repayments under financing arrangements

     (45     (31     (69

Proceeds from long-term debt, net of issuance costs

                   312  

Repayments of long-term debt

     (21     (6     (321

Increase (decrease) in notes payable to banks, net

     30       (8     (16

Purchases of common stock

     (59     (5     (2

Proceeds from sales of common stock

     5       3         

Cash dividends paid to noncontrolling interests

     (12     (6     (9

Cash dividends paid to common stockholders

     (47     (47     (48

Proceeds from restricted stock loan payments

     6       6       1  
  

 

 

   

 

 

   

 

 

 

Cash used in financing activities

     (72     (57     (127
  

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash

     8       3       8  
  

 

 

   

 

 

   

 

 

 

(Decrease) increase in cash and cash equivalents

     (101     83       175  

Cash and cash equivalents at beginning of period

     387       304       129  
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 286     $ 387     $ 304  
  

 

 

   

 

 

   

 

 

 

Income taxes paid

   $ 64      $ 43     $ 30  

Interest paid

     34       28       24  

Non-cash additions to property, plant and equipment

     14             

  

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

 

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CABOT CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)

Years Ended September 30

(In millions, except shares in thousands)

 

    Common Stock,
Net of Treasury

Stock
    Additional
Paid-in
Capital
    Retained
Earnings
    Deferred
Employee
Benefits
    Notes
Receivable
for

Restricted
Stock
    Accumulated
Other

Comprehensive
Income
    Total
Cabot
Corporation

Stockholders’
Equity
    Non-
controlling
Interests
    Total
Stockholders’
Equity
    Comprehensive
Loss
 
                      
2009   Shares     Cost                    

Balance at September 30, 2008

    65,278     $ 61      $ 21      $ 1,143      $ (30   $ (21   $ 75      $ 1,249      $ 110      $ 1,359     

Net loss attributable to Cabot Corporation

          (77               $ (77
                     

 

 

 

Foreign currency translation adjustment, net of tax of $6

                22             22  

Change in employee benefit plans, net of tax of $4

                (36           (36

Change in unrealized loss on investments and derivative instruments, net of tax $1

                (1           (1
                     

 

 

 

Total other comprehensive loss

                      $ (15
                     

 

 

 

Comprehensive loss attributable to Cabot Corporation

                  (92       $ (92
                     

 

 

 

Net income attributable to noncontrolling interests, net of tax $1

                    2         2  
                     

 

 

 

Comprehensive income attributable to noncontrolling interests

                      $ 2   
                     

 

 

 

Comprehensive loss

                      (90   $ (90
                     

 

 

 

Noncontrolling interests—dividends

                    (9     (9  

Cash dividends paid to common stockholders

          (48           (48       (48  

Issuance of stock under employee compensation plans, net of forfeitures

    172       2       3               5         5    

Application of stock option accounting for restricted stock awards

        (19         19                      

Amortization of share-based compensation

        14               14         14    

Purchase and retirement of common and treasury stock

    (141            (1             (1       (1  

Notes receivable for restricted stock— payments and forfeitures

              2         2         2    

Principal payment by Employee Stock Ownership Plan under guaranteed loan

            5           5         5    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance at September 30, 2009

    65,309     $ 63      $ 18      $ 1,018      $ (25   $      $ 60      $ 1,134      $ 103      $ 1,237     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

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

 

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Table of Contents
    Common Stock,
Net of Treasury

Stock
    Additional
Paid-in
Capital
    Retained
Earnings
    Deferred
Employee
Benefits
    Accumulated
Other

Comprehensive
Income
    Total
Cabot
Corporation

Stockholders’
Equity
    Non-
controlling
Interests
    Total
Stockholders’
Equity
    Comprehensive
Income
 
                   
2010   Shares     Cost                  

Balance at September 30, 2009

    65,309     $ 63      $ 18      $ 1,018      $ (25   $ 60      $ 1,134      $ 103      $ 1,237     

Net income attributable to Cabot Corporation

          154               $ 154   
                   

 

 

 

Foreign currency translation adjustment, net of tax of $4

              43             43  

Change in employee benefit plans, net of tax of $6

              (15           (15
                   

 

 

 

Total other comprehensive income

                    $ 28   
                   

 

 

 

Comprehensive income attributable to Cabot Corporation

                182         $ 182   
                   

 

 

 

Net income attributable to noncontrolling interests, net of tax of $3

                  15         15  

Noncontrolling interests—foreign currency translation adjustment

                  2         2  
                   

 

 

 

Comprehensive income attributable to noncontrolling interests

                    $ 17   
                   

 

 

 

Comprehensive income

                    199     $ 199   
                   

 

 

 

Contribution from noncontrolling interests

                  1       1    

Noncontrolling interest— dividends

                  (6     (6  

Cash dividends paid to common stockholders

          (47         (47       (47  

Issuance of stock under employee compensation plans, net of forfeitures

    283       1       8             9         9    

Amortization of share-based compensation

        18             18         18    

Purchase and retirement of common and treasury stock

    (222     (1     (4           (5       (5  

Principal payment by Employee Stock Ownership Plan under guaranteed loan

            5         5         5    

Notes receivable for restricted stock-payments

        6             6         6    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance at September 30, 2010

    65,370     $ 63      $ 46      $ 1,125      $ (20   $ 88      $ 1,302      $ 115      $ 1,417     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

CABOT CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)

Years Ended September 30

(In millions, except shares in thousands)

 

60

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


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CABOT CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)

Years Ended September 30

(In millions, except shares in thousands)

 

    Common Stock,
Net of Treasury

Stock
    Additional
Paid-in
Capital
    Retained
Earnings
    Deferred
Employee
Benefits
    Accumulated
Other

Comprehensive
Income
    Total
Cabot
Corporation

Stockholders’
Equity
    Non-
controlling
Interests
    Total
Stockholders’
Equity
    Comprehensive
Income
 
                   
2011   Shares     Cost                  

Balance at September 30, 2010

    65,370     $ 63      $ 46      $ 1,125      $ (20   $ 88      $ 1,302      $ 115      $ 1,417     

Net income attributable to Cabot Corporation

          236               $ 236   
                   

 

 

 

Foreign currency translation adjustment, net of tax of $3

              19             19  

Change in unrealized loss on investments and derivative instruments, net of tax of $—

              (1           (1
                   

 

 

 

Total other comprehensive income

                    $ 18   
                   

 

 

 

Comprehensive income attributable to Cabot Corporation

                254         $ 254   
                   

 

 

 

Net income attributable to noncontrolling interests, net of tax of $4

                  22         22  

Noncontrolling interests—foreign currency translation adjustment

                  3         3  
                   

 

 

 

Comprehensive income attributable to noncontrolling interests

                    $ 25   
                   

 

 

 

Comprehensive income

                    279     $ 279   
                   

 

 

 

Noncontrolling interest— dividends

                  (11     (11  

Cash dividends paid to common stockholders

          (47         (47       (47  

Issuance of stock under employee compensation plans, net of forfeitures

    294       1       7             8         8    

Amortization of share-based compensation

        17             17         17    

Purchase and retirement of common and treasury stock

    (1,803     (1     (58           (59       (59  

Principal payment by Employee Stock Ownership Plan under guaranteed loan

            6         6         6    

Notes receivable for restricted stock-payments

        6             6         6    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Balance at September 30, 2011

    63,861     $ 63      $ 18      $ 1,314      $ (14   $ 106      $ 1,487      $ 129      $ 1,616     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

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

 

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Notes to Consolidated Financial Statements

Note A. Significant Accounting Policies

The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States. The significant accounting policies of Cabot Corporation (“Cabot” or “the Company”) are described below. Certain changes have been made to operating segment information for prior years to reflect changes made in the fourth quarter of fiscal 2011 related to changes in the Company’s reporting segments.

In August 2011, the Company entered into an agreement to sell its Supermetals Business. The applicable assets and liabilities of the business have been classified as held for sale in the Consolidated Balance Sheets as of September 30, 2011 and 2010. Consolidated Statements of Operations for all periods presented have been recast to reflect the presentation of discontinued operations. Unless otherwise indicated, all disclosures and amounts in the Notes to Consolidated Financial Statements relate to the Company’s continuing operations.

Principles of Consolidation

The consolidated financial statements include the accounts of Cabot and its wholly-owned subsidiaries and majority-owned and controlled U.S. and non-U.S. subsidiaries. Additionally, Cabot considers consolidation of entities over which control is achieved through means other than voting rights, of which there were none in the periods presented. Intercompany transactions have been eliminated in consolidation.

Cash and Cash Equivalents

Cash equivalents include all highly liquid investments with a maturity of three months or less at date of acquisition. Cabot continually assesses the liquidity of cash and cash equivalents and, as of September 30, 2011, has determined that they are readily convertible to cash.

Inventories

Inventories are stated at the lower of cost or market. The cost of most U.S. inventories is determined using the last-in, first-out (“LIFO”) method. The cost of other U.S. and all non-U.S. inventories is determined using the average cost method or the first-in, first-out (“FIFO”) method.

Investments

The Company has investments in equity affiliates and marketable securities. As circumstances warrant, all investments are subject to periodic impairment reviews. Unless consolidation is required, investments in equity affiliates, where Cabot generally owns between 20% and 50% of the affiliate, are accounted for using the equity method. Cabot records its share of the equity affiliate’s results of operations based on its percentage of ownership of the affiliate. Dividends received from equity affiliates are a return on investment and are recorded as a reduction to the equity investment value.

All investments in marketable securities are classified as available-for-sale and are recorded at fair value with the corresponding unrealized holding gains or losses, net of taxes, recorded as a separate component of other comprehensive income within stockholders’ equity. Unrealized losses that are determined to be other-than-temporary, based on current and expected market conditions, are recognized in earnings. The fair value of marketable securities is determined based on quoted market prices at the balance sheet dates. The cost of marketable securities sold is determined by the specific identification method. Short-term investments consist of investments in marketable securities with maturities of one year or less. The Company’s investment in marketable securities was immaterial as of both September 30, 2011 and 2010.

 

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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 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.

Cabot capitalizes interest costs when they are part of the historical cost of acquiring and constructing certain assets that require a period of time to get them ready for their intended use. During fiscal 2011, 2010 and 2009, Cabot capitalized $2 million, $1 million and $4 million of interest costs, respectively. These amounts will be amortized over the life of the related assets.

Goodwill and Other Intangible Assets

Goodwill is comprised of the cost 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 at least annually. The annual review consists of the comparison of each reporting unit’s carrying value to its fair value, which is performed as of March 31. Certain circumstances may give rise to an impairment assessment at a date other than the annual assessment date.

The fair value of a reporting unit is primarily 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, discount rates and market conditions over an estimate of the remaining operating period at the reporting unit level. If an impairment exists, a loss is recorded to write-down the value of goodwill to its implied fair value.

Cabot’s intangible assets are primarily comprised of patented and unpatented technology and other intellectual property. Finite lived intangible assets are amortized over their estimated useful lives. Amortization expense was less than $1 million in each of fiscal 2011, 2010 and 2009.

Assets Held for Rent

Assets held for rent represent cesium formate product in the Specialty Fluids Segment that will be rented to customers in the normal course of business. Assets held for rent are stated at average cost.

Assets Held for Sale

Cabot classifies its long-lived assets as held for sale when management commits to a plan to sell the assets, the assets are ready for immediate sale in their present condition, an active program to locate buyers has been initiated, the sale of the assets is probable and expected to be completed within one year, the assets are marketed at reasonable prices in relation to their fair value and it is unlikely that significant changes will be made to the plan to sell the assets. The Company measures the value of long-lived assets held for sale at the lower of the carrying amount or fair value, less cost to sell.

Assets and liabilities held for sale in the Consolidated Balance Sheets pertain to applicable assets and liabilities of the Supermetals business. See Note C for additional information.

Asset Retirement Obligations

Cabot estimates incremental costs for special handling, removal and disposal of materials that may or will give rise to conditional asset retirement obligations (“AROs”) and then discounts the expected costs

 

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back to the current year using a credit adjusted risk free rate. Cabot recognizes ARO liabilities and costs when the timing and/or settlement can be reasonably estimated. The ARO reserves were $7 million and $10 million at September 30, 2011 and 2010, respectively.

Impairment of Long-Lived Assets

Cabot’s long-lived assets primarily include property, plant and equipment, long-term investments, assets held for rent and sale and intangible assets. 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. Cabot’s 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 Cabot is no longer using the asset.

Foreign Currency Translation

The functional currency of the majority of Cabot’s foreign subsidiaries is the local currency in which the subsidiary operates. Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet dates. Income and expense items are translated at average monthly exchange rates during the year. Unrealized currency translation adjustments are accumulated as a separate component of other comprehensive income within stockholders’ equity.

Realized and unrealized foreign currency gains and losses arising from transactions denominated in currencies other than the subsidiary’s functional currency are reflected in earnings with the exception of (i) intercompany transactions considered to be of a long-term investment nature; and (ii) foreign currency borrowings designated as net investment hedges. Gains or losses arising from these transactions are included as a component of other comprehensive income. In fiscal 2011, 2010 and 2009, net foreign currency transaction losses of $6 million, gains of less than $1 million and losses of $15 million, respectively, are included in Other expense in the Consolidated Statement of Operations as part of continuing operations.

Financial Instruments

Cabot’s financial instruments consist primarily of cash and cash equivalents, accounts and notes receivable, investments, accounts payable and accrued liabilities, short-term and long-term debt, and derivative instruments. The carrying values of Cabot’s financial instruments approximate fair value with the exception of long-term debt that has not been designated as part of a fair value hedge. The non-hedged long-term debt is recorded at amortized cost. The fair values of the Company’s financial instruments are based on quoted market prices, if such prices are available. In situations where quoted market prices are not available, the Company relies on valuation models to derive fair value. Such valuation takes into account the ability of the financial counterparty to perform.

Cabot uses derivative financial instruments primarily for purposes of hedging exposures to fluctuations in interest rates and foreign currency exchange rates, which exist as part of its on-going business operations. Cabot does not enter into derivative contracts for speculative purposes, nor does it hold or issue any derivative contracts for trading purposes. All derivatives are recognized on the Consolidated Balance Sheets at fair value. Where Cabot has a legal right to offset derivative settlements under a master netting agreement with a counterparty, derivatives with that counterparty are presented on a net basis. The changes in the fair value of derivatives are recorded in either earnings or Accumulated other comprehensive income, depending

 

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on whether or not the instrument is designated as part of a hedge transaction and, if designated as part of a hedge transaction, the type of hedge transaction. The gains or losses on derivative instruments reported in Accumulated other comprehensive income are reclassified to earnings in the period in which earnings are affected by the underlying hedged item. The ineffective portion of all hedges is recognized in earnings during the period in which the ineffectiveness occurs.

In accordance with Cabot’s risk management strategy, the Company may enter into certain derivative instruments that may not be designated as hedges for hedge accounting purposes. Although these derivatives are not designated as hedges, the Company believes that such instruments are closely correlated with the underlying exposure, thus managing the associated risk. The Company records in earnings the gains or losses from changes in the fair value of derivative instruments that are not designated as hedges. Cash movements associated with these instruments are presented in the Consolidated Statement of Cash Flows as Cash Flows from Operating Activities because the derivatives are designed to mitigate risk to the Company’s cash flow from operations.

Revenue Recognition

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

Shipping and handling charges related to sales transactions are recorded as revenue when billed to customers or included in the sales price. Shipping and handling costs are included in cost of sales.

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

 

     Years ended September 30  
     2011     2010     2009  

Core Segment

     65     63     63

Performance Segment

     29     30     31

New Business Segment

     4     4     3

Specialty Fluids Segment

     2     3     3

Cabot derives the substantial majority of revenues from the sale of products in the Core and Performance Segments. Revenue from these products is typically recognized when the product is shipped and title and risk of loss have passed to the customer. The Company offers 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. Cabot periodically reviews the assumptions underlying the estimates of discounts and volume rebates and adjust revenues accordingly.

Revenue in the New Business Segment 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.

The majority of the revenue in the Specialty Fluids Segment 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. On occasion Cabot also makes sales of cesium formate outside of a rental process and revenue is recognized upon delivery of the fluid.

 

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Accounts and Notes Receivable

Trade receivables are recorded at the invoiced amount and do not bear interest. Trade receivables in China may at certain times be settled with the receipt of bank issued non-interest bearing notes, which represent the Company’s notes receivable balance. These notes totaled 380 million Chinese Renminbi (“RMB”) ($60 million) and 143 million RMB ($21 million) as of September 30, 2011 and 2010, respectively, and are included in accounts and notes receivable. Cabot periodically sells a portion of the trade receivables in China at a discount and such sales are accounted for as asset sales. The Company does not have any continuing involvement with the notes after the sale. The difference between the proceeds from the sale and the carrying value of the receivables is recognized as a loss on the sale of receivables and is included in other expense in the accompanying Consolidated Statements of Operations. During fiscal 2011, 2010 and 2009, the Company recorded charges of less than a million, $2 million and $1 million, respectively, for the sale of these receivables.

Cabot maintains allowances for doubtful accounts based on an assessment of the collectibility 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. Changes in the allowance during fiscal 2011, 2010 and 2009 were immaterial. There is no off-balance sheet credit exposure related to customer receivable balances.

Stock-based Compensation

Cabot recognizes stock-based awards granted to employees as compensation expense using a fair value method. Under the fair value recognition provisions, stock-based compensation cost is measured at the grant date based on the fair value of the award, and is recognized as expense over the service period, which generally represents the vesting period, and includes an estimate of the awards that will be forfeited, and an estimate of what level of performance the Company will achieve for Cabot’s performance-based stock awards. Cabot calculates the fair value of its stock options using the Black-Scholes option pricing model. The fair value of restricted stock and restricted stock units is determined using the closing price of Cabot stock on the day of the grant.

Research and Technical Expenses

Research and technical expenses include salaries, equipment and material expenditures, and contractor fees and are expensed as incurred.

Income Taxes

Deferred income taxes are determined based on the estimated future tax effects of differences between financial statement carrying amounts and the tax bases of existing assets and liabilities. Deferred tax assets are recognized to the extent that realization of those assets is considered to be more likely than not.

A valuation allowance is established for deferred taxes when it is more likely than not that all or a portion of the deferred tax assets will not be realized. Provisions are made for the U.S. income tax liability and additional non-U.S. taxes on the undistributed earnings of non-U.S. subsidiaries, except for amounts Cabot has designated to be indefinitely reinvested.

Cabot records 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. The Company also accrues for interest and penalties on its uncertain tax positions and includes such charges in its income tax provision in the Consolidated Statements of Operations.

 

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Accumulated Other Comprehensive Income

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

Environmental Costs

Cabot accrues environmental costs when it is probable that a liability has been incurred and the amount can be reasonably estimated. When a single liability amount cannot be reasonably estimated, but a range can be reasonably estimated, Cabot accrues the amount that reflects the best estimate within that range or the low end of the range if no estimate within the range is better. The amount accrued reflects Cabot’s assumptions about remediation requirements at the contaminated site, the nature of the remedy, 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. Cabot discounts certain of its long-term environmental liabilities to reflect the time value of money if the amount of the liability and the amount and timing of cash payments for the liability are fixed and reliably determinable. The liability will be discounted at a rate that will produce an amount at which the liability theoretically could be settled in an arm’s length transaction with a third party. This discounted rate may not exceed the risk-free rate for maturities comparable to those of the liability. Cabot does not reduce its estimated liability for possible recoveries from insurance carriers. Proceeds from insurance carriers are recorded when realized by either the receipt of cash or a contractual agreement.

Use of Estimates

The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make certain estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

Note B. Accounting Pronouncements

New and Adopted

On October 1, 2010 the Company adopted authoritative guidance on the consolidation of variable interest entities. The new guidance requires revised evaluations of whether entities represent variable interest entities, ongoing assessments of control over such entities, and additional disclosures for variable interests. The impact of the adoption is not material to the consolidated financial statements.

In September 2011, the FASB issued amended guidance on testing goodwill for impairment. Companies will now have the option to 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 amount. If after considering the totality of events and circumstances an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, performing the two-step impairment is unnecessary. The amended guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 but early adoption is permitted. The Company will early adopt this amended guidance for its annual impairment test in fiscal 2012 and believes the impact will not be material to the consolidated financial statements.

 

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Note C. Discontinued Operations

Cabot Supermetals Business

In August 2011, the Company entered into a Sale and Purchase Agreement (the “Purchase Agreement”) with Global Advanced Metals Pty Ltd., an Australian company (“GAM”), for the sale of substantially all of the assets of the Company’s Supermetals Business in exchange for a minimum of $401.5 million comprised of the following: (i) $175 million payable in cash at the closing, subject to certain working capital adjustments at closing, (ii) $175 million of 10.84% interest-bearing two-year promissory notes, which may be pre-paid by GAM at any time prior to maturity for an amount equal to $215 million (consisting of principal, interest and a prepayment premium), secured by liens on the property and assets of the acquired business and guaranteed by the GAM corporate group, (iii) quarterly contingent cash payments to be made in each calendar quarter that the promissory notes are outstanding in an amount equal to 50% of Adjusted EBITDA of the acquired business for the relevant calendar quarter, guaranteed to be at least $11.5 million for the first year following the closing of the transaction, and (iv) the assumption of certain liabilities associated with the Supermetals Business.

The parties expect the transaction to close by the end of calendar year 2011. Completion of the sale is subject to regulatory approval and certain other customary conditions. The Purchase Agreement is not subject to a financing condition.

In connection with the transaction, the parties have entered into a tantalum ore supply agreement under which the Company will sell to GAM all of the tantalum ore mined at the Company’s mine in Manitoba, Canada for a period of three years following the closing of the transaction. The Company also entered into a transition services agreement for the Company to provide certain information technology applications and infrastructure and various administrative services to GAM during the transition period of six months from the closing date in exchange for one time and monthly service fees. GAM has the option to terminate such transition services with notice at any time and may elect to extend such services for up to three months. The future continuing cash flows from the disposed business to Cabot resulting from the tantalum ore supply agreement and transition services agreement are not significant and do not constitute a material continuing financial interest in the Supermetals Business.

The Supermetals Business, which had previously been presented as a separate reporting business, meets the criteria for being reported as a discontinued operation and has been segregated from continuing operations. The following table summarizes the results from discontinued operations:

 

     Years Ended September 30  
       2011         2010         2009    
     (Dollars in millions)  

Net sales and other operating revenues

   $ 201     $ 177     $ 135  
  

 

 

   

 

 

   

 

 

 

Income (loss) from operations before income taxes

     84       42       (3

(Provision) benefit for income taxes

     (31     (16     1  
  

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations, net of tax

   $ 53     $ 26     $ (2
  

 

 

   

 

 

   

 

 

 

 

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The following table summarizes the assets held for sale and the liabilities held for sale in the Company’s Consolidated Balance Sheets:

 

     September 30,  
     2011      2010  
     (Dollars in millions)  

Assets

     

Accounts and notes receivable, net of reserve for doubtful accounts

   $ 41      $ 36  

Inventories

     64        66  

Prepaid expenses and other current assets

     1        1  
  

 

 

    

 

 

 

Total current assets held for sale

   $ 106      $ 103