UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended

June 30, 2006

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 of Incorporation)

 

(I.R.S. Employer Identification No.)

 

 

 

Two Seaport Lane

 

02210-2019

Boston, Massachusetts

 

(Zip Code)

(Address of principal executive offices)

 

 

 

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ X ]                 Accelerated filer  [   ]                           Non-accelerated filer  [   ]

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

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

As of August 1, 2006 the Company had 63,333,032 shares of Common

Stock, par value $1 per share, outstanding.

 




 

CABOT CORPORATION

INDEX

Part I.   Financial Information

 

Page

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

Consolidated Statements of Operations for the Three Months and Nine Months Ended June 30, 2006 and 2005 (unaudited)

3

 

 

 

 

 

 

Consolidated Balance Sheets as of June 30, 2006 and September 30, 2005 (unaudited)

4

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2006 and 2005 (unaudited)

6

 

 

 

 

 

 

Consolidated Statement of Changes in Stockholders’ Equity for the Nine Months Ended June 30, 2006 (unaudited)

7

 

 

 

 

 

 

Notes to Consolidated Financial Statements

8

 

 

 

 

Item 2.

 

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

24

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

43

 

 

 

 

Item 4.

 

Controls and Procedures

43

 

 

 

 

Part II. Other Information

 

 

 

 

 

Item 1.

 

Legal Proceedings

44

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

46

 

 

 

 

Item 6.

 

Exhibits

47

 

 

 

 

EX-10.1 Non-Employee Directors’ Stock Deferral Plan, dated July 14, 2006.

 

EX-31.1 Section 302 Certification of CEO

 

EX-31.2 Section 302 Certification of CFO

 

EX-32 Section 906 Certification of CEO and CFO

 

 




 

Part I.   Financial Information

Item 1.   Financial Statements

CABOT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Nine Months Ended June 30, 2006 and 2005

(In millions, except per share amounts)

UNAUDITED

 

 

Three Months Ended
June 30,

 

Nine Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Net sales and other operating revenues

 

$

666

 

$

545

 

$

1,880

 

$

1,567

 

Cost of sales

 

551

 

427

 

1,574

 

1,202

 

Gross profit

 

115

 

118

 

306

 

365

 

 

 

 

 

 

 

 

 

 

 

Selling and administrative expenses

 

59

 

63

 

176

 

173

 

Research and technical expenses

 

14

 

14

 

41

 

43

 

Goodwill asset impairment

 

 

 

 

90

 

Income from operations

 

42

 

41

 

89

 

59

 

 

 

 

 

 

 

 

 

 

 

Interest and dividend income

 

 

2

 

3

 

5

 

Interest expense

 

(6

)

(8

)

(19

)

(24

)

Other income (expense)

 

(2

)

1

 

 

5

 

Income from continuing operations before income taxes

 

34

 

36

 

73

 

45

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

(8

)

(9

)

(13

)

(30

)

Equity in net income of affiliated companies, net of tax

 

1

 

2

 

8

 

6

 

Minority interest in net income, net of tax

 

(2

)

(3

)

(9

)

(9

)

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

25

 

26

 

59

 

12

 

 

 

 

 

 

 

 

 

 

 

Cumulative effect of an accounting change, net of tax

 

 

 

2

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

25

 

26

 

61

 

12

 

 

 

 

 

 

 

 

 

 

 

Dividends on preferred stock, net of tax

 

(1

)

(1

)

(2

)

(2

)

 

 

 

 

 

 

 

 

 

 

Net income available to common shares

 

$

24

 

$

25

 

$

59

 

$

10

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

60

 

60

 

60

 

60

 

Diluted

 

69

 

69

 

69

 

69

 

Income per common share:

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.41

 

$

0.43

 

$

0.95

 

$

0.18

 

Cumulative effect of an accounting change

 

 

 

0.04

 

 

Net income per share - basic

 

$

0.41

 

$

0.43

 

0.99

 

$

0.18

 

Diluted:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.37

 

$

0.39

 

$

0.85

 

$

0.18

 

Cumulative effect of an accounting change

 

 

 

0.04

 

 

Net income per share - diluted

 

$

0.37

 

$

0.39

 

$

0.89

 

$

0.18

 

 

 

 

 

 

 

 

 

 

 

Dividends per common share

 

$

0.16

 

$

0.16

 

$

0.48

 

$

0.48

 

 

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

3




 

CABOT CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, 2006 and September 30, 2005

(In millions)

ASSETS

UNAUDITED

 

 

 

June 30,

 

September 30,

 

 

 

2006

 

2005

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

114

 

$

181

 

Short-term marketable securities investments

 

1

 

30

 

Accounts and notes receivable, net of reserve for doubtful accounts of $7 and $4

 

541

 

430

 

Inventories:

 

 

 

 

 

Raw materials

 

144

 

169

 

Work in process

 

120

 

134

 

Finished goods

 

145

 

151

 

Other

 

39

 

39

 

Total inventories

 

448

 

493

 

Prepaid expenses and other current assets

 

92

 

66

 

Assets held for sale

 

 

5

 

Deferred income taxes

 

50

 

41

 

Total current assets

 

1,246

 

1,246

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

Equity affiliates

 

57

 

63

 

Long-term marketable securities and cost investments

 

3

 

6

 

Total investments

 

60

 

69

 

 

 

 

 

 

 

Property, plant and equipment

 

2,479

 

2,264

 

Accumulated depreciation and amortization

 

(1,530

)

(1,430

)

Net property, plant and equipment

 

949

 

834

 

 

 

 

 

 

 

Other assets:

 

 

 

 

 

Goodwill

 

35

 

25

 

Intangible assets, net of accumulated amortization of $9 and $9

 

5

 

6

 

Assets held for rent

 

39

 

37

 

Deferred income taxes

 

106

 

108

 

Other assets

 

58

 

49

 

Total other assets

 

243

 

225

 

 

 

 

 

 

 

Total assets

 

$

2,498

 

$

2,374

 

 

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

4




 

CABOT CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, 2006 and September 30, 2005

(In millions, except for share and per share amounts)

LIABILITIES & STOCKHOLDERS’ EQUITY

UNAUDITED

 

 

 

June 30,

 

September 30,

 

 

 

2006

 

2005

 

Current liabilities:

 

 

 

 

 

Notes payable to banks

 

$

44

 

$

34

 

Accounts payable and accrued liabilities

 

369

 

321

 

Income taxes payable

 

44

 

30

 

Deferred income taxes

 

1

 

1

 

Current portion of long-term debt

 

39

 

47

 

Total current liabilities

 

497

 

433

 

 

 

 

 

 

 

Long-term debt

 

458

 

463

 

Deferred income taxes

 

13

 

15

 

Other liabilities

 

292

 

307

 

 

 

 

 

 

 

Commitments and contingencies (Note I)

 

 

 

 

 

 

 

 

 

 

 

Minority interest

 

64

 

57

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock:

 

 

 

 

 

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

 

 

 

 

 

Series B ESOP Convertible Preferred Stock 7.75% Cumulative issued: 75,336 shares; outstanding: 57,043 and 61,068 shares (aggregate Redemption value of $40 and $44)

 

57

 

61

 

Less cost of shares of preferred treasury stock

 

(38

)

(38

)

Common stock:

 

 

 

 

 

Authorized: 200,000,000 shares of $1 par value
Issued and outstanding: 63,452,646 and 62,971,872 shares

 

63

 

63

 

Less cost of shares of common treasury stock

 

(5

)

(5

)

Additional paid-in capital

 

21

 

32

 

Retained earnings

 

1,144

 

1,127

 

Unearned compensation

 

 

(41

)

Deferred employee benefits

 

(39

)

(42

)

Notes receivable for restricted stock

 

(15

)

(19

)

Accumulated other comprehensive loss

 

(14

)

(39

)

Total stockholders’ equity

 

1,174

 

1,099

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

2,498

 

$

2,374

 

 

The accompanying notes are an integral part of these financial statements

5




 

CABOT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended June 30, 2006 and 2005

(In millions)

UNAUDITED

 

 

 

2006

 

2005

 

Cash Flows from Operating Activities:

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

61

 

$

12

 

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

 

 

 

 

 

Depreciation and amortization

 

92

 

106

 

Deferred tax provision

 

(3

)

5

 

Cumulative effect of an accounting change

 

(2

)

 

Equity in income of affiliated companies

 

(8

)

(6

)

Goodwill asset impairment

 

 

90

 

Other asset impairment charges

 

 

2

 

Non-cash compensation

 

20

 

21

 

Other non-cash charges, net

 

14

 

10

 

Changes in assets and liabilities (net of effect of acquisition):

 

 

 

 

 

Accounts and notes receivable

 

(67

)

(51

)

Inventory

 

55

 

(50

)

Prepayments and other assets

 

(8

)

8

 

Accounts payable and accrued liabilities

 

10

 

(27

)

Income taxes payable

 

(28

)

6

 

Other liabilities

 

(25

)

(25

)

Other, net

 

4

 

(7

)

Cash provided by operating activities

 

115

 

94

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

 

 

 

 

 

 

Additions to property, plant and equipment

 

(144

)

(114

)

Cash paid for acquisition of affiliate, net of cash acquired

 

(19

)

 

Proceeds from sales of property, plant and equipment

 

8

 

1

 

Increase in assets held for rent

 

(2

)

(4

)

Purchase of marketable securities investments

 

(20

)

(94

)

Proceeds from sale and maturity of marketable securities investments

 

57

 

159

 

Cash used in investing activities

 

(120

)

(52

)

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

 

 

 

 

 

 

Repayments of long-term debt

 

(43

)

(5

)

Proceeds from issuance of long-term debt

 

33

 

 

Increase in notes payable

 

7

 

3

 

Repayments of debt related to Cabot Japan

 

(21

)

 

Purchases of common stock

 

(8

)

(47

)

Proceeds from sales of common stock

 

7

 

3

 

Proceeds from cash contributions received from minority interest shareholders

 

2

 

4

 

Cash dividends paid to stockholders

 

(32

)

(32

)

Cash dividends paid to minority interest stockholders

 

(7

)

(8

)

Restricted stock loan repayments

 

2

 

2

 

Cash used in financing activities

 

(60

)

(80

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(2

)

 

Decrease in cash and cash equivalents

 

(67

)

(38

)

Cash and cash equivalents at beginning of period

 

181

 

159

 

Cash and cash equivalents at end of period

 

$

114

 

$

121

 

 

 

 

 

 

 

 

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

6




 

CABOT CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

Nine Months Ended June 30, 2006

(In millions, except shares in thousands)

UNAUDITED

 

Preferred Stock, net of
Treasury Stock

 

Common Stock, net of
Treasury Stock

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Unearned
Compensation

 

Deferred
Employee
Benefits

 

Notes
Receivable
from
Restricted
Stock

 

Accumulated
Other
Comprehensive
Loss

 

Total
Stockholders’
Equity

 

Comprehensive
Income

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2006

 

Shares

 

Cost

 

Shares

 

Cost

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2005

 

44

 

$

23

 

62,820

 

$

58

 

$

32

 

$

1,127

 

$

(41

)

$

(42

)

$

(19

)

$

(39

)

$

1,099

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

61

 

 

 

 

 

 

 

 

 

 

 

$

61

 

Foreign currency translation adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

18

 

 

 

18

 

Unrealized gain on derivative instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7

 

 

 

7

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

25

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

86

 

$

86

 

Common dividends paid

 

 

 

 

 

 

 

 

 

 

 

(30

)

 

 

 

 

 

 

 

 

(30

)

 

 

Issuance of stock under employee

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

compensation plans, net of actual forfeitures

 

 

 

 

 

301

 

 

25

 

 

 

 

 

 

 

 

 

 

 

25

 

 

 

Preferred stock conversion

 

(4

)

(4

)

589

 

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Purchase and retirement, common and treasury stock

 

 

 

 

 

(406

)

 

(7

)

 

 

 

 

 

 

 

 

 

 

(7

)

 

 

Preferred dividends paid to Employee Stock Ownership Plan, net of tax benefit

 

 

 

 

 

 

 

 

 

 

 

(2

)

 

 

 

 

 

 

 

 

(2

)

 

 

Principal payment by Employee Stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ownership Plan under guaranteed loan

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3

 

 

 

 

 

3

 

 

 

Reversal of unearned compensation due to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FAS 123 (R) implementation

 

 

 

 

 

 

 

 

 

(29

)

(12

)

41

 

 

 

 

 

 

 

 

 

 

Cumulative effect of change in accounting principle

 

 

 

 

 

 

 

 

 

(4

)

 

 

 

 

 

 

 

 

 

 

(4

)

 

 

Notes receivable for restricted stock —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

repayments and forfeitures

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4

 

 

 

4

 

 

 

Balance at June 30, 2006

 

40

 

$

19

 

63,304

 

$

58

 

$

21

 

$

1,144

 

$

 

$

(39

)

$

(15

)

$

(14

)

$

1,174

 

 

 

 

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

7




 

CABOT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2006

Unaudited

A.           Basis of Presentation

The consolidated financial statements include the accounts of Cabot Corporation and its majority-owned and controlled U.S. and non-U.S. subsidiaries (“Cabot” or the “Company”). Intercompany transactions have been eliminated.

The unaudited consolidated financial statements have been prepared in accordance with the requirements of Form 10-Q and consequently do not include all disclosures required by Form 10-K. Additional information may be obtained by referring to Cabot’s Annual Report on Form 10-K for the fiscal year ended September 30, 2005 (“2005 10-K”).

The financial information submitted herewith is unaudited and reflects all adjustments which are, in the opinion of management, necessary to provide a fair statement of the results for the interim periods ended June 30, 2006 and 2005. All such adjustments are of a normal recurring nature. The results for interim periods are not necessarily indicative of the results to be expected for the fiscal year.

Certain amounts in fiscal 2005 have been reclassified to conform to the fiscal 2006 presentation.

B.           Significant Accounting Policies

Revenue Recognition

Cabot derives most of its revenues from the sale of rubber blacks, performance products, inkjet colorants, fumed metal oxides and tantalum and related products and from the rental and sale of cesium formate. Revenue from product sales is typically recognized when the product is shipped and title and risk of loss have passed to the customer. Revenue from the rental of cesium formate is recognized throughout the rental period based on the contracted rental amount. Customers are also billed and revenue is recognized, typically at the end of the job, for cesium formate product that is not returned. Other operating revenues, which represent less than ten percent of total revenues, include tolling, servicing and royalties for licensed technology.

Cabot’s revenue recognition policies are in accordance with Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which establishes criteria that must be satisfied before revenue is realized or realizable and earned. Cabot recognizes revenue when persuasive evidence of a sales arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility 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, the revenue is deferred until product acceptance has occurred.

Certain customer contracts contain price protection clauses that provide for the potential reduction in past or future sales prices. Cabot analyzes these contract provisions to determine if an obligation related to these clauses exists and records revenue net of any estimated price protection commitments.

Under certain multi-year supply contracts with declining prices and minimum volumes, Cabot recognizes revenue based on the estimated average selling price over the contract lives. At June 30, 2006 and September 30, 2005, Cabot had less than a million and $1 million, respectively, of revenue deferred related to certain supply agreements representing the difference between the billed price and the estimated average selling price. The revenue deferred will be recognized as customers purchase the contracted minimum volumes through calendar 2006.

The Company offers certain of its customers cash discounts and volume rebates as sales incentives. The discounts and volume rebates are recorded as a reduction of sales at the time revenue is recognized based on historical experience. Rebates are estimated and recorded based primarily on historical experience and contractual obligations. Cabot reviews its estimates for discounts and volume rebates, and the assumptions underlying the estimates are modified to reflect changes in facts and circumstances as appropriate.

Accounts and notes receivable as of June 30, 2006 and September 30, 2005 primarily include trade accounts receivable, which arise in the normal course of business, income tax receivables of $31 million and $23 million, respectively, and the current portion of notes receivable of $10 million and $6 million, respectively.

8




 

CABOT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006

Unaudited

Trade receivables are recorded at the invoiced amount and do not bear interest. Certain receivables in one subsidiary may be settled through the receipt of bank issued non interest bearing notes. These notes totaled 64 million RMB ($8 million) and 42 million RMB ($5 million) as of June 30, 2006 and September 3, 2005, respectively, and are included in Accounts and notes receivable. Cabot periodically sells a portion of these notes receivables from customers related to one of its subsidiaries at a discount. These transactions are accounted for as sales under the provisions of FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” 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 statements of operations.

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 for doubtful accounts when Cabot determines it is probable the receivable will not be recovered. Changes made in the allowance during both the third fiscal quarter of 2006 and 2005 were not material.

Shipping and handling charges related to sales transactions are recorded as sales revenue when billed to customers or included in the sales price in accordance with Emerging Issues Task Force (“EITF”) 00-10, “Accounting for Shipping and Handling Fees and Costs.” Shipping and handling costs are included in cost of sales.

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 values and it is unlikely that significant changes will be made to the plan to sell the assets. The Company measures long-lived assets to be disposed of by sale at the lower of the carrying amount and fair value, less cost to sell.

During the second quarter of fiscal 2006, Cabot sold the property, plant and equipment assets related to the Supermetals Business’s direct finished tantalum sputtering target business to Tosoh SMD, a division of Tosoh Corporation. These assets were recorded at their fair value and classified as assets held for sale at December 31, 2005. There was no gain or loss recognized upon completion of the sale.

Last-In First-Out (“LIFO”) Liquidation

During the third quarter of 2006, inventory quantities were reduced at the Company’s U.S. Supermetals site.  This reduction led to a liquidation of LIFO inventory quantities carried at lower costs, that were prevailing in prior years, as compared with the cost of current fiscal year purchases through June 30, 2006. This resulted in a decrease of cost of goods sold of $2 million and an increase of net income by approximately $1 million, or $0.02 per share, for the three and nine months ended June 30, 2006.

C.                                    Stock-Based Compensation

Cabot established the 2006 Long-Term Incentive Plan (the “2006 Plan”) in order to provide equity-based compensation to the Company’s key employees, advisors and consultants. The 2006 Plan was approved by Cabot’s stockholders on March 9, 2006 and replaces the 1996 Equity Incentive Plan and the 1999 Equity Incentive Plan. Although the 2006 Plan allows Cabot to issue various forms of equity, Cabot expects to use the 2006 Plan primarily to issue shares of restricted stock and stock options under its long-term incentive compensation program. The terms of awards made under this program are generally determined by the Compensation Committee of the Board of Directors. As the program has been administered since 1992, participants are granted a specific number of shares of common stock (the “Grant Number”) that the participant may then elect either (i) to purchase as shares of restricted stock at a percentage of the market price of such stock on the date of grant (which in the last six years has been 30%) or (ii) to receive as non-qualified stock options for a number of shares of common stock equal to two times the Grant Number, exercisable at 100% of the market price of such stock on the date of grant. Both the purchased restricted stock and the stock options granted under the program are subject to a three-year vesting period. Stock options granted under the program expire five years from the date of grant. Variations of the restricted stock awards are made to international employees in order to provide benefits comparable to U.S. employees. Approximately 1.0 million restricted stock awards were granted under the 2006 Plan and there are approximately 3.4 million shares available for future grants at June 30, 2006. No new awards may be granted under either the 1996 Equity Incentive Plan or the 1999 Equity Incentive Plan, but there remain outstanding certain awards previously granted under these plans.

Through fiscal year 2005, Cabot followed Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, which resulted in the accounting for grants of awards to employees at their intrinsic value in the consolidated financial statements. On October 1, 2005, Cabot adopted FAS No. 123(R), “Accounting for Stock-Based Compensation,” using the modified prospective method, which permits the provisions of FAS 123(R) to be applied to the consolidated financial statements on a going-forward basis. Prior periods have not been restated. FAS 123(R)

9




 

CABOT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006

Unaudited

requires companies to recognize share-based payments to employees as compensation expense on a fair value method. Under the fair value recognition provisions of FAS 123(R), 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. The fair value of stock options is calculated using the Black-Scholes option-pricing model and the fair value of restricted stock is based on intrinsic value. The expense recognized over the service period is required to include an estimate of the awards that will be forfeited. Previously, and as permitted under APB 25, Cabot recorded the impact of forfeitures as they occurred. In connection with the adoption of FAS 123(R), during the first quarter of fiscal year 2006, Cabot recorded a $2 million gain (after-tax) from the cumulative effect of the change from recording forfeitures as they occur to estimating forfeitures during the service period. In addition, the previously recorded unearned compensation balance of $41 million that existed as of the date of adoption and which was included as a component of stockholders’ equity, was reclassified to additional paid-in capital and retained earnings.

Stock-based Compensation

Prior to the adoption of FAS No. 123(R), Cabot included in its financial statements the stock-based compensation disclosure requirements of FAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” The following table illustrates the effect the fair value recognition provisions of FAS No. 123, “Accounting for Stock Based Compensation” would have had on net earnings per share for the three and nine months ended June 30, 2005.

(in millions, except for per share amounts)

 

Three Months Ended
June 30, 2005

 

Nine Months Ended
June 30, 2005

 

Net income, as reported

 

$

26

 

$

12

 

Add: Stock-based compensation expense included in reported net income, net of related tax effects

 

5

 

15

 

Deduct: Stock-based compensation using fair value method for all awards, net of related tax effects

 

(5

)

(16

)

Pro forma net income

 

$

26

 

$

11

 

Net income per common share:

 

 

 

 

 

Basic, pro forma

 

$

0.43

 

$

0.18

 

Basic, as reported

 

$

0.43

 

$

0.16

 

Diluted, pro forma

 

$

0.39

 

$

0.18

 

Diluted, as reported

 

$

0.39

 

$

0.16

 

 

10




 

CABOT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006

Unaudited

Stock-based employee compensation expense was $4 million and $12 million after tax for the three and nine months ending June 30, 2006, respectively. The Company recognized the full impact of its stock-based employee compensation in the consolidated statements of operations for the nine months ended June 30, 2006 under FAS 123(R) and did not capitalize any such costs on the consolidated balance sheets because those that qualified for capitalization were not material. The following table presents stock-based compensation expenses included in the Company’s consolidated statement of operations:

(Dollars in millions)

 

Three Months Ended
June 30, 2006

 

Nine Months Ended
June 30, 2006

 

Cost of sales

 

$

2

 

$

7

 

Selling and administrative

 

3

 

10

 

Research and technical

 

1

 

2

 

Stock-based compensation expense before tax

 

6

 

19

 

Income tax benefit

 

(2

)

(7

)

Net stock-based compensation expense

 

$

4

 

$

12

 

 

Stock Options- As of June 30, 2006, Cabot has $2 million of total unrecognized compensation cost related to non-vested options granted under the Company’s equity incentive plans. That cost is expected to be recognized over a weighted-average period of 1.76 years.

Restricted Stock- As of June 30, 2006, Cabot has $42 million of total unrecognized compensation cost related to non-vested restricted stock granted under the Company’s equity incentive plans. That cost is expected to be recognized over a weighted-average period of 1.81 years.

Equity Incentive Plan Activity

The following tables summarize the total stock option and restricted stock activity in the equity incentive plans for the three and nine months ended June 30, 2006:

 

 

Three Months Ended June 30, 2006

 

 

 

Stock Options

 

Restricted Stock

 

(Shares in thousands)

 

Total
Options

 

Weighted
Average
Exercise
Price

 

Non-
Vested
Options

 

Weighted
Average
Exercise
Price

 

Restricted
Shares

 

Weighted
Average
Fair Value

 

Outstanding at March 31, 2006

 

647

 

$

29.31

 

431

 

$

29.83

 

2,918

 

$

30.27

 

Granted

 

93

 

35.23

 

93

 

35.23

 

966

 

35.23

 

Exercised/Vested

 

(32

)

33.86

 

(157

)

28.00

 

(831

)

28.06

 

Cancelled/Forfeited

 

(6

)

34.87

 

 

 

(31

)

31.27

 

Outstanding at June 30, 2006

 

702

 

29.84

 

367

 

31.97

 

3,022

 

32.45

 

Exercisable at June 30, 2006

 

336

 

27.50

 

 

 

 

 

 

 

 

 

 

11




 

CABOT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006

Unaudited

 

Nine Months Ended June 30, 2006

 

 

 

Stock Options

 

Restricted Stock

 

(Shares in thousands)

 

Total
Options

 

Weighted
Average
Exercise
Price

 

Non-
Vested
Options

 

Weighted
Average
Exercise
Price

 

Restricted
Shares

 

Weighted
Average
Fair Value

 

Outstanding at March 31, 2005

 

866

 

$

29.42

 

450

 

$

29.79

 

3,092

 

$

30.29

 

Granted

 

93

 

35.23

 

93

 

35.23

 

972

 

35.23

 

Exercised/Vested

 

(236

)

30.34

 

(161

)

28.00

 

(858

)

28.19

 

Cancelled/Forfeited

 

(21

)

30.80

 

(15

)

29.22

 

(184

)

30.66

 

Outstanding at June 30, 2006

 

702

 

29.84

 

367

 

31.97

 

3,022

 

32.45

 

Exercisable at June 30, 2006

 

336

 

27.50

 

 

 

 

 

 

 

 

 

 

Stock Options

The following table summarizes information related to the outstanding and vested options on June 30, 2006:

 

Options
Outstanding

 

Vested
Options

 

Aggregate Intrinsic Value (dollars in millions)

 

$

2

 

$

2

 

Weighted Average Remaining Contractual Term (in years)

 

3

 

1

 

 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the closing price of the Company’s common stock ($34.52) on June 30, 2006, which would have been received by the option holders had all option holders exercised their options on that date.

The following table summarizes information related to the total intrinsic value of options exercised during the three and nine months ended June 30, 2006:

 

Three Months Ended
June 30, 2006

 

Nine Months Ended
June 30, 2006

 

(Dollars in millions)

 

 

 

 

 

Intrinsic Value

 

$

 

$

2

 

Cash Received

 

1

 

7

 

Tax Benefit

 

 

1

 

 

The Company settles employee stock option exercises with newly issued common shares. The total fair value of the options vested during the three and nine months ended June 30, 2006 was $6 million.

The Company uses the Black-Scholes option-pricing model to estimate the fair value of the options at the grant date. There were approximately 93,000 options granted during the three and nine months ended June 30, 2006. The fair values of options outstanding on June 30, 2006 were calculated using the following assumptions:

 

For the Years Ended September 30,

 

 

 

2006

 

2005

 

2004

 

2003

 

Expected weighted-average stock price volatility

 

31

%

42

%

44

%

46

%

Risk free interest rate

 

4.9

%

3.8

%

3.7

%

2.2

%

Expected weighted-average life of options (years)

 

4

 

4

 

4

 

4

 

Expected annual dividends per share

 

$

0.64

 

$

0.64

 

$

0.60

 

$

0.52

 

 

12




 

CABOT CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006

Unaudited

The expected stock price volatility assumption was determined using the historical volatility of the Company’s common stock over the expected life of the option.

D.           Acquisitions

Cabot had a 50:50 joint venture arrangement with Showa Denko K.K. in an entity called Showa Cabot K.K. (“SCK”). On November 8, 2005, Cabot purchased Showa Denko K.K.’s 50% joint venture interest in SCK for $19 million and renamed the entity Cabot Japan K.K (“Cabot Japan”). In addition, as part of the acquisition, Cabot assumed approximately $26 million of SCK’s debt obligations and approximately $10 million of unfunded pension liabilities.

Prior to the acquisition, Cabot’s investment in SCK was accounted for as an equity method investment. Included in Cabot’s consolidated results for the period ended June 30, 2006 are 50% of the operating results of SCK from October 1, 2005 through November 7, 2005 and 100% of the operating results of Cabot Japan from November 8, 2005 through June 30, 2006.

The fair value of the assets acquired and liabilities and debt assumed represents the 50% of SCK that Cabot purchased. A preliminary allocation of the purchase price is as follows:

(Dollars in millions)

 

 

 

Cash paid

 

$

19

 

 

 

 

 

Accounts receivable

 

$

20

 

Inventories

 

3

 

Deferred income taxes

 

7

 

Investments in marketable securities

 

1

 

Property, plant and equipment

 

26

 

Total assets acquired

 

$

57

 

 

 

 

 

Accounts payable and accrued expenses

 

27

 

Notes payable

 

12

 

Pension obligation

 

10

 

Total liabilities assumed

 

$

49

 

Net assets acquired

 

$

8

 

Excess purchase price

 

$

11

 

 

At June 30, 2006, the excess purchase price related to the acquisition of SCK has been included as a component of goodwill in the accompanying consolidated balance sheets. The allocation of the purchase price is based on preliminary estimates of the fair value of the net assets acquired, and is subject to revision. The allocation is not yet finalized as management is still in the process of performing the valuation of tangible and intangible assets and pension obligations with the assistance of independent valuation specialists. The allocation will be finalized during the fourth quarter of fiscal 2006.

13




 

CABOT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006
Unaudited

The following unaudited pro forma financial information reflects the consolidated results of operations of Cabot for the three and nine months ended June 30, 2006 and 2005 as though the acquisition of SCK had occurred on the first day of the respective period. The pro forma operating results are presented for comparative purposes only and do not purport to present Cabot’s actual operating results for these periods or results that may occur in the future:

 

Three Months Ended
June 30,

 

Nine Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

(In millions, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

666

 

$

579

 

$

1,893

 

$

1,667

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

25

 

$

26

 

$

61

 

$

14

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.41

 

$

0.43

 

$

0.99

 

$

0.23

 

Diluted

 

$

0.37

 

$

0.39

 

$

0.89

 

$

0.20

 

 

E.            Goodwill and Other Intangible Assets

The carrying amount of goodwill attributable to each reportable segment with goodwill balances and the changes in those balances during the nine months ended June 30, 2006 are as follows:

(Dollars in millions)

 

Carbon Black
Business

 

Metal Oxides
Business

 

Total

 

Balance at September 30, 2005

 

$

15

 

$

10

 

$

25

 

Increase for Acquisition of SCK

 

11

 

 

11

 

Foreign exchange translation adjustment

 

(1

)

 

(1

)

Balance at June 30, 2006

 

$

25

 

$

10

 

$

35

 

 

As required by FAS No. 142, “Goodwill and Other Intangibles,” impairment tests are performed at least annually. The Company performs its annual impairment assessment for goodwill during the third quarter of each fiscal year. During the third quarter of fiscal 2006, Cabot performed its annual FAS No. 142 impairment test and determined that there was no impairment.

Cabot does not have any indefinite-lived intangible assets. At June 30, 2006 and September 30, 2005, Cabot had $5 million of finite-lived intangible assets. Intangible assets are amortized over their estimated useful lives, which range from two to fifteen years, with a weighted average amortization period of ten years.

In May 2006, Cabot entered into a cross license agreement with Aspen Aerogel, Inc. where each party granted certain patent rights to the other.  In consideration for use of the patents granted by Cabot, the agreement calls for Cabot to receive $8 million of cash in ten equal semi-annual payments beginning in September 2006 and the right to receive equity in Aspen. No amounts were recorded in the third quarter for either the cash or equity, because of the contingent nature of the arrangements.

14




 

CABOT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006
Unaudited

F.            Employee Benefit Plans

Net periodic defined benefit pension and other postretirement benefit costs include the following components for the three months ended June 30, 2006 and 2005:

 

Three Months Ended June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

Pension Benefits

 

Postretirement Benefits

 

(Dollars in millions)

 

U.S.

 

Foreign

 

U.S.

 

Foreign

 

U.S.

 

Foreign

 

U.S.

 

Foreign

 

Service cost

 

$

2

 

$

1

 

$

2

 

$

2

 

$

 

$

 

$

1

 

$

 

Interest cost

 

2

 

3

 

2

 

3

 

1

 

1

 

1

 

1

 

Expected gain on plan assets

 

(3

)

(2

)

(3

)

(2

)

 

 

 

 

Recognized loss

 

 

1

 

 

1

 

1

 

 

1

 

 

Amortization of prior service cost

 

 

 

 

 

(1

)

 

(1

)

 

Net periodic benefit cost

 

$

1

 

$

3

 

$

1

 

$

4

 

$

1

 

$

1

 

$

2

 

$

1

 

 

Net periodic defined benefit pension and other postretirement benefit costs include the following components for the nine months ended June 30, 2006 and 2005:

 

Nine Months Ended June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

Pension Benefits

 

Postretirement Benefits

 

(Dollars in millions)

 

U.S.

 

Foreign

 

U.S.

 

Foreign

 

U.S.

 

Foreign

 

U.S.

 

Foreign

 

Service cost

 

$

5

 

$

4

 

$

4

 

$

5

 

$

2

 

$

 

$

2

 

$

 

Interest cost

 

5

 

8

 

5

 

9

 

4

 

1

 

4

 

1

 

Expected gain on plan assets

 

(8

)

(7

)

(8

)

(8

)

 

 

 

 

Recognized loss

 

 

3

 

 

3

 

2

 

 

2

 

 

Amortization of prior service cost

 

 

 

 

 

(1

)

 

(2

)

 

Net periodic benefit cost

 

$

2

 

$

8

 

$

1

 

$

9

 

$

7

 

$

1

 

$

6

 

$

1

 

 

In connection with the Altona plant closure and subsequent windup of the related employee benefit plans, during the first quarter of 2006 the Company recognized $1 million of previously unrecognized actuarial gains. This has been included as a component of the Altona restructuring charges.

G.           Restructuring

Altona Restructuring

In October 2004, Cabot initiated a plan to shut down its Altona, Australia carbon black manufacturing facility due to an indication by Cabot’s raw materials supplier that it would cease supply in September 2005, as well as the decline of the carbon black business in Australia. Production at this facility ceased on October 3, 2005. As of June 30, 2006, Cabot expects the shutdown plan to result in a total pre-tax charge to earnings of approximately $26 million, which is expected to be partly offset by gains on the sale of the land on which the facility is located. These gains are estimated to be between approximately $7 million and $10 million (net of transaction costs). The $26 million of estimated charges includes approximately $7 million for severance and employee benefits, $6 million for accelerated depreciation of the facility assets, $3 million for the demolition of the facility, $2 million for asset retirement obligations related to site remediation and restoration and $8 million for the realization of foreign currency translation adjustments. All charges associated with this restructuring initiative are related to the Carbon Black Business. Cabot has recorded $18 million of these charges in the consolidated statements of operations since October 2004 and has $4 million of reserves recorded as of June 30, 2006. It is anticipated that the remaining $4 million of reserves will be paid over the next three months in connection with the closure, demolition, remediation and restoration of the property. Additionally, the $8 million non-cash charge for the foreign currency translation adjustment will be realized upon substantial liquidation of the entity, which is expected to occur upon settlement of the entity’s liabilities, anticipated in the fourth quarter of 2006.

15




 

CABOT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006
Unaudited

Details of the Altona restructuring activity and changes in the reserve during the three months ended June 30, 2006 are as follows:

(Dollars in millions)

 

Severance
and
Employee
Benefits

 

Asset
Retirement
Obligation

 

Total

 

Reserve at March 31, 2006

 

$

2

 

$

2

 

$

4

 

Charges for the three months ended June 30, 2006

 

1

 

 

1

 

Cash Paid

 

(1

)

 

(1

)

Reserve at June 30, 2006

 

$

2

 

$

2

 

$

4

 

 

Details of the Altona restructuring activity and changes in the reserve during the nine month period ended June 30, 2006 are as follows:

(Dollars in millions)

 

Severance
and
Employee
Benefits

 

Asset
Retirement
Obligation

 

Total

 

Reserve at September 30, 2005

 

$

4

 

$

2

 

$

6

 

Charges for the nine months ended June 30, 2006

 

2

 

2

 

4

 

Costs charged against assets

 

1

 

 

1

 

Cash Paid

 

(5

)

(2

)

(7

)

Reserve at June 30, 2006

 

$

2

 

$

2

 

$

4

 

 

The charges related to the Altona restructuring for the nine month period ended June 30, 2006 are exclusive of $1 million of gains on the sale of fixed assets.

European and Zierbena Restructuring

As of June 30, 2006, the Company had less than a million dollars of restructuring reserves for severance and employee benefits related to the Company’s fiscal 2003 European restructuring plan and closure of its carbon black manufacturing facility in Zierbena, Spain and less than a million dollars of asset retirement obligations related to site remediation and restoration of the Zierbena facility. During the third quarter of fiscal 2006, nominal payments were made related to these restructurings. Cabot expects the remaining accruals to be paid out over the next three months in connection with the completion of the site remediation and restoration.

As of June 30, 2006, the reserve balances for the Altona, European and Zierbena restructurings are included in accrued expenses in the consolidated balance sheets.

Restructuring costs were recorded in the consolidated statements of operations for the three and nine months ended June 30, 2006 and 2005 as follows:

 

Three Months Ended
June 30,

 

Nine Months Ended
June 30,

 

(Dollars in millions)

 

2006

 

2005

 

2006

 

2005

 

Net sales and other operating revenue

 

$

 

$

 

$

1

 

$

 

Cost of sales

 

(1

)

(4

)

(3

)

(11

)

Selling and administrative expense

 

 

 

(2

)

(1

)

Total

 

$

(1

)

$

(4

)

$

(4

)

$

(12

)

 

16




 

CABOT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006
Unaudited

H.           Financing

China Renminibi Debt

Prior to the third quarter of fiscal 2006, majority owned joint ventures operating in China had unsecured debt facilities with numerous banks in China for borrowings of up to 953 million RMB ($119 million) of which there were outstanding borrowings of 389 million RMB ($49 million).  During the third quarter of fiscal 2006, Cabot entered into new facilities that allow for total borrowings in China Renmibini (RMB) of 75 million RMB ($9 million) with fixed rates of interest based on the prevailing Peoples Bank of China rate. During the third quarter of fiscal 2006, 128 million RMB ($16 million) was drawn down from these and other existing debt facilities in China and 32 million RMB ($4 million) was repaid. The debt bears interest at rates ranging from 5.0% to 5.6% and have maturities ranging from 2006 to 2011. The financing has been used to fund capital expenditures at the Tianjin (Carbon Black) and Bluestar (Metal Oxides) joint ventures and overall working capital needs.

Additionally, during the third quarter of 2006, the Company issued notes from these facilities to satisfy certain vendor payments. These amounted to 30 million RMB ($4 million) and are included in the Notes payable to banks in the Company’s consolidated balance sheet and reduce the availability under the facilities described above. As of June 30, 2006, 481 million RMB ($60 million) remains available for future drawdowns under these facilities.

 

India Rupee Revolving Credit Facility

 

During the third quarter of fiscal 2006, a Cabot subsidiary in India entered into new unsecured revolving credit facilities in India Rupee (INR) with available borrowings of 420 million INR ($9 million).  During the third quarter of 2006, 350 million INR ($8 million) was drawn down from these facilities.  The instruments bear interest of 8% and mature one month from issuance.  The financing will be used for general working capital needs.

 

I.             Commitments and Contingencies

Reserves

As of June 30, 2006 and September 30, 2005, Cabot had approximately $15 million and $17 million, respectively, reserved for environmental matters primarily related to divested businesses. This reserve represents Cabot’s best estimate of its share of costs likely to be incurred at those sites where costs are reasonably estimable based on its analysis of the extent of clean up required, alternative clean up methods available, abilities of other responsible parties to contribute and its interpretation of laws and regulations applicable to each site. At June 30, 2006, $5 million of the $15 million reserve for environmental matters is recognized on a discounted basis and is being accreted up to the undiscounted liability through interest expense over the expected cash flow period. Interest expense is not material.

Cabot has exposure in connection with a safety respiratory products business that a subsidiary acquired from American Optical Corporation (“AO”) in an April 1990 asset transaction. As more fully described in the fiscal 2005 Form 10-K, the Company’s respirator liabilities involve claims for personal injury, including asbestosis and silicosis, allegedly resulting from the use of AO respirators that are alleged to have been negligently designed or labeled. As of June 30, 2006, there were approximately 76,000 claimants in pending cases asserting claims against AO in connection with respiratory products. The reserve recorded is expected to cover Cabot’s share of liability for existing and future respirator liability claims. The book value of the reserve, which is recorded on a discounted basis, is being accreted up to the undiscounted liability through interest expense over the expected cash flow period, and, at June 30, 2006, is approximately $18 million (or $31 million on an undiscounted basis).

Cabot is a party to various other lawsuits and subject to other claims and contingent liabilities arising in the ordinary course of its business. Although final disposition of some or all of these suits and claims may impact Cabot’s financial statements in a particular period, the Company does not expect the disposition of these suits and claims, individually and in the aggregate, to have a material adverse effect on Cabot’s financial position.

17




 

CABOT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006
Unaudited

Purchase Commitments

Cabot has entered into long-term purchase agreements for various key raw materials in the Carbon Black, Metal Oxides and Supermetals Businesses. The table below includes all of the Company’s annual long-term purchase commitments.

(Dollars in millions)

 

 

 

2006

 

$

173

 

2007

 

182

 

2008

 

166

 

2009

 

112

 

2010

 

87

 

Thereafter

 

721

 

Total future purchase commitments

 

$

1,441

 

 

During February 2006, Cabot made a lump sum payment of $27 million to the Sons of Gwalia to terminate an existing supply agreement and other related agreements, and entered into a new tantalum ore supply agreement which is denominated in Australian dollars.

To mitigate the foreign currency exposure associated with the future settlement of the Australian dollar denominated payables under the new tantalum ore supply agreement, during April 2006 Cabot entered into option contracts with a total notional amount of 136 million Australian dollars ($97 million). These contracts provide Cabot with the right, but not the obligation, to purchase Australian dollars at agreed strike prices through January 2009. Certain of these option contracts have been designated as foreign currency cash flow hedges under FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and related interpretations. Thus, the effective portion of gains and losses for those options are deferred as a component of accumulated other comprehensive income and recognized in cost of goods sold when the hedged item affects cost of goods sold. The changes in fair value of the options contracts that have not been designated as a hedge under FAS No. 133 are marked to market through earnings.

In connection with the contracts designated as hedges, Cabot recorded less than a million of expense in earnings during the quarter ended June 30, 2006 related to the ineffective portion. For those options not designated as hedges, the Company recorded less than a million of income in earnings during the third quarter of fiscal 2006. The hedges had an initial value in April (upon entering into the contracts) of $1.7 million, which has increased to $2.4 million as of June 30, 2006. For the third quarter, the expense related to the hedges totaled less than a million. At June 30, 2006, the Company expects to reclassify less than a million of gains on derivative instruments from accumulated other comprehensive income over the next twelve months.

Guarantee Agreements

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

18




 

CABOT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006
Unaudited

J.           Earnings Per Share

Basic and diluted earnings per share (“EPS”) were calculated for the three and nine months ended June 30, 2006 and 2005 as follows:

 

Three Months Ended
June 30,

 

Nine Months
Ended June 30,

 

(Dollars in millions, except per share amounts)

 

2006

 

2005

 

2006

 

2005

 

Basic EPS:

 

 

 

 

 

 

 

 

 

Income available to common shares (numerator)

 

$

24

 

$

25

 

$

59

 

$

10

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

63

 

63

 

63

 

63

 

Less: restricted stock shares (1)

 

(3

)

(3

)

(3

)

(3

)

Adjusted weighted average common shares (denominator)

 

60

 

60

 

60

 

60

 

Basic EPS

 

$

0.41

 

$

0.43

 

$

0.99

 

$

0.18

 

 

 

 

 

 

 

 

 

 

 

Diluted EPS:

 

 

 

 

 

 

 

 

 

Income available to common shares

 

$

24

 

$

25

 

$

59

 

$

10

 

Dividends on preferred stock (2)

 

1

 

1

 

2

 

2

 

Income available to common shares plus assumed conversions (numerator)

 

$

25

 

$

26

 

$

61

 

$

12

 

 

 

 

 

 

 

 

 

 

 

Adjusted weighted average common shares outstanding

 

60

 

60

 

60

 

60

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

Assumed conversion of preferred stock

 

6

 

7

 

6

 

7

 

Common shares issuable (3)

 

3

 

2

 

3

 

2

 

Adjusted weighted average shares (denominator)

 

69

 

69

 

69

 

69

 

Diluted EPS

 

$

0.37

 

$

0.39

 

$

0.89

 

$

0.18

 

 

(1)                Represents outstanding restricted stock issued under Cabot’s Equity Incentive Plans.

(2)                Represents dividends paid on preferred stock, which would not be paid on common stock issued upon conversion of preferred stock.

(3)                Represents the effects of outstanding stock options and restricted stock. For both the three and nine month periods ending June 30, 2006, options to purchase 0.1 million shares of common stock were not included in the calculation of diluted earnings per share because those options’ exercise prices were greater than the average market price of Cabot common stock. For the three- and nine-month periods ending June 30, 2005, options to purchase 0.3 million and 0.1 million shares of common stock, respectively, were not included in the calculation of diluted earnings per share because those options’ exercise prices were greater than the average market price of Cabot common stock.

19




 

CABOT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)

June 30, 2006
Unaudited

K.         Financial Information by Segment

During the last quarter of fiscal 2005, management changed its segment reporting structure to better reflect the way the Company manages and thinks about its businesses. Under the new reporting structure, Cabot is organized into four reportable segments: the Carbon Black Business, the Metal Oxides Business, the Supermetals Business, and the Specialty Fluids Business. Prior year segment information, which included the disclosure of reportable segments, has been restated to reflect this change. The following table provides financial information by segment for the three and nine months ended June 30, 2006 and 2005:

(Dollars in millions)

 

Carbon
Black
(1)

 

Metal
Oxides

 

Supermetals(2)

 

Specialty
Fluids

 

Segment
Total

 

Unallocated
and Other
(3)

 

Consolidated
Total

 

Three months ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales and other operating revenues(4)

 

$

514

 

$

66

 

$

66

 

$

12

 

$

658

 

$

8

 

$

666

 

Income (loss) before taxes (5)

 

$

23

 

$

6

 

$

9

 

$

5

 

$

43

 

$

(9

)

$

34

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales and other operating revenues(4)

 

$

387

 

$

57

 

$

93

 

$

11

 

$

548

 

$

(3

)

$

545

 

Income (loss) before taxes (5)

 

$

26

 

$

4

 

$

13

 

$

5

 

$

48

 

$

(12

)

$

36

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales and other operating revenues(4)

 

$

1,409

 

$

185

 

$

226

 

$

33

 

$

1,853

 

$

27

 

$

1,880

 

Income (loss) before taxes (5)

 

$

70

 

$

13

 

$

32

 

$

13

 

$

128

 

$

(55

)

$

73