Cabot 10-K 2009
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended September 30, 2009
For the transition period from to
Commission file number 1-5667
(Exact name of Registrant as specified in its charter)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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 ¨ 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 Registrants 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 Registrants most recently completed second fiscal quarter (March 31, 2009), the aggregate market value of the Registrants common stock held by non-affiliates was approximately $677,797,425. As of November 19, 2009, there were 65,326,403 shares of the Registrants common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrants definitive proxy statement for its 2010 Annual Meeting of Shareholders are incorporated by reference in Part III of this annual report on Form 10-K.
TABLE OF CONTENTS
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; the benefits we expect to receive from our restructuring activities; when we expect to commence manufacturing operations at our new facility in Dubai; the adequacy of our supply of tantalum ore for the near term; our expectations for geographic expansion of business activity by our Specialty Fluids Business outside of the North Sea; the life of our pollucite ore reserves; 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 litigation costs; exposure to interest rate and foreign exchange risk; future benefit payments we expect to make; our expected tax rate for fiscal 2010; 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 Cabots 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).
Cabots business was founded in 1882 and incorporated in the State of Delaware in 1960. 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, tantalum and related products, 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. 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.
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 existing and emerging applications.
We are organized into four business segments: the Core Segment, which is further disaggregated for financial reporting purposes into the Rubber Blacks and the Supermetals Businesses; 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, which includes North and South America; Europe, Middle East and Africa (EMEA); and Asia Pacific, including China. The business segments are discussed in more detail later in this section. Financial information about our business segments appears in Managements 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.
The Core Segment is comprised of the Rubber Blacks Business and the Supermetals Business. A discussion of each of these Businesses follows.
Rubber Blacks Business
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. In addition to the carbon black we make using conventional carbon black manufacturing methods, we have developed elastomer composite products (referred to as Cabot Elastomer Composites or CEC) that are compounds of natural rubber and carbon black made by a patented liquid phase process. Our CEC products are currently targeted primarily for tire applications because we believe these compounds improve wear resistance, reduce fatigue and reduce rolling resistance compared to natural rubber/carbon black compounds made by conventional methods.
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 Businesss total net sales and operating revenues. The loss of any of these customers could have a material adverse effect on the Rubber Blacks Business. In fiscal 2009, sales to The Goodyear Tire and Rubber Company and its affiliates amounted to 10% of Cabots consolidated revenues. We did not have sales during the fiscal year to any other customer in an amount equal to or greater than 10% of our consolidated revenues for the year.
Under appropriate circumstances, we have pursued a strategy of entering into annual and long-term supply contracts (those with an initial term longer than one year) with certain customers. These contracts are designed to provide our customers with a secure supply of rubber blacks and help us reduce the volatility in volumes and margins over time. Many of these contracts provide for sales price adjustments to account for
changes in feedstock costs and, in some cases, changes in other relevant costs (such as the cost of natural gas). In fiscal 2009, approximately half of our rubber blacks volume was sold under long-term or annual 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.
We are one of the leading manufacturers of carbon black in the world. We compete in the manufacture of carbon black primarily with four 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 and price, as well as on the proximity of our manufacturing operations to those of our customers. We believe our technological leadership, global manufacturing presence, operations excellence and customer service provide us a competitive advantage.
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.
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, India, 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, 2009 in rubber blacks operations in which we own less than 100%:
We continue to expand the manufacturing capacity of our Rubber Blacks Business in emerging markets. In fiscal 2009 we completed constructing 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.
As part of our 2009 global restructuring plan, during fiscal 2009 we closed our rubber blacks manufacturing operations in Stanlow, U.K., and in October 2009 we closed our manufacturing operations in Berre, France.
We produce tantalum, niobium (columbium) and their alloys. Tantalum, which accounts for substantially all of this Businesss 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.
Sales and Customers
Sales are made primarily through Cabot employees. In fiscal 2009, sales to four capacitor materials customers represented a material portion of the total net sales and operating revenues of the Supermetals Business. The loss of any of these customers could have a material adverse effect on the Supermetals Business.
Many of our tantalum products are used in products for the electronics industry, which is cyclical in nature.
We are a leading producer of electronic grade tantalum powder products. Competition in the tantalum business is based on technical innovation, product performance, quality, reliability, service and price. We compete principally with three other producers of tantalum powder and believe our technological leadership in high capacitance tantalum powder provides us with a competitive advantage.
Tantalum ore is the principal raw material used in this business. Historically, we obtained a large portion of our raw material under long-term supply contracts with third-parties and from a mine we own in Manitoba, Canada, although during fiscal 2009 we suspended our tantalum mining operations. Given our current ore inventory levels and other currently available sources of ore, we believe we have an adequate supply of raw material for this Business for the foreseeable future.
We have not purchased or sourced any material containing tantalum, including coltan, from the Democratic Republic of the Congo.
We operate manufacturing facilities for this business in Boyertown, Pennsylvania and Kawahigashi-machi, Japan. We have a license from the Department of Environmental Protection for the receipt, storage and processing of tantalum containing Class 7 ores at our Boyertown facility, and transport this material under a license from the U.S. Nuclear Regulatory Commission.
As part of our 2009 global restructuring plan, we suspended our tantalum mining operations in Manitoba in fiscal 2009 and plan to close our tantalum powder operations in Boyertown, Pennsylvania in calender 2010. We will continue to operate our tantalum mill and ore processing operations in Boyertown.
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. Products are used in a wide variety of applications across the automotive, construction and infrastructure, and electronics and consumer products sectors.
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 electronics. In addition, we manufacture and source thermoplastic concentrates and compounds 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 with certain customers for sales of our products. In fiscal 2009, sales under these contracts accounted for approximately 25% of the Performance Segments 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 are sold to customers located in North America and Western Europe.
We are one of the leading manufacturers of carbon black in the world. We compete in the manufacture of carbon black primarily with four companies with a global presence and a significant number of other companies which have a regional presence. We are also a leading producer of thermoplastic concentrates in Europe 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, as well as on the proximity of our manufacturing operations to those of our customers. We believe our technological leadership, global manufacturing presence, operations excellence and customer service provide us a competitive advantage.
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 thermoplastic concentrates are titanium dioxide, 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.
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 thermoplastic concentrates and compounds are produced in facilities in Belgium, Italy, and China (Hong Kong). 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, 2009 in these segment operations in which we own less than 100%:
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 nameplate capacity of approximately 20,000 metric tons. We also continue to work to expand our fumed silica capacity in China. In addition, in fiscal 2009 we purchased a facility in Dubai for the manufacture of masterbatch to serve increasing plastics demand in the Middle East. We expect to commence manufacturing operations at that facility in the first half of 2010.
As part of our 2009 global restructuring plan, during fiscal 2009 we closed our performance products manufacturing operations in Dukinfield, U.K. and our carbon black manufacturing operations in Stanlow, U.K. and in October 2009 we closed our manufacturing operations in Berre, France. During fiscal 2010, we plan to close our remaining manufacturing operations in Stanlow.
New Business Segment
Our New Business Segment includes the Inkjet Colorants and Aerogel Businesses and the business development activities of Cabot Superior Micropowders. A discussion of each of these Businesses follows.
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.
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 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.
Our inkjet colorants are manufactured at our facility in Haverhill, Massachusetts.
Cabots aerogel is a nano-structured, high surface area, hydrophobic, silica-based particle that is used in a variety of thermal insulation and specialty chemical applications. In the construction industry, the product is used in 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.
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.
The principal raw materials for the production of aerogels are silica sol and/or sodium silicate, which we believe are in adequate supply.
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 (CSMP)
CSMP is a research and development enterprise with multiple technology platforms and core competencies in advanced particle manufacturing across a wide range of materials and the related materials chemistries. Its principal areas of commercial focus are in developing advanced materials for anti-counterfeiting security applications, fuel cell applications, solar energy applications, environmental and industrial catalyst applications, and for other performance material applications. We expect the CSMP platforms to support the development of new technologies that complement existing applications and provide opportunities for new business growth. Most of these activities are conducted at our facilities in Albuquerque, New Mexico.
Specialty Fluids Segment
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.
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. The rates to be charged to the customer for the daily product rental and for lost product are agreed to before a job begins.
Since 2003, 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. More recently, we have expanded the use of our fluids to drilling operations outside of the North Sea.
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.
The principal raw material used in this business is pollucite (cesium ore), which we obtain from our mine in Manitoba, Canada. We own a substantial portion of the worlds 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. In addition, we have identified technical projects to recover cesium from low grade ore not currently in our reserve estimates. These proposed technical projects may require different, although well-established, recovery techniques than we currently use.
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.
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. In fiscal 2007, we established a regional sales office in Singapore in order to increase marketing initiatives to prospective customers in China, Southeast Asia, Australia and New Zealand.
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.
Our businesses are generally not seasonal in nature, although we typically experience some decline in European and North American sales in the fourth fiscal quarter due to summer plant shutdowns and in Asia Pacific sales in the second fiscal quarter because of the New Year holidays in that region.
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.
As of September 30, 2009, we had approximately 3,950 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.
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 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 $21 million in environmental-related capital expenditures at existing facilities in fiscal 2009 and anticipate spending approximately $21 million for such matters in fiscal 2010.
In recognition of the importance of 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 Cabots safety, health and environmental management programs. In particular, the Committee reviews Cabots environmental reserve, 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 and capital expenditures. The Committee also consults with our outside and internal advisors regarding management of Cabots safety, health and environmental programs.
In February 2006, the International Agency for Research on Cancer (IARC) reaffirmed its classification of carbon black as a Group 2B substance (known animal carcinogen, possible human carcinogen). We have communicated IARCs 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.
In February 2003, 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. 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. We have been informed that OEHHA is 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.
In October 2003, the European Commission (EC) developed a new European Union (EU) regulatory framework for chemicals called REACH (Registration, Evaluation and Authorization of Chemicals). REACH, which became effective in June 2007, 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. As we are committed to continuing to supply our EU customers, we have registered silica and cesium formate under REACH, and carbon black is expected to be registered in late 2009 or early 2010. We are also working with the manufacturers and importers of our other substances, including our feedstocks, to ensure their registration prior to the applicable deadline.
We are experiencing increased regulations by environmental agencies worldwide relating to the air emissions from our manufacturing operations. This increased regulation is 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 Emission Trading Scheme, which establishes a maximum allowable emission credit for each ton of CO 2 emitted, for the period 2008 to 2012. 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. We are also pursuing certain Clean Development Mechanism projects at various facilities in an effort to generate carbon credits to offset potential allocation shortfalls. There are also ongoing discussions in other regions and countries, including the United States, Canada, China, and Brazil regarding greenhouse gas emission reporting and reduction programs, but those programs have not yet been fully defined and their impact on us cannot be estimated at this time. Finally, Cabots U.S. carbon black facilities will be required to report their greenhouse gas emissions under the U.S. Environmental Protection Agencys new rule for the Mandatory Reporting of Greenhouse Gases in 2011.
Since the terrorist attacks in the U.S. on September 11, 2001, 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 are closely monitoring 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 V of the Notes to the Companys Consolidated Financial Statements).
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 economic conditions may adversely impact our business.
Our operations and performance are materially affected by worldwide economic conditions, which deteriorated significantly during fiscal 2009. Market turmoil and tightened credit availability generally reduced consumer confidence, increased difficulty in collecting accounts receivable, increased pricing pressure on products and services, and led to widespread reduction of global business activity. Uncertainty about current global economic conditions has resulted in decreased consumer spending and a significant decline in sales in the automotive, electronics and construction industries worldwide. As a result, we have experienced declines in global demand for our products that serve these industries, with volumes in our Core and Performance Segments for fiscal 2009 more than 20% below the levels that we experienced in fiscal 2008. These developments have resulted in decreased revenues and weaker results of operations. While we have seen signs of recovery and increased demand in most of our businesses, continued weakness in worldwide economic conditions could have a material adverse effect on our financial condition and cash flows.
Changes in supply-demand balance in the regions and the industries in which we operate may adversely affect our financial results.
Our key customers continue to shift their manufacturing capacity from mature markets such as North America and Western Europe to emerging regions such as Asia, South America and Eastern Europe. Although we are responding to meet these market demand conditions, we cannot be certain that we will be successful expanding capacity in emerging regions (which depends in part on economic and political conditions in these regions and, in some cases, on our ability to acquire or form strategic business alliances) or in reducing capacity in mature regions commensurate with industry demand. Similarly, demand for our customers products and our competitors reactions to market conditions could affect our financial results.
In addition, our Rubber Blacks and Supermetals Businesses are sensitive to changes in industry capacity utilization. As a result, pricing tends to decrease when capacity utilization in these businesses decreases, which could affect our financial performance.
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. In connection with many of these actions we have projected significant one-time and on-going cost savings. The success of these activities is not predictable and 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, where we have closed manufacturing facilities, we may not be successful in migrating our customers from those closed facilities to our other facilities.
Volatility in the price of raw materials or their reduced availability 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 effect our working capital and results of
operations. Although our long-term and some of our annual carbon black supply contracts provide for a price adjustment to account for changes in feedstock costs, there is a lag between the time when we incur feedstock costs and the time when prices are adjusted under some of these contracts. Accordingly, we may not be able to pass increased costs along to our customers when they occur, which can have a significant negative impact on results of operations and cash flows in a given quarter. We have reduced the time lag in many of our long-term contracts as they have come up for renewal, but we may not be successful in reducing the time lag in some or all of the remainder of these contracts as they come up for renewal in the future. In addition, it is possible that a supply contract with a price adjustment mechanism could expire by its terms before we are able to recapture fully our raw material cost increases. 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 customers 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 total of nine customers in the tire, silicones, capacitor materials and microelectronics industries that together represent a significant portion of our total net sales and operating revenues. In fiscal 2009, sales to The Goodyear Tire and Rubber Company by our Rubber Blacks Business accounted for approximately 10% of our consolidated 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 of 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 operations involve the handling of hazardous and, in some instances, radioactive materials, and we are subject to extensive safety, health and environmental requirements, which could increase our costs and/or reduce our revenues.
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 United States 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 facilitys compliance with certain regulatory and permitting requirements under the Clean Air Act, including the New Source Review (NSR) construction permitting requirements. We responded to EPAs information request in August 2009 and are awaiting a response from EPA. As a result of this initiative, based upon how EPA has handled similar NSR initiatives with other industrial sectors, it is possible that EPA could attempt to compel us to employ additional technology control devices or approaches with respect to emissions at certain facilities and/or seek a civil penalty from us.
In addition, 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, tantalum, niobium, 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 SH&E Requirements. The processing of tantalum ore also involves radioactive substances. The transportation of chemical products and other activities associated with the manufacturing process 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. We believe that our ongoing operations comply with current SH&E Requirements in a manner that should not materially affect our earnings or cash flow in an adverse manner. 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.
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 2009, 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. Because of 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 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.
We rely on our committed lines of credit to provide us with working capital.
At September 30, 2009, we had $460 million in committed lines of credit, including $400 million under a revolving credit facility that matures in August 2010. We plan to replace our revolving credit facility. A replacement facility may be for a lesser amount and a shorter term, and at borrowing costs that are higher than those under our current revolving credit facility. In addition, a new facility may contain more restrictive terms and covenants than our current facility.
We have entered into a number of 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. While we have not experienced any losses due to counterparty nonperformance, 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 instruments failure to hedge a financial risk.
We are exposed to political or country risk inherent in doing business in some countries.
Sales outside of the United States constituted a majority of our revenues in fiscal 2009. 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.
Plant capacity expansions may be delayed and 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 such as weather conditions, and other risks customarily associated with construction projects. Moreover, capacity expansion in our Rubber Blacks, Performance Products and Fumed Metal Oxides 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.
The money we spend developing new businesses 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 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 results.
Any failure to realize benefits from joint ventures, acquisitions or alliances 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 predictable and we may not be successful in realizing our objectives as anticipated.
We may be required to impair or write off certain assets if our assumptions about future sales and profitability prove incorrect.
In our analysis of the recoverability of certain assets, namely inventory, property, plant and equipment, investments, intangible assets and deferred tax assets, we have made assumptions about future sales (pricing, volume and region of sale), costs, cash generation and the ultimate profitability of the business and/or tax jurisdiction. These assumptions were based on managements 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, 2009, which could lead to an impairment or write-off of certain of these assets in the future.
Increases in our tax rate may reduce our net income.
Our future tax rates may be adversely affected by a number of factors including the enactment of the currently proposed U.S. tax legislation; other changes in tax laws or the interpretation of such tax laws; changes in the estimated realization of our deferred tax assets and liabilities; 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. taxes; adjustments to estimated taxes upon finalization of various tax returns; increases in expenses that are not always deductible for tax purposes, including write-offs of acquired in-process research and development and impairment of goodwill in connection with acquisitions; changes in available tax credits; changes in share-based compensation expense 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 increase in our future tax rates could reduce net income in those periods.
Regulations requiring a reduction of greenhouse gas emissions will impact the carbon black industry, including us.
Carbon dioxide is emitted in the carbon black manufacturing process. In December 2005, the European Commission published a new directive that includes carbon black manufacturing in the combustion sector and in Phase II of the Emissions Trading Scheme for the period 2008 to 2012. Various European Union member states have included carbon black facilities in their national allocation plans and we have taken actions to comply with applicable carbon dioxide emission requirements. However, there can be no assurance that we will be able to purchase emissions credits if our carbon black operations generate more carbon dioxide 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 United States, Canada, China and Brazil regarding greenhouse gas emission reporting and 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 3Legal 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, coal workers pneumoconiosis and berylliosis, and exposure to various chemicals. Adverse rulings, judgments or settlements in pending or future litigation (including contract litigation and liabilities associated with respirator claims and our former beryllium operations) could cause our results to differ materially from those expressed or forecasted in any forward-looking statements.
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.
We may be subject to information technology system failures, network disruptions and breaches in data security.
Information technology system failures, 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, catastrophic events such as fires, earthquakes, 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.
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 hurricanes 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.
Cabots 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.
We conduct research and development for our various businesses primarily at facilities in Billerica, MA; Albuquerque, NM; Pampa, TX; Pepinster, Belgium; Frankfurt and Rheinfelden, Germany; Kawahigashi-machi, Japan; 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.
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, 2009, unless otherwise specified.
In June 2009, Cabot received an information request from the United States Environmental Protection Agency (EPA) regarding Cabots carbon black manufacturing facility in Pampa, Texas. The information request relates to the Pampa facilitys 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 EPAs information request in August 2009 and is awaiting a response from EPA. As a result of this initiative, based upon how EPA has handled similar NSR initiatives with other industrial sectors, it is possible that EPA could attempt to compel Cabot to employ additional technology control devices or approaches with respect to emissions 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 signed in late 2009 or early 2010.
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.
We have several environmental-related lawsuits pending in Campana, Argentina related to our carbon black plant in Campana. Those lawsuits were filed between 2003 and 2006 by several residential neighbors living near the industrial area where our plant is located. The lawsuits also name other industrial companies operating in the Campana area. The plaintiffs seek monetary damages for property damage and other injury allegedly caused by emissions from neighboring industrial facilities. We believe the claims relative to Cabot are without merit.
As of September 30, 2009, we had a $6 million reserve on a discounted basis ($6 million on an undiscounted basis) for environmental remediation costs at various sites. The operation and maintenance component of this reserve was $3 million on a discounted basis ($4 million on an undiscounted basis). This amount 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.
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 AOs 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 subsidiarys assumption of certain of AOs respirator liabilities, AO agreed to provide to the subsidiary the benefits of: (i) AOs insurance coverage for the period prior to the 1990 acquisition and (ii) a former owners 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 workers 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 giving rise to an asbestos 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, AOs insurers, and another former owner and its insurers (collectively, the Payor Group), are responsible for significant portions of the costs of these liabilities, leaving Cabots 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, 2009, there were approximately 52,000 claimants in pending cases asserting claims against AO in connection with respiratory products. Cabot has contributed to the Payor Groups 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 exposure and respirator use. Using those and other assumptions, HR&A estimated the number of future claims that would be filed and the related costs that would be incurred in resolving those 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 actual contractual obligations assuming that all other members of the Payor Group meet their obligations. Based on the HR&A estimates, we have recorded on a net present value basis a $13 million reserve ($23 million on an undiscounted basis) to cover our estimated share of liability for pending and future respirator claims.
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 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 AOs insurance coverage, (ix) changes in the allocation of costs among the Payor Group and (x) a determination that our interpretation of the contractual obligations on which we have estimated our share of liability is 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 could 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.
Carbon Black Antitrust Litigation
Cabot was one of several carbon black manufacturer defendants in federal and state class actions initially filed in 2003 alleging that the defendants violated federal and state antitrust laws in connection with the sale of carbon black. As of September 30, 2009, the only pending state action was in Florida, with all of the other federal and state class actions having been previously settled. The parties in the Florida action entered into a settlement agreement, which received final court approval in October 2009. We deny any wrongdoing of any kind in these cases and strongly believe we have good defenses to the claims, but agreed to the settlements to avoid further expense, inconvenience, risk and the distraction of burdensome and protracted litigation.
We are a party to several pending actions in connection with our discontinued beryllium operations in Reading, Pennsylvania. We entered the beryllium industry through an acquisition in 1978. We ceased manufacturing beryllium products at one of the acquired facilities in 1979, and the balance of our former beryllium business was sold to NGK Metals, Inc. in 1986. The actions involve claims for personal injury and medical monitoring relating to alleged contact with beryllium in various ways and are pending in the state and federal courts in Pennsylvania and in the state court in California. All of the personal injury and medical monitoring actions filed in the Pennsylvania courts have either been settled or resolved in our favor at the trial court level, although the plaintiffs in some cases have filed appeals. The actions pending in the California state court all involve claims for medical monitoring. We believe that we have valid defenses to all of these beryllium actions and will assert them vigorously in the various venues in which claims have been asserted. In addition, there is a contractual indemnification obligation running from NGK to Cabot in connection with many of these matters.
AVX Contract Dispute
In March 2004, AVX Corporation (AVX) filed an action against us in the United States District Court for the District of Massachusetts. The complaint alleged that we violated the federal antitrust laws in connection with the parties January 1, 2001 tantalum supply agreement (the Supply Agreement) by purportedly tying AVXs purchases of Cabots flake tantalum powder to its purchases of Cabots nodular tantalum powder. In February 2009, the court granted Cabots motion for summary judgment in this matter and dismissed this case against Cabot, which AVX appealed. In addition, in September 2005, AVX filed an action in the Superior Court of Massachusetts for Suffolk County, which was moved to the Business Litigation Section of the Superior Court of Massachusetts in November 2005, alleging that Cabot improperly administered the most favored customer provisions of the parties Supply Agreement for the years 2003 through 2005. Cabot filed counterclaims against AVX asserting that AVX actually underpaid for tantalum products during that period. AVXs damage claim had been limited by the court to approximately $30 million, not including pre-judgment interest. In October 2009, Cabot and AVX entered into an
agreement settling both of these matters. We deny any wrongdoing of any kind in these cases and strongly believe we have good defenses to the claims, but agreed to the settlement to avoid further expense, inconvenience, risk and the distraction of burdensome and protracted litigation.
We have various other lawsuits, claims and contingent liabilities arising in the ordinary course of our business, including a number of claims asserting premises liability for asbestos exposure, and 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.
Executive Officers of the Registrant
Set forth below is certain information about Cabots executive officers. Ages are as of November 28, 2009.
Patrick M. Prevost, age 54, joined Cabot in January 2008 as President and Chief Executive Officer. Mr. Prevost has also been a member of Cabots 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 Corporations Chemicals and Plastics business in North America. Prior to joining BASF in 2003, he held senior management positions at BP Chemicals and Amoco.
Eduardo E. Cordeiro, age 42, 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 Cabots 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 50, joined Cabot in September 2009 as Executive Vice President, General Manager of Cabots Core Segment and General Manager of the Americas region. Prior to joining Cabot, Mr. Miller held a variety of management positions in BP, p.l.c.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 47, is Vice President and General Counsel. Mr. Berube joined Cabot in 1994 as an attorney in Cabots law department and became Deputy General Counsel in June 2001. Mr. Berube was 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 42, 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.
Cabots common stock is listed for trading (symbol CBT) on the New York Stock Exchange. As of November 19, 2009, there were 1,242 holders of record of Cabots common stock. The tables below show the high and low sales price for Cabots 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 Cabots common stock for the past two fiscal years.
Stock Price and Dividend Data
Issuer Purchases of Equity Securities
The table below sets forth information regarding Cabots purchases of its equity securities during the quarter ended September 30, 2009:
In addition to the 2007 Authorization, the Board has authorized us to repurchase shares of restricted stock purchased by recipients of long-term incentive awards in 2006, 2007 and 2008 at any date on or after such shares vest to satisfy tax withholding obligations that arise on the vesting of such shares and to satisfy associated loan repayment liabilities. The shares are repurchased from employees at fair market value. During the fourth quarter of fiscal 2009, we repurchased 54,260 shares from employees to satisfy loan repayment liabilities.
From time to time, we also repurchase shares of unvested restricted stock from employees whose employment is terminated before such shares vest. These shares are repurchased pursuant to the terms of our equity incentive plans and are not included in the shares repurchased under the authorizations described above. During the fourth quarter of fiscal 2009, we repurchased 47,650 forfeited shares pursuant to the terms of our equity incentive plans.
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 result could have a material impact on the consolidated financial statements. On an ongoing basis, we evaluate our policies and estimates. We base our estimates on historical experience, current conditions and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates that we believe are critical to the preparation of the Consolidated Financial Statements are presented below.
Revenue Recognition and Accounts Receivable
We recognize revenue when persuasive evidence of a sales arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility 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, the revenue is deferred until product acceptance has occurred.
Shipping and handling charges related to sales transactions are recorded as sales revenue when billed to customers or included in the sales price. Shipping and handling costs are included in cost of sales.
The following table summarizes the percentages of total net sales and other operating revenues recognized in each of our reportable segments. Other operating revenues, which represent less than two percent of total revenues, are primarily royalties for licensed technology:
As indicated above, we derive a 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. Certain Rubber Blacks Business and Performance Segment customer contracts contain price protection clauses that provide for the potential reduction in past or future sales prices under specific circumstances. We analyze these contract provisions to determine if an obligation related to these clauses exists and record revenue net of any estimated protection commitments.
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.
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 2009 and 2008 were not material. There is no off-balance sheet credit exposure related to customer receivable balances.
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 were $64 million and $75 million at September 30, 2009 and 2008, respectively. These inventories represent 18% and 14% 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 $119 million and $140 million higher as of September 30, 2009 and September 30, 2008, 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 60 days earlier, 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, 2008 and 2007, inventory quantities were reduced at our U.S. Supermetals site. Additionally, during fiscal 2009 and 2008 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 $6 million, $14 million and $4 million and an increase in net income of $4 million ($0.07 per diluted common share), $9 million ($0.14 per diluted common share) and $3 million ($0.04 per diluted common share) for fiscal 2009, 2008 and 2007, respectively.
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 our inventories if they are considered to be obsolete or unsaleable by an amount equal to the difference between the cost of inventory and the estimated market value. In cases where inventories are still saleable but the market value is below cost, the inventory is adjusted to its 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.
We issue restricted stock and stock options under our equity compensation plans. The fair value of restricted stock is based on intrinsic value at the grant date and is recognized as expense over the service period, which generally represents the vesting period. There are no significant estimates involved in
recording compensation costs under the intrinsic value method 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.
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, forfeiture 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 Other Intangible Assets
We perform an impairment test for goodwill at least annually and when events or changes in business circumstances indicate that the carrying value may not be recoverable. To test whether an impairment exists, the fair value of the applicable reporting unit is estimated based on discounted future cash flows. The calculation of fair value is sensitive to both the estimated future cash flows and the discount rate applied to those cash flows. The assumptions used to estimate the discounted cash flows are based on managements best estimates about selling prices, production and sales volumes, costs, future growth rates, capital expenditures and market conditions over an estimate of the remaining operating period at the reporting unit. 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 to write down the value of goodwill to its implied fair value is recorded. While this would have no direct impact on our cash flows, it would reduce our earnings. No impairments were recorded in fiscal 2009, 2008 or 2007.
Valuation of Long-Lived Assets
Our long-lived assets primarily include property, plant, equipment, long-term investments and assets held for rent. 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.
We make various estimates and assumptions when analyzing whether there is an impairment of our long-lived assets, excluding goodwill and long-term investments. These estimates and assumptions include determining which cash flows are directly related to the potentially impaired asset, the useful life of the asset over which the cash flows will occur, their amounts and the assets residual value, if any. An asset impairment exists when the carrying value of the asset is not recoverable based on the undiscounted estimated cash flows expected from the asset. The impairment loss is determined by the excess of the assets carrying value over its fair value. Our estimated future cash flows reflect managements assumptions about selling prices, production and sales volume, costs, and market conditions over an estimate of the remaining useful life of the asset. While an impairment charge would have no direct impact on our cash flows, it would reduce our earnings.
The fair values of long-term investments are dependent on the financial performance of the entities in which we invest and the external factors inherent in the markets in which these entities operate. We consider these factors as well as the forecasted financial performance of the investment entities when assessing the potential impairment of these investments.
Our financial instruments consist primarily of cash and cash equivalents, short-term and long-term debt, and derivative instruments. The carrying values of our financial instruments approximate fair value with the exception of certain long-term debt that has not been designated with a fair value hedge. This
portion of long-term debt is recorded at face value. The fair values of our derivative instruments are based on quoted market prices. 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 contracts for speculative purposes, nor do we hold or issue any financial instruments for trading purposes.
All derivatives are recognized on the consolidated balance sheets at fair value. The changes in the fair value of derivatives are recorded in either earnings or 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 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 immediately.
In accordance with our risk management strategy, we 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, we believe that such instruments are closely correlated with the underlying exposure, thus managing the associated risk. We record directly to earnings the gains or losses from changes in the fair value of derivative instruments that are not designated as hedges.
In the recent past, the ability of financial counterparties to perform under these financial instruments has become less certain. We attempt to take into account the financial viability of counterparties in both valuing the instruments and determining their effectiveness as hedging instruments. If a counterparty was unable to perform, our ability to qualify for hedge accounting for certain transactions would be compromised and the realizable value of these financial instruments would be uncertain. As a result, our results of operations and cash flows could be impacted.
We carry a variety of different cash and cash equivalents on our consolidated balance sheets. We continually assess the liquidity of cash and cash equivalents and as of September 30, 2009, we have determined that they are readily convertible to cash.
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 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 2009, restructuring activities resulted in certain pension plan curtailments and settlements, which tend to accelerate the recognition of the deferred gains and losses.
We are partially self-insured for certain third-party liability, 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 for combined workers compensation and third-party liabilities in the United States in fiscal 2009 is $5 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.
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 estimated discount rates 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. 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 that contribute to the settlement of respirator claims, (viii) a change in the availability of American Opticals insurance coverage, (ix) changes in the allocation of costs among other parties that contribute to the settlement of respirator claims and (x) a determination that our interpretation of the contractual obligations on which we have estimated our share of liability is 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 could no longer reasonably predict the timing of such payments, we could then be required to record the reserve amount on an undiscounted basis on our consolidated balance sheets, causing an immediate impact to earnings.
Our business operations are global in nature, and we are subject to taxes in numerous jurisdictions. Tax laws and tax rates vary substantially in these jurisdictions and are subject to change based on the political and economic climate in those countries. We file our tax returns in accordance with our interpretations of each jurisdictions tax laws.
Significant judgment is required in determining our worldwide provision for income taxes and recording the related tax assets and liabilities. In the ordinary course of our business, there are operational decisions, transactions, facts and circumstances, and calculations which make the ultimate tax determination uncertain. Furthermore, our tax positions are periodically subject to challenge by taxing authorities throughout the world. We have recorded reserves for taxes and associated interest and penalties that may become payable in future years as a result of audits by tax authorities. Certain of these reserves are for uncertain income tax positions taken on income tax returns.
We record obligations 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, the full amount of the uncertain tax position is recorded as a liability. If the threshold is met, the tax benefit that is recognized is the largest amount that is greater than 50 percent 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 and lower stockholders equity, and could have a significant impact on our earnings in future periods. The release of valuation allowances in periods when these tax attributes become realizable would reduce our effective tax rate.
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. This change in functional currency to the U.S. Dollar would result in (i) a one time remeasurement of our net monetary assets and liabilities, directly impacting our statement of operations, and (ii) foreign exchange gains or losses being recognized on all transactions and monetary assets and liabilities denominated in currencies other than the U.S. Dollar. As of September 30, 2009, Venezuela is on our watch list and we expect the Bolivar will trigger highly inflationary accounting during fiscal 2010.
Our consolidated financial statements detail specific charges relating to restructuring activities as well as the actual spending that has occurred against the restructuring accruals. Our restructuring charges are estimates based on our preliminary assessments of numerous factors, including (i) severance benefits to be granted to employees which are based on known benefit formulas and identified job grades, (ii) the timeframe and costs to vacate certain facilities and (iii) asset impairments. Because these accruals are estimates, they are subject to change as a result of deviations from initial restructuring plans or subsequent information that may come to our attention. These deviations may lead to changes in estimates, which 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 and 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.
Newly Issued Accounting Pronouncements Not Yet Adopted
In December 2007, the Financial Accounting Standards Board (FASB) issued authoritative guidance on business combinations that will become effective for all business combinations completed by us on or after October 1, 2009. The guidance establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. It also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of business combinations.
In December 2007, the FASB issued authoritative guidance that changes the accounting and reporting for non-controlling interests that will become effective for us beginning October 1, 2009. The guidance establishes accounting and reporting standards for the ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in the parents ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. It also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the
noncontrolling owners. Adoption of the guidance is not expected to have a material impact on our consolidated financial statements.
In June 2009, the FASB issued authoritative guidance on the consolidation of variable interest entities, which is effective for us beginning October 1, 2010. 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. We are evaluating the impact of this guidance on our consolidated financial statements.
Results of Operations
Definition of Terms
The following discussion of results includes information about our reportable segment sales and segment (or business) operating profit (loss) before tax (PBT). Segment PBT is a non-GAAP financial measure and is not intended to replace income (loss) from operations before taxes, the most directly comparable GAAP financial measure. In calculating segment PBT we exclude certain items, meaning items that are significant and unusual or infrequent, as these amounts are not believed to reflect our true underlying business performance. In addition, in calculating segment PBT we include equity in net income of affiliated companies, royalties paid by equity affiliates and minority interest but exclude interest expense, foreign currency transaction gains and losses, interest income, dividend income and unallocated corporate costs. Our Chief Operating Decision-Maker uses segment PBT to evaluate changes in the operating results of each segment and to allocate resources to the segments. We believe that this non-GAAP measure also assists our investors in evaluating the changes in our results and performance. A reconciliation of segment PBT to income (loss) from operations is set forth within this section.
When discussing our business activities we use several terms. The term operating expenses means fixed costs, including both fixed manufacturing costs, which includes utilities, and selling, technical and administrative expenses. The term product mix refers to the various types and grades, or mix, of products sold in a particular Business or Segment during the period, and the positive or negative impact of that mix on the revenue or profitability of the Business or Segment. The term LIFO benefit or LIFO impact 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 price adjustments in certain of our rubber blacks supply contracts to account for changes in feedstock costs and, in some cases, changes in other relevant costs. The term unallocated corporate costs refers to costs that are not controlled by the segments which primarily benefit corporate interests.
Cabot is organized into four business segments: the Core Segment, which is further disaggregated for financial reporting purposes into the Rubber Blacks and the Supermetals Businesses, 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, which includes North and South America; Europe, Middle East and Africa; and Asia Pacific, including China. Discussions of all periods reflect these structures.
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 the number of tires produced resulting from vehicle miles driven and automotive builds. Over the past several years, the Rubber
Blacks Business results have been driven by increases or decreases in sales volumes, changes in raw material costs, our ability to obtain sales price increases for our products commensurate with increases in raw material costs, global and regional capacity utilization, fixed cost savings achieved through restructuring and other cost saving activities, our growth in emerging markets, capacity management and technology investment, including the impact of energy utilization technology at our manufacturing facilities. Historically, the timing of sales price increases has been influenced by the time lag of pricing adjustments in our annual and long term 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 and during 2009 substantially reduced the percentage of volume subject to this time lag. In the Supermetals Business, longer term demand for tantalum is largely driven by the number of electronic devices produced using tantalum capacitors versus competing materials. Over the past several years capacitors have been made using higher efficiency powders that require a lower volume of tantalum powder to achieve the same capacitance, thus reducing overall demand. Profitability in recent years has largely been determined by volume changes associated with fluctuations in the electronics market, our cost of ore, our ability to implement cost reduction initiatives, a highly competitive market environment and our ability to increase prices to stabilize margins.
In our Performance Segment, longer term demand is driven primarily by the construction and infrastructure, automotive, electronics and consumer products industries. In recent years, results in the Performance Segment have been driven by growth in emerging markets, delivering differentiated products that drive enhanced performance in customers applications, our ability to obtain value pricing for this differentiation, changes in raw material and energy costs and our ability to obtain sales price increases for our products commensurate with increases in these costs.
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 our Aerogel Business has been driven by an increasing number of projects using our products in the oil and gas and daylighting markets. In recent years, demand in Superior MicroPowders has been driven principally by the number of security taggant applications incorporating our unique and proprietary particles. Results in the New Business Segment have been influenced by our ability to improve the pace of revenue generation in the Segment, by choosing the highest value opportunities and working with lead users in the appropriate markets, and by ensuring that the overall cost platform of the Segment is sized appropriately for the opportunities.
In our Specialty Fluids Segment, demand for cesium formate is primarily driven by the level of drilling of high pressure oil and gas wells and by the petroleum industrys acceptance of our product as a drilling and completion fluid for this application. Results in the Specialty Fluids Segment have been driven by the size and type of jobs, the mix of rental versus sale revenue and our ability to expand the use of our fluids into regions outside of the North Sea.
Results for Fiscal 2009
During fiscal 2009, profitability decreased compared to fiscal 2008. The decrease was principally caused by lower volumes from weak demand and destocking in the tire, automotive, construction and electronics markets due to the global economic slowdown and credit crisis. Lower sales volumes resulted in excess levels of inventory in our Rubber Blacks and Performance Products Businesses. These inventories were not sold until later in the year when finished product prices had been adjusted downward due to falling raw material costs. The resulting unit margin compression reduced profitability. These factors were partially offset by contract lag and LIFO benefits from lower carbon black feedstock costs and lower operating expenses from restructuring and cost saving actions implemented during fiscal 2009. We substantially improved the performance of our New Business Segment during the year, increasing revenue, profitability and cash flow. Our cash and liquidity position remained solid during fiscal 2009 as we significantly reduced working capital. In September 2009 we raised $300 million in long term public debt. A portion of the net
proceeds was used to pay down borrowings under our revolving credit facility, and the remainder will be used for general corporate purposes.
During the second half of fiscal 2009 we experienced sequential improvement in volumes and operating results. The improvement was driven by a trend of increasing demand in our key end markets. Volume increases were particularly strong in emerging markets. Additionally, the unfavorable impact of older higher cost inventories on our results was significantly less in the second half of fiscal 2009 than it was in the first half.
Outlook for Fiscal 2010
Although the improvement in volume we experienced from increasing demand in our key end markets during the second half of fiscal 2009 was positive, we remain cautiously optimistic about the speed of a full volume recovery to fiscal 2008 levels given the broader economic environment. The actions we have taken during fiscal 2009, including our restructuring program, and investments in emerging market capacity and energy recovery technology, position us well to benefit from a continued recovery. We anticipate building on the progress we made in the New Business Segment during fiscal 2009 with opportunities for additional revenue growth. Given our success over the past several years in the Specialty Fluids Segment at expanding the use of our fluids outside of the North Sea, we are optimistic about our ability to continue this trend in fiscal 2010.
Fiscal 2009 compared to Fiscal 2008 and Fiscal 2008 compared to Fiscal 2007Consolidated
Net Sales and Gross Profit
The $948 million decrease in sales in fiscal 2009, when compared to fiscal 2008, was primarily due to lower volumes ($757 million) from weaker demand in our key end markets resulting from the global economic downturn, lower prices ($119 million) driven by lower carbon black raw material costs and the unfavorable effect of foreign currency translation ($87 million). The $575 million increase in sales in fiscal 2008, when compared to fiscal 2007, was primarily due to higher prices ($354 million) and the benefit of foreign currency translation ($215 million). These positive factors were partially offset by slightly lower volumes ($12 million), principally associated with the expiration in fiscal 2007 of a fixed price, fixed volume contract in the Supermetals Business that resulted in an unfavorable comparison for fiscal 2008.
Our gross profit was 10% of net sales in fiscal 2009, compared to 15% in fiscal 2008 and 19% in fiscal 2007. Gross profit decreased by $257 million in fiscal 2009 when compared to fiscal 2008 principally due to lower volumes from weaker demand in our end markets, charges recorded as cost of sales during fiscal 2009 principally related to restructuring expenses and the unfavorable impact of older, high cost inventories in our carbon black related businesses. These factors were partially offset by contract lag and LIFO benefits resulting from lower carbon black feedstock costs, reduced operating expenses from the implementation of restructuring and cost saving actions and improved performance in our New Business Segment.
Gross profit decreased by $21 million in fiscal 2008 relative to fiscal 2007 as increases in raw material costs outpaced sales price increases. This was partially offset by lower restructuring related charges recorded as cost of sales in fiscal 2008 when compared to fiscal 2007.
Selling and Administrative Expenses
Selling and administrative expenses decreased by $35 million in fiscal 2009 when compared to fiscal 2008. The decrease is principally due to restructuring and cost saving actions implemented during fiscal 2009, partially offset by restructuring related charges. Selling and administrative expenses decreased by $3 million in fiscal 2008 when compared to fiscal 2007. Charges related to the fiscal 2007 settlement of the federal carbon black antitrust litigation did not reoccur in fiscal 2008, leading to a favorable comparison. This was partially offset by unfavorable foreign currency translation on our expenses in fiscal 2008.
Research and Technical Expenses
In fiscal 2009, research and technical expenses decreased by $3 million when compared to fiscal 2008. The lower expenses were principally associated with cost reduction efforts and a greater focus on the efficiency of our new business development activities. Research and technical expenses increased by $5 million in fiscal 2008 when compared to fiscal 2007, primarily due to increased spending in the Performance Segment for the continued development of differentiated products.
Interest and Dividend Income
Interest and dividend income decreased by $1 million in fiscal 2009 when compared to fiscal 2008 due to lower interest rates in fiscal 2009. Interest and dividend income decreased by $6 million in fiscal 2008 when compared to fiscal 2007 due principally to lower cash balances in fiscal 2008 available for interest earning investments.
Interest expense decreased by $8 million in fiscal 2009 when compared to fiscal 2008. The decrease was due to a lower level of borrowing, as we materially reduced our debt during most of fiscal 2009, and the benefit of lower interest rates associated with our floating rate debt. Interest expense increased by $4 million in fiscal 2008 when compared to fiscal 2007. The increase was due principally to increases in debt levels.
Other (Charges) Income
Other charges in fiscal 2009 increased by $2 million when compared to fiscal 2008. The increase is primarily attributable to an increased unfavorable impact from foreign currency transactions ($12 million), including from the write-down in value of Bolivars that had accumulated over several years in Venezuela to a parallel exchange rate ($6 million). These factors were partially offset by a reduced impact of fair market value currency hedges ($7 million) and a lower impact of certain items recorded as other charges in our statement of
operations ($2 million). When comparing other charges of $18 million in fiscal 2008 to other income of $5 million in fiscal 2007, the difference was principally attributable to foreign currency transaction gains or losses in the comparative periods driven by fluctuations in foreign currencies against the U.S. dollar.
Benefit (Provision) for Income Taxes
The benefit for income taxes was $22 million for fiscal 2009, resulting in an overall 22% tax rate. We recorded benefits of approximately $9 million (9%) in the current year related to the settlement of various tax audits, $2 million (2%) for the renewal of the U.S. research and experimentation credit, and $1 million (1%) for reinvestment credits earned. Excluding settlement and credit benefits, our tax rate would have been approximately 10% for fiscal 2009 primarily due to our geographic earnings mix.
The provision for income taxes was $14 million for fiscal 2008, resulting in an overall 13% tax rate on income from continuing operations. Our tax rate varies from the U.S. statutory rate of 35% for a variety of reasons. Specifically, our global tax structure provided us with a benefit of approximately $11 million (10%) from the U.S. statutory rate owing primarily to the recognition of income in jurisdictions with lower effective tax rates. We also recorded benefits of $8 million (7%) in fiscal 2008 related to the settlement of various tax audits, $3 million (3%) for reinvestment tax credits earned and $4 million (4%) for the utilization of a previously unrecognized capital loss carryforward, partially offset by a $2 million (2%) charge from miscellaneous adjustments. Excluding settlement and credit benefits, our tax rate would have been approximately 23% for fiscal 2008.
The provision for income taxes was $38 million for fiscal 2007, resulting in an overall 23% tax rate on income from continuing operations. Our global tax structure provided us with a benefit of approximately $16 million (10%) from the U.S. statutory rate owing primarily to the recognition of income in jurisdictions with lower effective tax rates. In addition, we recorded benefits of approximately $4 million (2%) for research and experimentation credits and $3 million (2%) from various audit settlements, partially offset by a $2 million (1%) charge from miscellaneous adjustments. Excluding the $3 million in settlement tax benefits, our tax rate would have been approximately 25% for fiscal 2007.
Our anticipated tax rate for fiscal 2010 is between 25% and 28%, absent tax settlements and other changes in tax estimates. The IRS is currently examining our 2005 and 2006 tax years. In addition, 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 2010. We have filed our tax returns in accordance with the tax laws in each jurisdiction and maintain tax reserves for differences between tax expense as finally determined and estimated tax expense for exposures that can be reasonably estimated.
Equity in Net Income of Affiliates and Minority Interest in Net Income, net of tax
Equity in net income of affiliates decreased by $3 million in fiscal 2009 when compared to fiscal 2008 due to the impact of the global economic downturn, primarily on our affiliate in Mexico. Equity in net income of affiliates decreased by $4 million in fiscal 2008 when compared to fiscal 2007 due to a $3 million decrease in our share of earnings from our affiliates in Venezuela and Mexico and a $1 million decrease from the April 1, 2008 consolidation of results of our equity affiliate in Malaysia.
Minority 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. In fiscal 2009 losses in our consolidated joint ventures in Malaysia and Indonesia offset earnings in our other consolidated joint ventures. Additionally, the earnings of our profitable ventures, particularly in China were significantly lower than in fiscal 2008 explaining the $18 million reduction in minority interest. The increase in minority interest in net income, net of tax, of $5 million in fiscal 2008 when compared to fiscal 2007 was primarily due to increased earnings from our joint ventures in China.
In fiscal 2009 we recorded a loss from our discontinued operations of less than $1 million ($0.01 per diluted common share) for legal settlements in connection with our discontinued operations. In fiscal 2008 we did not have material income or charges related to discontinued operations. In fiscal 2007, we recorded income from discontinued operations of $2 million ($0.03 per diluted common share) which included tax benefits of $3 million, partially offset by a charge of less than $1 million for legal settlements.
Net (Loss) Income
In fiscal 2009 we reported a net loss of $77 million ($1.23 per diluted common share). This compared to net income for fiscal 2008 of $86 million ($1.34 per diluted common share) and net income of $129 million ($1.90 per diluted common share) for fiscal 2007.
Fiscal 2009 compared to Fiscal 2008 and Fiscal 2008 compared to Fiscal 2007By Business Segment
Total segment PBT, certain items, other unallocated items and (loss) income from continuing operations before taxes for fiscal 2009, 2008 and 2007 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.
In fiscal 2009, total segment PBT decreased by $131 million when compared to fiscal 2008. The decrease was principally due to lower volumes from weaker demand in our end markets ($283 million) resulting from the global economic downturn and the unfavorable impact of older, high cost inventories ($62 million). These factors were partially offset by contract lag and LIFO benefits from lower carbon black raw material costs relative to unfavorable impacts in fiscal 2008 (net $129 million benefit). Additionally, lower operating expenses ($44 million) from restructuring and cost saving actions and foreign currency translation ($39 million) benefited results in fiscal 2009 when compared to fiscal 2008. The LIFO benefit during fiscal 2009 was a favorable $21 million, comprised of $15 million of COGS impact and $6 million of liquidation impact. This is compared to $41 million of unfavorable LIFO impact during fiscal 2008, which was comprised of $55 million of unfavorable COGS impact partially offset by $14 million of favorable liquidation impact.
The $52 million decrease in total segment PBT in fiscal 2008 when compared to fiscal 2007 was primarily driven by the unfavorable impact of rising raw material costs that could not be fully offset by price increases (net $55 million) and lower volumes ($11 million), principally in the Supermetals Business from the expiration of a fixed price, fixed volume contract in fiscal 2007. These unfavorable factors were partially offset by the benefit of foreign currency translation ($16 million).
In recent years we have undertaken restructuring initiatives, which were recorded as certain items, and thus not included in segment results. During fiscal 2009 we implemented a restructuring of our operations, including closing four of our manufacturing operations and one regional office, mothballing assets at several additional sites and suspending mining of tantalum and spodumene at our mine in Manitoba, Canada. During the third quarter of fiscal 2008, we terminated work on under-performing projects in the New Business Segment resulting in workforce reductions. In March 2008, we closed our carbon black plant in Waverly, West Virginia.
Details of the certain items for fiscal 2009, 2008 and 2007 are as follows:
In fiscal 2009, $103 million of charges principally related to restructuring initiatives were recorded as certain items. In fiscal 2008, $13 million of charges principally from restructuring activities, executive transition costs and environmental reserves and legal settlements were recorded as certain items. In fiscal 2007, certain items included $34 million of charges principally from restructuring activities, the settlement of the carbon black federal antitrust litigation and environmental reserves and other legal settlements.
Other unallocated items
Details of other unallocated items for fiscal 2009, 2008 and 2007 are as follows:
Sales and PBT for the Rubber Blacks and Supermetals Businesses, which together comprise the Core Segment, for fiscal 2009, 2008 and 2007 are as follows:
Rubber Blacks Business
Sales in the Rubber Blacks Business in fiscal 2009 decreased by $582 million when compared to fiscal 2008 principally due to 21% lower volumes ($402 million) driven by decreased demand in the tire and automotive markets, lower prices ($126 million) driven by lower carbon black raw material costs, and the unfavorable effect of foreign currency translation ($58 million), principally from the Brazilian Real and the Euro. The $452 million increase in sales in the Rubber Blacks Business in fiscal 2008, when compared to fiscal 2007, was primarily due to higher prices ($308 million) resulting from feedstock related price increases and the benefit of foreign currency translation ($147 million). Volumes for fiscal 2008 were flat compared to fiscal 2007 as lower volumes in North America and Europe offset strong growth in Asia Pacific.
In fiscal 2009 PBT in the Rubber Blacks Business decreased by $74 million when compared to fiscal 2008. The decrease is principally attributable to lower volumes ($115 million), as global tire and automotive production fell in response to weaker consumer demand, and the unfavorable impact of older, high cost inventories ($46 million). These unfavorable factors more than offset contract lag and LIFO benefits ($19 million and $9 million, respectively), relative to unfavorable impacts in fiscal 2008 ($66 million and $8 million, respectively), and the benefit of lower operating expenses from restructuring and cost saving actions. Rubber Blacks PBT increased by $5 million in fiscal 2008 when compared to fiscal 2007. The combination of reduced operating expenses and increased pricing more than offset a significant increase in raw material costs during fiscal 2008.
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 costs and, in some cases, changes in other relevant costs. These feedstock adjustments have been based upon the average of a relevant index over a three-month period. Because of the need to communicate these adjustments to our customers in a timely manner, 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 can have a significant impact on the results of the Rubber Blacks Business. During 2009, we reduced the percentage of our Rubber Blacks volume subject to this time delay from approximately 50% to approximately 25%.
Sales in the Supermetals Business in fiscal 2009 decreased by $55 million when compared to fiscal 2008 as lower volumes ($85 million) from weaker electronics demand driven by the global economic slowdown more than offset higher prices and a favorable product mix ($22 million) and the positive effect of foreign currency translation ($6 million). Sales in the Supermetals Business decreased by $38 million in
fiscal 2008 compared to fiscal 2007. Over the past several years, sales and PBT in the Supermetals Business have been unfavorably impacted by the expiration of fixed volume, fixed price contracts, which led to lower prices and volumes. The last of these contracts expired at the end of the first quarter of fiscal 2007 causing an unfavorable sales and PBT comparison for fiscal 2008. During fiscal 2008 lower tantalum volumes unfavorably affected sales by $31 million while lower tantalum pricing affected sales by $12 million when compared to fiscal 2007. Partially offsetting these unfavorable factors was a $6 million benefit of foreign currency translation.
In fiscal 2009, PBT in the Supermetals Business was flat when compared to fiscal 2008. Substantially lower volumes from weaker demand in the electronics industry ($31 million) were offset by higher prices ($23 million), lower operating expenses from cost reduction actions ($5 million) and lower ore costs ($3 million). During fiscal 2009, the Supermetals Business generated $39 million in cash, on a constant currency basis, principally from lower working capital. PBT in the Supermetals Business decreased by $27 million in fiscal 2008 compared to fiscal 2007. This comparison was heavily influenced by the expiration of a fixed volume, fixed price customer supply contract in 2007. Lower volumes unfavorably impacted fiscal 2008 PBT by $14 million when compared to fiscal 2007, while the unfavorable impact of lower pricing was $12 million. These unfavorable factors were partially offset by lower operating expenses ($6 million).
Sales and PBT for the Performance Segment for fiscal 2009, 2008 and 2007 are as follows:
For fiscal 2009, the $312 million decrease in sales in the Performance Segment when compared to fiscal 2008 was due principally to lower volumes ($258 million) from weaker demand in our key end markets, the unfavorable effect of foreign currency translation ($36 million) and lower prices from lower carbon black feedstock costs ($22 million). Volumes in the Performance Products and Fumed Metal Oxides Businesses decreased by 29% and 26%, respectively, in fiscal 2009 when compared to fiscal 2008. The $122 million increase in sales in fiscal 2008, when compared to fiscal 2007, was primarily due to the benefit of foreign currency translation ($59 million), higher prices ($53 million), due in part to rising carbon black feedstock costs, and increased volumes ($11 million). Volumes in the Performance Products and Fumed Metal Oxides Businesses increased by 1% and 2%, respectively, in fiscal 2008 when compared to fiscal 2007.
PBT in the Performance Segment decreased by $79 million in fiscal 2009 when compared to fiscal 2008. The decrease was driven principally by lower volumes from weaker demand in our key end markets ($127 million). The unfavorable impact of older, higher cost inventories ($16 million) was more than offset by favorable commercial efforts leading to expanded unit margins. Additionally, a $10 million favorable LIFO impact, relative to a $17 million unfavorable impact in fiscal 2008, and lower operating expenses from restructuring and cost saving actions benefited results. Fiscal 2008 PBT was $29 million lower than fiscal 2007 PBT driven principally by the impact of higher raw material costs that could not be fully offset by increased pricing, a $17 million unfavorable LIFO impact relative to an unfavorable $1 million LIFO impact in fiscal 2007, and continued investment in the development of differentiated products and geographic expansion. These unfavorable factors were partially offset by higher volumes ($8 million) and the benefit of foreign currency translation.
New Business Segment
Sales and PBT for the New Business Segment for fiscal 2009, 2008 and 2007 are as follows:
Sales in the New Business Segment increased by $10 million in fiscal 2009 when compared to fiscal 2008 driven by increased revenue in all businesses as the Segment focused on improving its pace of revenue generation. Sales in the New Business Segment increased by $6 million in fiscal 2008 when compared to fiscal 2007 primarily due to higher revenues in the Aerogel Business and Superior MicroPowders. These increases were partially offset by lower volumes and an unfavorable product mix in the Inkjet Colorants Business.
Net losses in the New Business Segment for fiscal 2009 improved by $25 million from fiscal 2008. Results for fiscal 2009 benefited from increased sales revenue and lower operating expenses from the improved discipline of our business development process, and the elimination of underperforming projects during fiscal 2008. In fiscal 2009 cash generation in the New Business Segment improved by $43 million when compared to fiscal 2008. The loss in the New Business Segment increased slightly in fiscal 2008 when compared to fiscal 2007. Higher volumes were offset by an unfavorable product mix and slightly higher fixed costs in the Aerogel Business as we fulfilled orders for the oil and gas and construction market segments.
In 2006, we entered into a cross license agreement with Aspen Aerogel, Inc. (Aspen) under which each party granted certain intellectual property rights to the other. In consideration for the license of certain patents granted by Cabot we are entitled to payments totaling $38 million. We received $4 million, $4 million and $2 million in fiscal 2009, 2008 and 2007, respectively, of installment payments which have been recorded in earnings. The remaining $27 million is payable in installments over the next four years, and will be recognized in earnings if and when collectibility is reasonably assured.
Specialty Fluids Segment
Sales and PBT for the Specialty Fluids Segment for fiscal 2009, 2008 and 2007 are as follows:
During fiscal 2009, sales in the Specialty Fluids Segment decreased by $9 million, when compared to fiscal 2008. The decrease was due principally to lower volumes partially offset by favorable pricing. During fiscal 2008, sales in the Specialty Fluids Segment increased by $10 million compared to fiscal 2007 driven by an increase in the number of jobs using our fluid during the year.
In fiscal 2009 PBT in the Specialty Fluids Segment was $3 million lower than in fiscal 2008. Lower volumes were partially offset by favorable pricing, and lower operating expenses. When comparing fiscal 2008 to fiscal 2007, Segment PBT was flat.
We remain focused on expanding the use of our fluids outside of the North Sea as one of the elements of continued growth in this Segment. During fiscal 2009, 29% of sales in the Specialty Fluids Segment were generated from regions outside of the North Sea, compared to 21% in fiscal 2008 and 17% in fiscal 2007.
Cash Flows and Liquidity
In September 2009 we issued $300 million of public notes that will mature on October 1, 2016. The net proceeds of this offering were $296 million after deducting discounts and issuance costs. As of September 30, 2009, we had cash or cash equivalents of $304 million, and current availability under our revolving and other credit facilities of approximately $460 million. Our cash worldwide was either invested in Money Market Funds or on deposit with our main cash management banks throughout the world. We recorded a $6 million loss on our cash on deposit in Venezuela as a result of a write-down to a parallel exchange rate intended to approximate the rate at which we can repatriate this cash. Other than this loss, we had no material losses on our cash and marketable securities investments during fiscal 2009.
Looking forward to 2010, we anticipate sufficient liquidity from cash on hand, cash flows and access to existing credit facilities to meet our operational needs and financial obligations. Our revolving credit facility expires in August 2010. Our intent is to replace this facility and the terms of any new line of credit could differ from the terms of our current facility. Our liquidity derived from cash flows is, to a large degree, predicated on our ability to collect our receivables in a timely manner, the cost of our raw materials and our ability to manage inventory levels.
The following discussion of the changes in our cash balance refers to the various sections of our Consolidated Statements of Cash Flows, which appears in Item 8 of this report.
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 $399 million in fiscal 2009 compared to $124 million in fiscal 2008. Cash generated from operating activities in fiscal 2009 was due principally to a decrease in working capital of $356 million. Specifically, we had a $215 million decrease in accounts receivable primarily attributable to lower sales and improved collections as well as a decrease of $184 million in inventories as a result of lower feedstock costs, and our efforts to reduce inventory quantities. Accounts payable and accrued liabilities decreased by $43 million as a result of the timing of raw material deliveries and payments. The positive cash flow for fiscal 2008 was primarily generated from net income of $86 million and depreciation and amortization of $163 million, partially offset by an increase in working capital of $142 million.
As of September 30, 2009, we had $21 million of total restructuring costs in accrued expenses in the consolidated balance sheet related to our 2009 global restructuring plan. We made cash payments of $30 million during fiscal 2009 related to all of our restructuring plans. We expect to make cash payments related to these restructuring activities of approximately $40 million in fiscal 2010, including the $21 million already accrued.
Environmental and Litigation
We have recorded a $6 million reserve on a discounted basis ($6 million on an undiscounted basis) as of September 30, 2009, 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, 2009 we have recorded a $13 million reserve on a discounted basis ($23 million on an undiscounted basis) for respirator claims. These expenditures will also be spread over a long period of time. We also have other litigation costs associated with lawsuits arising in the ordinary course of business including claims filed against us in connection with certain discontinued operations.
The following table represents the estimated future undiscounted payments related to our environmental and respirator reserves.
Employee Benefit Plans
We provide benefits under defined benefit plans for all U.S. and some foreign employees. As of September 30, 2009 we have a consolidated unfunded plan liability of $152 million, comprised of $68 million for our pension benefit plans and $84 million for our postretirement benefit plans.
The $68 million of unfunded pension benefit plan liability is derived as follows at September 30, 2009:
In fiscal 2009, we made cash contributions totaling approximately $5 million to our U.S. pension benefit plan and approximately $10 million to our foreign pension benefit plans. For fiscal 2010, we currently do not anticipate that we will be required to make a cash contribution to our U.S. pension plan, while we expect to make an approximate $8 million cash contribution to our foreign pension plans.
The $84 million of unfunded postretirement benefit plan liability is comprised of $69 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 2009, we paid postretirement benefits of $5 million under our U.S. plans and $1 million under our foreign plans and expect to make aggregate benefit payments of approximately $7 million under these plans in fiscal 2010.
Cash Flows from Investing Activities
Cash flows from investing activities consumed $105 million of cash in fiscal 2009 compared to $176 million in fiscal 2008, primarily as a result of reduced capital spending. Capital expenditures in fiscal 2009 of $106 million included spending to complete the expansion of rubber blacks capacity at an existing facility in China, new energy centers at other rubber blacks facilities and to acquire a new facility in Dubai for the manufacture of masterbatch.
Capital expenditures in fiscal 2008 of $199 million included spending for rubber blacks capacity expansion at an existing facility in China, residual spending on our new performance products manufacturing unit in China and new energy centers at other rubber blacks facilities. Capital spending in
fiscal 2008 was partially offset by proceeds of $18 million received from the sale of the land on which our Altona, Australia carbon black plant was located and by $7 million related to the consolidation of one of our equity affiliates.
During fiscal 2007, we purchased $95 million and received proceeds of $95 million from short term investments, which were mainly auction rate securities that generally reset every twenty-eight days even though their ultimate maturities were 20 years and longer. During fiscal 2008, we ceased investing in auction rate securities.
Capital expenditures for fiscal 2010 are expected to be approximately $150 million.
Cash Flows from Financing Activities
Financing activities consumed $127 million of cash in fiscal 2009 compared to cash provided by financing activities of $23 million in fiscal 2008. In both years, financing cash flows were primarily driven by changes in debt levels and dividend payments.
The following table provides a summary of our outstanding long-term debt.
During fiscal 2009, we issued or borrowed $312 million, offset by debt repayments of $321 million, bringing our total debt to $628 million as of September 30, 2009. Our primary borrowing and repayment related to the issuance of notes in September 2009 and the subsequent pay down of borrowings under our revolving credit facility. Our total debt, of which $5 million is current, matures at various times over the
next eighteen years. The weighted-average interest rate on our fixed rate long-term debt is 5.6%, including the effects of the interest rate swaps. The weighted-average interest rate on variable interest rate long-term debt was 3.7% as of September 30, 2009, including the effects of the interest rate swaps.
Under our existing revolving credit facility we may borrow up to $400 million. The revolving line of credit permits us to borrow funds on an unsecured basis in multiple currencies that are freely tradable and convertible into U.S. dollars at floating interest rates. The credit facility expires in August 2010. We intend to replace the revolving line of credit when it expires and the terms of any new line of credit could differ from the terms of the current facility. As of September 30, 2009, we had no outstanding borrowings and $16 million in standby letters of credit issued but not drawn on under this agreement. The remaining availability under the revolving credit facility as of September 30, 2009 was approximately $384 million. The credit facility contains various affirmative, negative and financial covenants which are customary for financings of this type, including financial covenants for maximum indebtedness and, under certain conditions, minimum cash flow requirements. As of September 30, 2009, we were in compliance with all of the covenants. In addition, we have $76 million in committed facilities available to us at various locations throughout the world.
At September 30, 2009, in addition to the $16 million of standby letters of credit issued under our revolving credit facility, we have provided standby letters of credit and bank guarantees totaling $25 million, which expire through fiscal 2011.
A downgrade of one level in our credit rating is not anticipated. Should it occur, however, it would not affect our ability to borrow money under our existing revolving credit facility but would affect the cost of this borrowing and we would be subject to one additional cash flow financial covenant.
During fiscal 2009, we did not repurchase any shares of our common stock on the open market. As of September 30, 2009, we have approximately 4.3 million shares remaining for repurchase under the Board of Directors share repurchase authorization. In fiscal 2009, however, we repurchased approximately 123,400 shares from employees to satisfy tax withholding obligations at a cost of approximately $2 million. During fiscal 2008, we repurchased 935,400 shares of our common stock on the open market for a total cost of $28 million. Additionally, we repurchased approximately 277,000 shares from employees who sold us shares to satisfy tax withholding obligations at a cost of approximately $11 million.
In each of fiscal 2009, 2008 and 2007, we paid cash dividends on our common stock of $0.72 per share of common stock. These cash dividend payments totaled $48 million in fiscal 2009, $47 million in fiscal 2008 and $48 million in fiscal 2007.
Off-balance sheet arrangements
We had no material transactions that meet the definition of an off-balance sheet arrangement.
The following table sets forth our long-term contractual obligations which are described in greater detail in Note T in the notes to our Consolidated Financial Statements in Item 8.
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 price has been used to quantify total commitments.
We have operating leases primarily comprised of leases for transportation vehicles, warehouse facilities, office space, and machinery and equipment.
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. We do not enter into financial instruments for trading or speculative purposes and all of the derivative instruments we enter into are reviewed and approved by our Financial Risk Management Committee, an internal management committee responsible for overseeing Cabots financial risk management policy.
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 reflects the asset or (liability) position as of September 30, 2009. 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, 2009, the counterparties that we have executed derivatives with were rated between AA and A, inclusive, by Standard and Poors. 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, 2009, we had long-term debt, including the current portion, totaling $628 million, which has both variable and fixed interest rate components. We have entered into interest rate swaps as a hedge of the 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 market value, but do not impact earnings or cash flows. Conversely, for floating rate debt, interest rate changes generally do not affect the fair market value, but do impact future earnings and cash flows, assuming other factors are held constant. We endeavor to maintain a certain fixed-to-floating interest rate mix on our long-term debt. As most of our long-term debt was issued at fixed rates, we use interest rate swaps to achieve the desired 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 market value at September 30, 2009.
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, 2009.
Foreign currency exposures also relate to current assets and current 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. In fiscal 2009 and fiscal 2008, none of our forward contracts were designated hedging instruments. As of September 30, 2009, we had $60 million in net notional foreign currency forward contracts, which were denominated in Japanese yen, British pound sterling, Canadian dollar, Australian dollar and Euros. These forwards had a fair value of less than $1 million as of September 30, 2009.
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.
For the calendar year 2009, certain of our carbon black plants in Europe were subject to mandatory greenhouse gas emission (GHG) trading schemes. Our objective is to ensure compliance with the European Union (EU) 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 (EUAs) originate from the individual EU states country allocation process and are issued by that countrys 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 committed to current prices by entering into agreements which run from fiscal years 2010 to 2013 to purchase CERs and to sell EUAs. The following table provides details of the derivatives held as of September 30, 2009 used to manage commodity risk.
INDEX TO FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Years ended September 30
(In millions, except shares in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Years ended September 30
(In millions, except shares in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Years ended September 30
(In millions, except shares in thousands)