FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 1-5667
Cabot Corporation
Registrant’s telephone number, including area code: (617) 345-0100
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.
As of August 2, 2004 the Company had 61,707,716 shares of CommonStock, par value $1 per share, outstanding.
CABOT CORPORATION
INDEX
- 2 -
Part I. Financial Information
Item 1. Financial Statements
(In millions, except per share amounts)
UNAUDITED
The accompanying notes are an integral part of these financial statements.
3
4
(In millions)
ASSETS
5
CABOT CORPORATIONCONSOLIDATED BALANCE SHEETSJune 30, 2004 and September 30, 2003
(In millions, except for share and per share amounts)
LIABILITIES & STOCKHOLDERS’ EQUITY
6
7
8
- 9 -
CABOT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)June 30, 2004UNAUDITED
- 10 -
- 11 -
- 12 -
Net periodic defined benefit pension and other postretirement benefit costs include the following components for the nine months ended June 30:
- 13 -
- 14 -
- 15 -
- 16 -
CABOT CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)June 30, 2004
17
18
19
20
21
22
23
24
O. Recent Accounting Pronouncements
In December 2003, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the “Act”) was passed by the United States Congress. The Act will be effective January 1, 2006 and provides Medicare government subsidies for employers that sponsor retiree medical programs for prescription drugs for former employees. Under FASB Staff Position Paper (“FSP”) 106-1 issued in January 2004, Cabot elected to defer recognition of this Act until the FASB issued final guidance. That guidance was issued in May 2004 in FSP106-2, which is effective for Cabot in the fourth quarter of fiscal 2004. Cabot is in the process of assessing the impact of the Act on the consolidated financial statements.
In December 2003, the FASB released a revised version of Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) called FIN 46R, which clarifies certain aspects of FIN 46 and provides certain entities with exemptions from requirements of FIN 46. FIN 46R only slightly modified the variable interest model from that contained in FIN 46 and did change guidance in many other areas. Some of the differences between FIN 46 and FIN 46R include, among others, (i) the addition of a scope exception for certain entities that meet the definition of a business provided that specified criteria are met, (ii) the addition of a scope exception in situations whereby an enterprise is unable to obtain certain information pertaining to the entity to comply with FIN 46R, and (iii) the addition of a list of events that require reconsideration of whether an entity is a variable interest entity and whether an enterprise is the primary beneficiary of a variable interest entity, rather than stating the general principle with examples that had previously been provided. Additionally, FIN 46R incorporates the guidance found in the eight final Staff Position Papers that were issued as of the release of FIN 46R. All entities created after January 31, 2003 have been and will continue to be analyzed under FIN 46. FIN 46R was implemented in the second quarter of fiscal 2004, as it relates to all non-special purpose entities created prior to February 1, 2003 and had no impact on the Company’s consolidated financial statements.
- 25 -
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
I. Critical Accounting Estimates
The preparation of the Company’s 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. Critical accounting policies are those that are central to the presentation of the Company’s financial condition and results of operations and that require management to make estimates about matters that are highly uncertain. On an ongoing basis, the Company evaluates its policies and estimates. The Company bases its estimates on historical experience, current conditions and on various other assumptions that are believed to be 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.
Revenue Recognition and Accounts Receivable
Cabot primarily derives its revenues from the sale of specialty chemicals, tantalum and related products and from the rental and sale of cesium formate. Revenue from product sales is typically recognized when the product is shipped and title and risk of loss have passed to the customer. Revenue from the rental of cesium formate is recognized throughout the rental period based on the contracted rental amount. Customers are also billed and revenue is recognized, typically at the end of the job, for cesium formate product that is not returned. Other operating revenues, which represent less than ten percent of total revenues, include tolling, services and royalties for licensed technology.
In the second quarter of 2004, the accounting treatment for the rental of cesium formate was changed from recording the revenue at the end of the rental period to recording the rental revenue throughout the rental period. Prior periods have not been adjusted as the impact is immaterial. This change also resulted in the reclassification for all periods presented of the cesium formate assets held for rent from a current asset to a non-current asset.
Cabot recognizes revenue when persuasive evidence of a sales arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable. Cabot generally is able to ensure that products meet customer specifications prior to shipment.
Under certain multi-year supply contracts with declining prices and minimum volumes, Cabot recognizes revenue based on the estimated average selling price over the contract lives.
The Company prepares its estimates for sales returns and allowances, discounts and volume rebates quarterly based primarily on historical experience updated for changes in facts and circumstances, as appropriate. The discounts and rebates are recorded as a reduction of sales at the time revenue is recognized based on historical experience. If actual future results vary, the Company may need to adjust its estimates, which could have an impact on earnings in the period of adjustment.
The Company maintains allowances for doubtful accounts for estimated losses resulting from the potential inability of its customers to make required payments. If the financial conditions of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required, which could materially affect future earnings. As of June 30, 2004, the allowance for doubtful accounts was $3 million.
Inventory Valuation
The cost of most raw materials, work in process, and finished goods inventories in the U.S. is determined by the last-in, first-out (“LIFO”) method. Had the Company used the first-in, first-out (“FIFO”) method instead of the LIFO method for such inventories the value of those inventories would have been $67 million higher as of June 30, 2004. The cost of other U.S. and all non-U.S. inventories is determined using the average cost method or the FIFO method.
- 26 -
In cases where the market value of inventories is below cost, the inventory is stated at market value. The Company writes down its inventories for estimated obsolescence or unmarketable inventory by an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. Such write-downs have not historically been significant. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
Valuation of Long-Lived Assets
The Company’s long-lived assets include property, plant, equipment, long-term investments, goodwill, other intangible assets and assets held for rent. The Company reviews 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. An asset impairment is recognized when the carrying value of the asset, excluding goodwill, is not recoverable based on the undiscounted estimated cash flows. The Company’s estimates reflect management’s assumptions about selling prices, production and sales volume, costs, and market conditions over an estimate of the remaining operating period. If an impairment is indicated, the asset is written down to the estimated fair value. In circumstances when an asset does not have separate indentifiable cash flows, an impairment charge is recorded when Cabot abandons the asset.
The Company performs an annual impairment test for goodwill in accordance with Statement of Financial Accounting Standard (“FAS”) No. 142. The fair value of the assets including goodwill balances is based on discounted estimated cash flows. The assumptions used to estimate fair value include management’s best estimates of future growth rates, capital expenditures, discount rates, and market conditions over an estimate of the remaining operating period. If an impairment exists, a loss to write down the value of goodwill is recorded.
Environmental Costs
The Company accrues environmental costs when it is probable that the Company has incurred a liability and the amount can be reasonably estimated. When a liability amount cannot be reasonably estimated, but a range can be reasonably estimated, the Company accrues the amount that reflects its best estimate within that range or the low end of the range if no estimate within the range is better. The amount accrued reflects the Company’s assumptions about remediation requirements at the contaminated site, the nature of the remedy, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites, and the number and financial viability of other potentially responsible parties. A portion of the reserve for environmental matters is recognized on a discounted basis. The availability of new information, changes in the estimates on which the accruals are based, unanticipated government enforcement action, or changes in applicable government laws and regulations could result in higher or lower costs. The Company does not reduce its estimated liability for possible recoveries from insurance carriers. Proceeds from insurance carriers are recorded when realized by the receipt of cash or a contractual agreement. As of June 30, 2004, the Company had $24 million reserved for various environmental matters.
Pensions and Other Postretirement Benefits
The Company maintains both defined benefit and defined contribution plans for its employees. In addition, the Company provides certain health care and life insurance benefits for retired employees. The costs and obligations related to these benefits reflect the Company’s assumptions related to general economic conditions, including interest rates, expected return on plan assets, and the rate of compensation increases for employees. Projected health care benefits reflect the Company’s assumptions about health care cost trends. The cost of providing plan benefits also depends on demographic assumptions including retirements, mortality, turnover, and plan participation. If actual experience differs from these assumptions, the cost of providing these benefits could increase or decrease. Actual results that differ from the assumptions are generally accumulated and amortized over future periods and, therefore, affect the recognized expense and recorded obligation in such future periods.
Litigation and Contingencies
The Company accrues a liability for litigation when it is probable that a liability will be incurred and the amount can be reasonably estimated. The estimated reserves are recorded based on the Company’s best estimate of the liability
- 27 -
associated with such matters or the low end of the estimated range of liability if the Company is unable to identify a better estimate within that range. Litigation is highly uncertain and there is always the possibility of an unusual result in any particular case that may have an adverse effect on the results of operations.
Income Taxes
The Company estimates its income taxes in each domestic and foreign jurisdiction that imposes a tax on its income. This process involves estimating the tax exposure for differences between actual results and estimated results. The Company has filed its tax returns in accordance with its interpretations of each jurisdiction’s tax laws and has established reserves for potential differences in interpretation of those laws. These reserves are recorded in deferred income taxes on the consolidated balance sheet. In the event that actual results are significantly different from those estimates, the Company’s provision for income taxes could be significantly impacted.
II. Results of Operations
THIRD QUARTER 2004 VERSUS THIRD QUARTER 2003 – CONSOLIDATED
Summary of Earnings
In the third quarter of 2004, the Company’s financial results reflected strong volumes in the Chemical and Supermetals Businesses, and increased contribution from the “excellence” initiative which the Company began last year to improve its overall operating performance. These favorable factors more than offset lower intermediate product sales in the Supermetals Business and a decline in carbon black variable margins.
The following table provides summary data of the Consolidated Statement of Operations:
- 28 -
Certain Items and Discontinued Operations
Results for the third quarter of 2004 and 2003 included certain items and discontinued operations as follows:
Certain charges for the third quarter of 2004 and 2003 are recorded in the consolidated statement of operations as follows:
Net Sales and Gross Profit
In the third quarter of 2004, consolidated net sales increased 5% from the same quarter in the prior year. This increase was primarily due to volume increases in the Chemical Business and favorable foreign currency translation, which offset the decrease in Supermetals’ intermediate product sales and lower pricing in the carbon black business. Gross profit as a percent of sales increased four percentage points, to 26%, due mainly to gross profit improvements in the Chemical and Supermetals Businesses and a decrease in certain charges.
Selling and Administrative Expense
Selling and administrative expense improved $26 million versus the same quarter in 2003, which included certain items of $27 million related to reserves for respirator claims and the Company’s European restructuring. Savings from the “excellence” initiative, a program implemented in early 2003 to improve Cabot’s overall operating performance, offset increases for annual salary adjustments and the impact of unfavorable foreign currency translation due to the strengthening of foreign currencies versus the dollar.
- 29 -
Research and Technical Expense
Research and technical expense decreased $14 million compared to the same period of last year, which included certain items of $14 million related to the 2003 write-off of in-process research and development associated with the purchase of Superior MicroPowders.
Interest Expense
Interest expense of $8 million for the third quarter of fiscal year 2004 was slightly higher than the third quarter last year as a result of the refinancing in September 2003 of the Company’s $175 million note payable, which is mostly fixed rate after the effect of interest rate swap arrangements. This increase in interest expense in the current quarter mainly represents the higher fixed rates of the current debt versus the lower variable rate debt associated with this period in 2003.
Effective Tax Rate
The $13 million provision for income tax expense for the third quarter of 2004 includes a reduction of tax reserves of approximately $2 million primarily associated with the resolution of certain tax audits and the expiration of the statutes of limitations on certain tax years. This resulted in an effective tax rate for the third quarter of 2004 of 23%. The effective tax rate in the same period of last year was 43% (representing a tax benefit on quarterly loss) due to the tax effects associated with $50 million of certain items recorded during the quarter. The Company expects the 2004 annual tax rate on continuing operations to be 25%.
The Company operates in over 25 countries and is routinely audited by the relevant Federal, state and local tax authorities. Several of the current tax audits are at advanced stages of the audit or appeals process and should reach resolution within the next three to four quarters. This may result in an adjustment to designated tax reserves.
Net Income
Net income for the third quarter of fiscal 2004 was $42 million ($0.62 per diluted common share) compared to a loss of $5 million ($0.09 per diluted common share) in the same quarter a year ago. The third quarter of fiscal 2003 results contained $34 million of after tax charges ($0.57 per diluted common share) from certain items and discontinued operations. Net income increased $47 million from the same period last year due primarily to an increase in gross profit and a decline in certain items, partly offset by a higher income tax provision.
THIRD QUARTER 2004 VERSUS THIRD QUARTER 2003 – BY BUSINESS SEGMENT
Net Sales by Business Segment
- 30 -
Profit (Loss) by Business Segment
Chemical Business
Sales increased 9%, from $366 million in the third quarter of fiscal 2003 to $398 million in the third quarter of fiscal 2004. Carbon black sales, which comprise the majority of sales in the Chemical Business, increased 8% due to higher volumes and positive currency translation that more than offset a decline in carbon black contract related prices that have quarterly feedstock adjustments. The volume increase was evident in all market segments and regions, particularly in China and South America. Fumed metal oxides’ sales increased 20%, due to higher volumes and market segment mix. Inkjet colorants business sales increased 28% due to continued growth in original equipment manufacturer (OEM) and after-market sectors.
Segment profit increased 50% from the third quarter of fiscal 2003. Carbon black contributed $10 million to the segment’s $15 million profit improvement due to stronger volumes, lower feedstock and controllable costs, and positive currency translation of foreign earnings. These favorable factors offset the variable margin decline due to lower contract prices and lower manufacturing cost absorption related to lower inventory levels. Fumed metal oxides’ profit was $3 million higher than the same quarter of the prior year, primarily due to improved volumes, market segment mix, and lower controllable costs, which were partially offset by lower manufacturing cost absorption related to lower inventory levels. Inkjet profits more than doubled from the prior year on higher sales volumes. Aerogel costs declined $1 million from the same quarter last year due mainly to timing of operating costs.
During the quarter, the carbon black business entered into an additional long-term carbon black supply agreement with an existing major tire customer that expands the geographic scope of its contracted supply arrangements with that customer.
Supermetals Business
Sales decreased 7%, from $92 million in the third quarter of fiscal 2003 to $86 million in the third quarter of fiscal 2004. The lower sales were due primarily to less intermediate product sales following the expiration of certain contracted sales at the end of the last fiscal year. This decline was partially offset by stronger tantalum powder volume.
Segment profit increased 29%, to $18 million, in the third quarter of 2004, as compared to $14 million in 2003, primarily due to the increase in tantalum powder volume and lower overall operating costs. These favorable factors offset the impact of unfavorable currency translation of foreign earnings and $15 million of profit from contracted intermediate product sales that occurred in the third quarter of 2003.
In accordance with the terms of one of its two long-term tantalum ore supply agreements with Sons of Gwalia, in August 2003, the Supermetals business provided notice of exercise of its option to renew that supply agreement, commencing January 1, 2006. Since that time, as contemplated by the supply agreement, the parties have been in discussions concerning certain of the terms of renewal, which continue. The agreement provides that in the event the parties are unable to
- 31 -
reach an agreement concerning such terms, either party may submit the matter to arbitration. Because arbitration proceedings are typically lengthy, in July 2004, Sons of Gwalia submitted a Request for Arbitration to the London Court of International Arbitration. The parties have continued, and expect to continue, their negotiations during this process.
Separately, Cabot elected not to extend its second long-term supply agreement with Sons of Gwalia beyond December 31, 2005, its current expiration date. Cabot will continue to purchase tantalum ore under the terms of its existing contracts with Sons of Gwalia.
In July 2004, the Supermetals business entered into an amendment of its current long-term tantalum supply agreement with EPCOS AG for the supply of capacitor grade tantalum powders, which, among other things, extended the term of the supply contract through 2009.
Specialty Fluids Business
Sales declined $2 million, from $6 million in the third quarter of fiscal 2003 to $4 million in the third quarter of fiscal 2004. This decrease was due to the timing of completion of jobs, which was partially offset by the increase in rental revenue recognized in the quarter. Although some revenue from the five active jobs was recognized this quarter, the majority of the revenue will be recognized when the jobs are completed, which is expected to occur in the fourth quarter.
Segment profit improved $1 million compared to the same period of last year due to the increased number of on-going jobs that recorded rental revenue.
NINE MONTHS 2004 VERSUS NINE MONTHS 2003 – CONSOLIDATED
In the first nine months of 2004, the Company’s financial results reflected strong volumes in the Chemical and Specialty Fluids Businesses, and cost improvements from the “excellence” initiative which the Company began implementing last year to improve its overall operating performance. These favorable factors more than offset lower intermediate product sales in the Supermetals Business and a decline in carbon black variable margins.
- 32 -
Results for the nine months of 2004 and 2003 included certain items and discontinued operations as follows:
Certain charges for the nine months of 2004 and 2003 are recorded in the consolidated statement of operations as follows:
In the first nine months of 2004, consolidated net sales increased 7% from the same period of the prior year. This increase was due to volume increases in the Chemical and Specialty Fluids Businesses and favorable foreign currency translation, which offset the decrease in Supermetals’ intermediate product sales and lower pricing in the carbon black business. Gross profit as a percent of sales was similar to last year, largely due to improved Chemical Business gross profit, which offset the lower Supermetals’ gross profit.
Selling and administrative expense declined $26 million versus the nine months of 2003, which included $27 million of certain items related to reserves for respirator claims and the Company’s European restructuring. Savings from the “excellence” initiative offset the following increases: 1) normal salary adjustments; 2) legal spending associated with civil antitrust suits relating to the Company’s carbon black business; 3) the impact of unfavorable foreign currency translation due to the strengthening of foreign currencies versus the dollar; and 4) consulting fees to assist in internal control documentation associated with the Company’s Sarbanes-Oxley compliance.
- 33 -
Research and technical expense decreased $12 million from the first nine months of 2003, which included $14 million of certain items related to the write-off of in-process research and development associated with the purchase of Superior MicroPowders. During fiscal year 2004, there has been an increase in research and development spending in the inkjet colorants business to support OEM and after-market development programs.
Interest expense of $23 million for the nine months of fiscal year 2004 was $2 million higher than the same period last year as a result of the refinancing in September 2003 of the Company’s $175 million note payable, which is mostly fixed rate after the effect of interest rate swap arrangements. This increase in interest expense in the current period mainly represents the higher fixed rates of the current debt versus the lower variable rate debt associated with this period in 2003.
Other Income and Expense
Other expense was $3 million for the first nine months of 2004, largely due to current year charges related to currency translation. This expense was a decrease of $21 million compared to the same period last year, which included $22 million for the impairment of two investments.
The $34 million provision for income tax expense for the nine months of 2004 reflects an effective tax rate of 24%, an increase of six percentage points from the same period last year. This increase in the effective tax rate reflects the prior year tax effect associated with certain items and the impact of other fixed dollar tax savings on higher earnings. The Company expects the 2004 annual tax rate on continuing operations to be 25%.
Net income for the nine months of fiscal 2004 was $108 million ($1.57 per diluted common share) compared to $52 million of net income ($0.74 per diluted common share) in the same period a year ago. The first nine months of fiscal 2004 results contained $3 million of after tax charges ($0.05 per diluted common share) from certain items and discontinued operations, while the results for the first nine months of 2003 contained $48 million of after tax charges ($0.69 per diluted common share) from certain items and discontinued operations. Net income increased $56 million due primarily to higher gross profits and a decline in certain items, partly offset by a higher income tax provision.
NINE MONTHS 2004 VERSUS NINE MONTHS 2003 – BY BUSINESS SEGMENT
- 34 -
Sales increased 12%, from $1,028 million in the first nine months of fiscal 2003 to $1,148 million in the same period of fiscal 2004. Carbon black sales, which comprise the majority of sales in the Chemical Business, increased 11% due to higher volumes and positive currency translation that more than offset a decline in carbon black contract related prices. The volume increase was evident in all regions and market segments. Fumed metal oxides’ sales increased 16%, primarily due to strong demand in all market segments. Inkjet colorants business sales increased 39% due to continued growth in OEM and after-market sectors.
Segment profit increased 51% from the first nine months of fiscal 2003. Carbon black contributed $29 million to the segment’s $39 million profit improvement due to stronger volumes, lower controllable costs, and positive currency translation of foreign earnings, which more than offset the variable margin decline due to lower contract prices and higher feedstock costs. Fumed metal oxides’ profit was $9 million higher than the same period last year, largely due to improved volumes, lower costs driven by “excellence” initiatives and lower administrative costs, which were partially offset by lower manufacturing cost absorption due to decreased inventory levels. Inkjet profits increased 84% from the prior year due to significantly higher sales, which were partially offset by higher operating costs related to development programs and increased R&D costs. Aerogel costs have increased slightly compared to the same period last year due mainly to unfavorable currency translation of foreign costs.
Sales decreased 12%, from $294 million in the first nine months of fiscal 2003 to $258 million in the same period of fiscal 2004. The lower sales were due primarily to lower intermediate product sales following the expiration of certain contracted sales at the end of the last fiscal year. This resulting gross profit decline was partially offset by stronger overall market demand.
Segment profit declined 33% to $55 million in the first nine months of 2004, as compared to $82 million in 2003, primarily due to the decrease in intermediate product sales. This decline was partially offset by lower operating costs and improved market demand, principally in tantalum powder.
Sales increased $3 million, from $11 million in the first nine months of fiscal 2003 to $14 million in the first nine months of fiscal 2004. The sales increase was primarily driven by higher activity associated with the Statoil supply agreement.
Segment profit of $1 million, represents a $3 million increase from the first nine months of 2003. This profit increase was primarily a result of the higher volumes.
- 35 -
III. Cash Flow and Liquidity
As of June 30, 2004, Cabot has $185 million in cash compared with $247 million at September 30, 2003. The decrease in cash is attributable to the Company’s purchase during the quarter of $65 million of highly rated securities that are classified as short-term investments and other long-term investments on the consolidated balance sheet.
Overview of Cash Flow
During the first nine months of fiscal 2004, cash provided by operating activities totaled $153 million compared to $159 million for the same period last year. The cash provided by operating activities in the first nine months of fiscal 2004 primarily resulted from net income before non-cash compensation and depreciation, which is offset by increases in receivables, prepayments and inventory. The increase in receivables is consistent with increased sales company-wide. The increase in prepayments is primarily related to a payment of $10 million for a tax assessment that is being appealed in a foreign jurisdiction. The cash provided by operating activities in the first nine months of fiscal 2003 is related to net income before non-cash compensation, depreciation and the impairment of investments, which is offset by increases in receivables and inventory.
Cash used for investing activities was $136 million in the first nine months of fiscal 2004 as compared to $93 million used for the same period last year. The increase in cash used for investing activities primarily relates to the purchase of $65 million of highly rated available-for-sale investments used to improve yields. Since the end of the quarter, in July 2004, the Company purchased an additional $29 million of short-term highly rated available-for-sale investments.
Capital spending on property, plant and equipment for the first nine months of fiscal 2004 was $66 million compared to $76 million in the first nine months of fiscal 2003. The majority of capital spending related to routine plant operating capital projects. Capital expenditures for fiscal 2004 are expected to be approximately $130 million and include expenditures for replacement projects, plant expansions, and the completion of projects started in fiscal 2003.
Cash used for financing activities was $80 million in the first nine months of fiscal 2004 compared to $50 million used during the same period last year. The increase in cash used for financing activities primarily relates to the purchase of Cabot common stock during the first nine months of fiscal 2004 for $52 million compared to $19 million during the same period last year and a $0.02 per share increase in the quarterly dividend rate that resulted in an increase of $4 million in dividends on Cabot’s common stock. During the second quarter of fiscal 2004, Cabot repaid $15 million of medium term notes. Since the end of the quarter, in July 2004, the Company repaid $22 million of medium term notes that matured in the month. The fiscal 2004 increase in short-term debt of $10 million primarily relates to increased working capital needs in Asia. During the first half of fiscal 2003, Cabot refinanced the yen based debt it assumed in its February 2002 acquisition of Cabot Supermetals Japan.
Significant Contingencies
As of June 30, 2004, the Company has a $24 million reserve for environmental matters related to remediation costs at various environmental sites. These sites are primarily associated with businesses divested in prior years. The Company anticipates that the expenditures at these sites will be made over a number of years, and will not be concentrated in any one year. Cabot also has a $20 million reserve for respirator claims as of June 30, 2004, and has various other litigation costs, including defense costs associated with the pending antitrust actions and lawsuits filed against the Company arising in the ordinary course of its business and in respect of its divested businesses. Due to the uncertain nature and timing of litigation proceedings, it is difficult to predict the timing of their cash flows.
Restructuring
At June 30, 2004, Cabot has a restructuring reserve of $10 million for severance and asset retirement obligations from the fiscal 2003 European and North American restructuring plans. An additional $6 million of severance related restructuring charges is anticipated to be incurred under these plans. The existing restructuring reserve and the additional charges are expected to be paid during the next nine to twelve months.
- 36 -
Details of the activity of the restructuring reserve for the three months ended June 30, 2004 are as follows:
Details of the activity of the restructuring reserve during the nine months ended June 30, 2004 are as follows:
The restructuring charges related to severance and employee benefits for the involuntary employment termination benefits at various European locations for 9 employees during the third quarter of fiscal 2004 and 36 employees during the first nine months of fiscal 2004. Additional information regarding the Company’s restructuring activities is included in Note I to the Consolidated Financial Statements.
Cash Requirements
The Company anticipates an increase in its capital expenditures program in fiscal year 2005 to take advantage of opportunities to add production capacity in China and other rapidly growing regions of the world.
The Company’s primary source of short-term liquidity will be existing cash balances, short-term investments, cash flows from operations and existing financing arrangements, including an unused line of credit of $250 million. Management believes that the Company’s financial resources will adequately meet the Company’s business requirements for the next twelve months and the foreseeable future beyond the next twelve months, including planned expenditures for the improvement or expansion of the Company’s manufacturing capacity and working capital requirements.
IV. Recent Accounting Pronouncements
In December 2003, the FASB released a revised version of Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) called FIN 46R, which clarifies certain aspects of FIN 46 and provides certain entities with
- 37 -
exemptions from requirements of FIN 46. FIN 46R only slightly modified the variable interest model from that contained in FIN 46 and did change guidance in many other areas. Some of the differences between FIN 46 and FIN 46R include, among others, (i) the addition of a scope exception for certain entities that meet the definition of a business provided that specified criteria are met, (ii) the addition of a scope exception in situations whereby an enterprise is unable to obtain certain information pertaining to the entity to comply with FIN 46R, and (iii) the addition of a list of events that require reconsideration of whether an entity is a variable interest entity and whether an enterprise is the primary beneficiary of a variable interest entity, rather than stating the general principle with examples that had previously been provided. Additionally, FIN 46R incorporates the guidance found in the eight final Staff Position Papers that were issued as of the release of FIN 46R. All entities created after January 31, 2003 have been and will continue to be analyzed under FIN 46. FIN 46R was implemented in the second quarter of fiscal 2004, as it relates to all non-special purpose entities created prior to February 1, 2003 and had no impact on the Company’s consolidated financial statements.
Forward-Looking Information: Included above are forward-looking statements relating to management’s expectations of future profits, future economic and business conditions, new business growth, the Company’s product development program, efforts to control costs, and implementation of restructuring initiatives. Actual results may differ materially from the results anticipated in the forward-looking statements included in this quarterly report due to a variety of factors, including domestic and global economic conditions, such as market supply and demand, prices and costs and availability of raw materials; fluctuations in currency exchange rates; patent rights of others; stock market conditions; the timely commercialization of products under development by the Company (which may be disrupted or delayed by technical difficulties, market acceptance, competitors’ new products, as well as difficulties in moving from the experimental stage to the production stage); the Company’s ability to successfully implement its cost reduction initiatives and organizational restructurings; demand for the Company’s and its customers’ products; competitors’ reactions to market conditions; the accuracy of the assumptions used by the Company in establishing a reserve for its share of liability for respirator claims; and the outcome of pending litigation and governmental investigations. Other factors and risks are discussed in the Company’s 2003 Annual Report on Form 10-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information about market risks for the period ended June 30, 2004 does not differ materially from that discussed under Item 7A of the Company’s Annual Report on Form 10-K for the year ended September 30, 2003.
Item 4. Controls and Procedures
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chairman of the Board, President and Chief Executive Officer, and its Executive Vice President and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Company’s Chairman of the Board, President and Chief Executive Officer and its Executive Vice President and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective, in all material respects, with respect to the recording, processing, summarizing and reporting, within the time periods specified in the Securities and Exchange Commission’s rules and forms, of information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
During the quarterly period covered by this report, there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II. Other Information
Item 1. Legal Proceedings
A subsidiary of Cabot has exposure in connection with a safety respiratory products business it acquired from American Optical Corporation (“AO”) in an April 1990 asset transaction. As more fully described in the Company’s
- 38 -
Annual Report on Form 10-K for the fiscal year ended September 30, 2003 (the “2003 10-K”), the subsidiary’s respirator liabilities involve claims for personal injury, including asbestosis and silicosis, allegedly resulting from the use of AO respirators that are alleged to have been negligently designed or labeled. As of June 30, 2004, there were approximately 90,000 claimants in pending cases asserting claims against AO in connection with respiratory products. In fiscal year 2003, the Company retained the assistance of Hamilton, Rabinovitz & Alschuler, Inc. (“HR&A”), a leading expert, to assist it in calculating the subsidiary’s estimated share of liability with respect to then-existing and future respirator liability claims. Based on the HR&A estimates, Cabot recorded a $20 million reserve during the third quarter of fiscal year 2003 to cover the subsidiary’s share of liability for then-existing and future respirator liability claims.
On July 29, 2002, AVX Corporation commenced an action against the Company in the United States District Court for the District of Massachusetts. The complaint involved a tantalum supply agreement between the Company and AVX, one of the Company’s tantalum customers, and alleged unfair and deceptive trade practices, breach of contract and other related matters. This action was dismissed on procedural grounds during fiscal year 2003. In connection with the dismissal, the Company filed an action against AVX in the Business Litigation Section of the Superior Court of Massachusetts seeking declaratory judgment as to the validity of the supply agreement, as well as a declaration that Cabot is not in breach of an alleged prior agreement, and that Cabot did not engage in unfair and deceptive trade practices. In June 2004, the Court granted Cabot’s partial summary judgment motion regarding these matters. On March 8, 2004, AVX filed another action against Cabot in the United States District Court for the District of Massachusetts. This complaint alleges that Cabot violated the federal antitrust laws in connection with the tantalum supply agreement between AVX and Cabot by tying the purchase of one type of tantalum product by AVX to the purchase of other types. In the complaint, AVX seeks monetary damages in an unspecified amount. During the quarter, Cabot filed a motion for summary judgement on this action. AVX continues to purchase product in accordance with the terms of its contract during the dispute.
Cabot is a party to several actions pending in state and federal court in connection with its discontinued beryllium operations. As described in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003, during the last several years, several individuals who have resided or worked for many years in the immediate vicinity of Cabot’s former beryllium facility located in Reading, Pennsylvania have brought suits against Cabot and NGK Metals, Inc. (which purchased a portion of Cabot’s former beryllium business in 1986), for personal injury allegedly caused by beryllium particle emissions produced at that facility. Ten such cases are currently pending in the Court of Common Pleas of Philadelphia County in Pennsylvania, and two similar cases remain pending on appeal in the Federal Court of Appeals for the 3rd Circuit. Since October 2003, approximately 50 individuals have asserted claims for medical monitoring now pending in numerous Pennsylvania state court actions. These plaintiffs allege contact with beryllium in various ways, including residence or employment in the area surrounding the Reading facility, employment at the Reading facility or contact with individuals who worked at the Reading facility. Discovery is underway in these cases. The Company believes it has valid defenses to the beryllium actions and will assert them vigorously in the various venues in which claims have been asserted.
In July 2004, Sons of Gwalia Ltd. filed a Request for Arbitration with the London Court of International Arbitration seeking arbitration between Sons of Gwalia and the Company to determine certain of the terms under a recently renewed long-term supply agreement between the parties for the purchase of tantalum ore by the Company.
Cabot has various other lawsuits, claims and contingent liabilities arising in the ordinary course of its business, including a number of claims asserting premises liability for asbestos exposure, and in respect of its divested businesses. In the opinion of the Company, although final disposition of all of its suits and claims may impact Cabot’s financial statements in a particular period, they should not, in the aggregate, have a material adverse effect on Cabot’s financial position.
- 39 -
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
The table below provides information with respect to purchases by the Company of shares of its common stock during the third fiscal quarter of 2004.
ISSUER PURCHASES OF EQUITY SECURITIES (shares in thousands)
* On May 10, 2002, the Company announced that the Board of Directors authorized an increase in its then-existing share repurchase authorization from 10 million shares to up to 12.6 million shares. On May 14, 2004, the Company announced the Board of Director’s action terminating the May 2002 share repurchase authorization with respect to any shares still available for purchase under that authorization, and separately authorizing the purchase of up to 5 million shares of the Company’s common stock.
In March 2004, the Board of Directors authorized the Company to repurchase shares of common stock awarded to participants in the Company’s 2001 Long-Term Equity Incentive Program, with the maximum number of shares purchased from each participant to be based on the tax and loan repayment liabilities arising from the vesting of such shares in May 2004, and at a purchase price equal to the closing price of the Company’s common stock as reported on the New York Stock Exchange Composite Transactions on the date of vesting. The authorization to repurchase these shares is separate from the Company’s then-existing authorization to repurchase up to 12.6 million shares of its common stock. Because the number of shares to be purchased cannot be determined until the shares vest, they are not included in this column. In May 2004, the Company purchased approximately 202,000 shares of common stock pursuant to this authorization.
** Includes an aggregate of 225,000 shares purchased by the Company in May 2004 from employees to cover (i) withholding taxes due upon the vesting of restricted stock in May 2004 under the Company’s 2001 Long-Term Equity Incentive Program, (ii) withholding taxes due upon the vesting in May 2004 of certain shares of restricted stock awarded in May 2000 under the Company’s Equity Incentive Plans, and (iii) withholding taxes due upon the vesting in May 2004 of certain gifted shares of restricted stock.
- 40 -
Item 6. Exhibits and Reports on Form 8-K
- 41 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
- 42 -
Exhibit Index
- 43 -