$10 million for the global restructuring, $11 million of charges related to the closure of our Altona facility, $3 million offor cost reduction initiatives and a $27 million payment to Sons of Gwalia. ~~Income (loss)~~Loss from operations for 2005 includes charges of $16 million for ~~restructuring~~restructurings and $15 million of charges for cost reduction initiatives in the Supermetals Business. Income from operations for 2004 includes a charge of $6 million for ~~restructuring,~~restructurings, income of $2 million for a reduction of the respirator reserve and income of $1 million for other recoveries. Income from operations for 2003 includes charges of $51 million for ~~restructuring,~~restructurings, $14 million for acquired in-process research and development, $20 million for a reserve for respirator claims, $4 million for asset impairments and proceeds of $4 million for insurance recoveries. Income from operations for 2002 includes a $5 million charge for the respirator claims liability, a $5 million asset impairment, a $3 million charge to increase the environmental reserve, an $8 million charge related to the cancellation of an energy project, a $1 million charge for severance and the benefit of $8 million for insurance recoveries.

^(b)

Net interest expense and other income (charges) for 2007 include foreign currency gains of approximately $8 million. Net interest expense and other income (charges) for 2006 includes a $8 million charge related to a foreign currency translation adjustment write-off due to the substantial liquidation of our Altona, Australia entity. Other income (charges) ~~income~~ for 2005 includes $2 million of insurance recoveries and $2 million of income related to foreign currency translation adjustments. Other income (charges) ~~income~~ for 2004 ~~includes~~include charges of $12 million for an investment impairment and $3 million for foreign currency translation adjustments. Other income (charges) ~~income~~ for 2003 includes a $22 million charge for the impairment of two investments and proceeds of $35 million for the sale of an equity interest in an investment. Other (charges) income for 2002 includes $2 million of costs related to a currency translation adjustment at a closed plant and a $1 million charge for non-capitalizable currency transaction costs related to the acquisition of Cabot Supermetals Japan.

^(c)

The Company’s ~~effective~~tax rate for 2007 was a provision of 23%, which includes $3 million in tax benefits resulting from the settlement of various tax audits during the year. The Company’s tax rate for 2006 was a ~~charge~~provision of 9%, which includes a $18 million tax benefit from the settlement of various tax audits during the year. The Company’s ~~effective~~ tax rate for 2005 was a benefit of 48%, which includes the effect of a $23 million tax settlement benefit. For fiscal years 2004 ~~2003~~ and ~~2002,~~2003, the Company’s ~~effective~~ tax rate was a provision of 24%~~, 18%~~ and ~~22%~~18%, respectively.

^(d) Discontinued operations for fiscal 2006 include amounts related to a favorable tax settlement recognized during the period related to our discontinued liquified natural gas (“LNG”) business. Discontinued operations include the LNG and Cabot Microelectronics businesses as well as other discontinued businesses.

~~(e)~~The weighted average common shares outstanding for the fiscal year ~~ending~~ended September 30, 2005 excludes approximately 8 million shares as those shares would have had an antidilutive effect due to the Company’s net loss position.

^(e)

The shares outstanding as of September 30, 2007 reflect the issuance in July 2007 of approximately 4.7 million shares of common stock upon the conversion of our outstanding shares of Series B Convertible Preferred Stock and the repurchase of approximately 4.6 million shares of common stock during fiscal 2007.

^(f)

Return on average stockholders’ equity is calculated using net income excluding minority interest expense divided by the average stockholders’ equity plus minority interest. This presentation changed slightly from prior years as minority interest expense has been added back to net income for consistency.

^(g)

Return on investment is calculated using net income excluding after-tax net interest income and ~~(expense)~~expense and minority interest expense, divided by the average total debt and stockholders’ equity plus minority interest less the average cash and marketable securities during the periods presented.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
~~Overview~~
Cabot’s strategy focuses on optimizing our core businesses and product lines (rubber blacks, performance products, fumed metal oxides and tantalum) and investing the cash and intellectual resources they generate in new businesses and product lines (inkjet colorants, cesium formate, aerogel and Superior MicroPowders).
Over the past several years, drivers of demand and profitability for the Company have differed by business and product line. Demand for carbon black is driven primarily by vehicle miles driven and general economic conditions which influence the consumption of products that are produced using carbon black. Rubber blacks’ and performance products’ results have been driven by changes in raw material costs, by our ability to obtain sales price increases for our products commensurate with increases in raw material costs and by global and regional capacity utilization. Inkjet colorants’ demand and results have been driven by the use of our pigments by an increasing number of original equipment inkjet printer manufacturers (“OEM”), by more printer launches using our pigments at both new and existing OEM customers and by growth in the inkjet printer cartridge aftermarket. Demand for fumed metal oxides is largely driven by the construction, automotive and electronics industries as well as by general consumer product growth. Fumed metal oxides results have been driven by our traditional silicones and electronics market segments, by growth in developing regions of the world and by global fumed silica capacity utilization. Demand for tantalum is largely driven by the number of electronic devices being produced using tantalum capacitors versus competing materials. Since 2004, sales in the Supermetals Business have been transitioning from principally those under fixed-price, fixed-volume contracts to market-based arrangements. In 2006, sales under these fixed-price contracts accounted for approximately 30% of sales in the Supermetals Business. Profitability for the Business has largely been determined by the terms of these supply contracts, by the cost of ore under our long-term raw materials contracts and by our ability to implement cost reduction initiatives. Cesium formate demand is primarily driven by the level of drilling of high pressure oil and gas wells and by the petroleum industry’s acceptance of our product as a drilling and completion fluid for this application. Results in the Specialty Fluids Business have been driven by the size and type of jobs and by the percentage of our total available fluid being utilized in any given period in our principal North Sea market. Aerogel and Superior MicroPowders are both in their early formative stages and do not currently generate material revenue.
In response to the movement of tire manufacturing from the developed regions of North America and Western Europe to emerging regions of the world, we are concentrating our expansion in these emerging regions to support our customers. As a direct result of these market conditions and general economic growth in emerging regions we commissioned a new carbon black manufacturing facility in China and expanded our carbon black manufacturing capacity in Brazil during 2006. Additionally, we expanded our fumed silica business in emerging regions by commissioning new capacity in China during 2006.
During 2006, we experienced strong demand for all of our principal products. The Carbon Black Business experienced strong volume growth in rubber blacks and inkjet colorants. However, results for this Business were unfavorably impacted by significant increases in raw material costs in rubber blacks and performance products, particularly in the first half of the year, and by lower volumes in performance products due to price increases we implemented in response to these rising raw material costs. In the first quarter, we purchased Showa Denko K.K.’s 50% joint venture interest in Showa Cabot K.K. The rubber blacks product line benefited from the consolidation of the results of that entity during the fiscal year. During the fourth quarter, we announced a number of cost reduction initiatives, including the elimination of approximately 130 positions in sales, manufacturing, technical service and certain functional groups, aimed at reducing the overall costs in the Company, particularly in the carbon black product lines. In the Metal Oxides Business there was a shift in sales volumes within the fumed metal oxides product line, with

decreases in sales to the silicones segment being more than offset by increases in sales to the electronics and niche market segments. Volume growth and high plant utilization in the fumed metal oxides product line more than offset increases in hydrogen and natural gas costs and the continued unfavorable earnings impact of business development efforts in the aerogel product line. The Supermetals Business was unfavorably impacted by lower prices and volumes during the year due to the continuing shift in sales from our long-term fixed-price, fixed-volume contracts to market-based arrangements. During the year, this Business substantially reduced its inventory, in part by curtailing production. While this reduction in inventory was part of our working capital initiative, it led to higher per-unit production costs, which reduced the Business’s earnings. In the second quarter, we entered into a new three-year tantalum ore supply agreement with the Sons of Gwalia that has a higher price for ore than we paid under our prior agreement, but at a significantly reduced annual volume commitment. These negative impacts were partially offset by benefits achieved from previously initiated efforts to reduce the cost structure of the Business. In the Specialty Fluids Business, reduced drilling activity in the North Sea resulted in lower fluid utilization and slightly reduced profitability.
Our consolidated working capital decreased during the year, which increased our operating cash flow. We focused our efforts on improving our overall working capital position in the face of higher raw material costs in the carbon black product lines. As a result of these efforts, we reduced raw material and finished goods inventory levels in rubber blacks and performance products and in the Supermetals Business. Working capital and operating cash flow are discussed in more detail in the cash flow and liquidity section below.
~~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 1) the estimate is complex in nature or requires a high degree of judgment and 2) 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 derive most of our revenues from the sale of rubber blacks, performance products, fumed metal oxides, 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 represents less than ten percent of total revenues, include tolling, servicing and royalties for licensed technology.
Our revenue recognition policies are in compliance with Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”, which establishes criteria that must be satisfied before revenue is realized or realizable and earned. 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. Certain customer contracts contain price protection clauses that provide for the potential reduction in past or future sales prices. We analyze these contract provisions to determine if an obligation related to these clauses exists and record revenue net of any estimated price protection commitments.
Under certain multi-year supply contracts with declining prices and minimum volumes, we recognize revenue based on the estimated average selling price over the contract lives. As of September 30, 2006 and 2005, we had less than $1 million and $1 million, respectively, of deferred revenue related to these supply agreements, representing the difference between the billed price and the estimated average selling price. The deferred revenue is expected to be recognized as customers purchase the contracted minimum volumes through the first quarter of fiscal 2007.
Shipping and handling charges related to sales transactions are recorded as sales revenue when billed to customers or included in the sales price in accordance with Emerging Issues Task Force (“EITF”) 00-10, “Accounting for Shipping and Handling Fees and Costs.” Shipping and handling costs are included in cost of sales.
Our trade receivables are recorded at the invoiced amount and do not bear interest. Certain receivables in China may be settled with bank issued non-interest bearing notes. We periodically sell a portion of these notes receivables in China at a discount. These transactions are accounted for as sales and the difference between the proceeds from the sale and the carrying value of the receivables is recognized as a loss on the sale of receivables.
The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of our accounts receivable and other economic information on both a historical and prospective basis. Additionally, we estimate sales returns based on historical trends in our customers’ product returns. While bad debt write-offs and product returns have not been significant historically, if there is a deterioration of a major customer’s credit-worthiness, actual defaults are higher than our previous experience or actual returns do not reflect historical trends, our estimates of the recoverability of the amounts due to us and our sales would be adversely affected.
~~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 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 $76 million and $73 million higher as of September 30, 2006 and 2005, respectively. The cost of other U.S. and all non-U.S. inventories is determined using the average cost method or the FIFO method.
We review inventory for potential obsolescence recoverability 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 for estimated obsolescence or unsaleable inventory by an amount equal to the difference between the cost of inventory and the estimated market value. In cases where the market value of inventories 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 have a negative impact on gross profit.
~~Stock-based Compensation~~
On October 1, 2005, we adopted FAS No. 123 (R), “Accounting for Stock-Based Compensation”, using the modified prospective method, which results in the provisions of FAS 123(R) being applied to the consolidated financial statements on a going-forward basis. Prior periods have not been adjusted and,

therefore, the financial results for 2006 are not necessarily comparable to the same period in prior years. However, the impact to the prior periods would have been immaterial. FAS 123(R) requires companies to recognize share-based awards granted to employees as compensation expense on a fair value method. Under the fair value recognition provisions of FAS 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the service period, which generally represents the vesting period. We use the Black-Scholes option-pricing model to calculate the fair value of stock options. The fair value of restricted stock is based on intrinsic value. In determining the fair value of share-based awards at the grant date we make judgments with respect to dividends expected to be paid on shares and the number of share-based awards that may be forfeited.
~~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 cash flows. The calculation is sensitive to both the estimated future cash flows and the discount rate. The assumptions used to estimate the discounted cash flows are based on management’s best estimates about selling prices, production and sales volume, 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.
~~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 asset’s 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 asset’s carrying value over its fair value. Our estimated cash flows reflect management’s assumptions about selling prices, production and sales volume, costs and market conditions over an estimate of the remaining useful life of the asset.
33

Overview

Cabot’s strategy focuses on optimizing our core businesses and product lines (rubber blacks, performance products, fumed metal oxides and the Supermetals Business) and investing the cash and intellectual resources they generate in new businesses and product lines (inkjet colorants, aerogel, the Specialty Fluids Business and Superior MicroPowders).

Drivers of demand and key factors impacting our profitability differ by business and product line. Demand for carbon black is driven primarily by vehicle miles driven and general economic conditions that influence the consumption of products that are produced using carbon black. Regional demand is influenced by shifts in demand from mature to emerging markets. Rubber blacks’ and performance products’ results have been driven by changes in raw material costs, by our ability to obtain sales price increases for our products commensurate with increases in raw material costs and by global and regional capacity utilization. Inkjet colorants’ demand and results have been driven by a relative increase of printer platforms using our pigments at both new and existing OEM customers and by the inkjet printer cartridge aftermarket. Over the past several years advances in inkjet technology, including printheads and high efficiency colorants, have enabled inkjet cartridge manufacturers to achieve similar print quality with less ink, leading to a decreased demand for inkjet pigments.

Demand for fumed metal oxides is largely driven by the construction, automotive and electronics industries, by general consumer product growth and by increasing demand for our products in emerging markets. Fumed metal oxides results have been driven by our traditional silicones and electronics market segments, by growth in emerging markets and by global fumed silica capacity utilization.

In the Supermetals Business, 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 high efficiency powders that require a lower volume of tantalum powder to achieve the same capacitance. Since 2004, sales in the Supermetals Business have been transitioning from principally those under fixed-price, fixed-volume contracts to market-based arrangements. This transition was completed in December 2006. In fiscal year 2007, sales under these fixed-price contracts accounted for 14% of sales in the Supermetals Business; this compares to 30% in 2006 and 56% in 2005. Profitability for the Business has largely been determined by the pricing and volume commitments under these supply contracts, by our ability to replace contracted volumes with market-based sales, by the cost of ore under our long-term raw materials supply contract and by our ability to implement cost reduction initiatives.

Cesium formate demand is primarily driven by the level of drilling of high pressure oil and gas wells and by the petroleum industry’s acceptance of our product as a drilling and completion fluid for this application. Results in the Specialty Fluids Business have been driven by the size and type of jobs, by the percentage of our total available fluid being utilized in any given period in our principal North Sea market and by our ability to expand the usage of our fluids outside of the North Sea. Aerogel and Superior MicroPowders are both in early formative stages and do not currently generate material revenue.

During 2007, our Carbon Black Business experienced solid volume growth in rubber blacks and performance products, but was unfavorably impacted by significant weakness in the inkjet colorants’ aftermarket market segment. This volume increase coupled with the positive impact of pricing relative to our raw material costs increased profitability. In the Metal Oxides Business, our fumed metal oxides product line experienced solid volume growth and high plant utilization, including the benefit of operating our fumed silica plant in China, which commenced operations in the second half of 2006. These factors coupled with a reduction in the unfavorable earnings impact from our aerogel product line led the Business to significant increases in profitability. The Supermetals Business was unfavorably impacted by lower prices and volumes during the year and by higher raw material costs under our long term tantalum ore supply contract. During the year, however, this Business continued to reduce its inventory levels, generating $30 million of cash. In the Specialty Fluids Business, increased drilling activity, particularly in the North

Sea, resulted in higher fluid utilization and increased profitability. We also expanded our geographic reach, increasing the number of wells using our fluid outside of the North Sea.

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 1) the estimate is complex in nature or requires a high degree of judgment and 2) 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 derive most of our revenues from the sale of rubber blacks, performance products, fumed metal oxides, 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 terms. 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 represents less than ten percent of total revenues, include tolling, servicing and royalties for licensed technology.

Our revenue recognition policies are in compliance with Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”, which establishes criteria that must be satisfied before revenue is realized or realizable and earned. 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.

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

We offer certain customers cash discounts and volume rebates as sales incentives. The discounts and volume rebates are recorded as a reduction of sales at the time revenue is recognized based on historical experience. Rebates are estimated and recorded based primarily on historical experience and contractual obligations. We review the estimates for discounts and volume rebates, and the assumptions underlying the estimates are modified to reflect changes in facts and circumstances as appropriate. This estimation process introduces some uncertainty as to the amount of revenue we recognize. Refinements to the initial estimates can result in increases or decreases to revenue and thus directly impact our earnings and cash flows. Such changes in our estimates have historically not been material.

The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of our accounts receivable and other economic information on both a historical and prospective basis. Additionally, we estimate sales returns based on historical trends in our customers’ product returns. While bad debt write-offs and product returns have not been significant historically, if there is a deterioration of a major customer’s credit-worthiness, actual defaults are higher than our previous experience or actual returns do not reflect historical trends, our estimates of the recoverability of the amounts due to us and our sales would be adversely affected, which may reduce our earnings.

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”) inventory method. Had we used the first-in, first-out (“FIFO”) inventory method instead of the LIFO method for such inventories, the value of those inventories would have been $95 million and $76 million higher as of September 30, 2007 and 2006, 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 prices, the inventory method we employ can have a significant impact on our profitability. (For example, the significant increase in oil prices recently caused our reported cost of sales in our Carbon Black Business to be higher than they would have been had we used a different inventory valuation method.) 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 ago, which were at lower prices, would instead be the first charged to cost of sales. The opposite result occurs should there be a rapid decline in prices.

We review inventory for potential obsolescence recoverability 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 for estimated obsolescence or unsaleable inventory by an amount equal to the difference between the cost of inventory and the estimated market value. In cases where the market value of inventories 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, additional inventory write-downs may be required, which could reduce our gross profit and our earnings.

Stock-based Compensation

Since October 1, 2005, we have followed the methodology set forth in FAS No. 123 “Share-Based Payments” (“FAS 123(R)”), using the modified prospective approach to account for all of our stock-based awards. Historically, we have issued significantly more shares of restricted stock than stock options under our equity compensation plans. Restricted stock awards, whether accounted for under FAS 123(R) or the previous standard, Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” generally result in a charge to the consolidated statement of operations. Accordingly, the impact of FAS 123(R) on our comparative results over a period of years is not significant. 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.

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 yields 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 management’s best estimates about selling prices, production and sales volume, 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.

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 asset’s 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 asset’s carrying value over its fair value. Our estimated future cash flows reflect management’s 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.

Financial Instruments

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.

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 do not qualify for hedge accounting, we believe that such instruments are closely correlated with the underlying exposure, thus managing the associated risk. We record in earnings the gains or losses from changes in the fair value of derivative instruments that are not accounted for as hedges.

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 generally accepted accounting principles in the United States. 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.

Self-Insurance Reserves

We are partially self-insured for certain third party liability, workers’ compensation and employee health benefits in the United States and Canada. 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. We have accrued amounts equal to the actuarially determined liabilities. The actuarial valuations are 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 in accordance with FAS No. 143, “Accounting for Asset Retirement Obligations” (“FAS 143”), and Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). Pursuant to FAS 143, companies are required to estimate 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. FIN 47 clarified that ARO liabilities and costs must be recognized when the timing and/or settlement can be reasonably estimated. If it is unclear when, or if, an ARO will be triggered, companies are required to use probability weightings for possible timing scenarios to determine the amounts that should be recognized in their 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 a company’s 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 reflects our assumptions about remediation requirements at the contaminated sites, the nature of the remedies, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites, and the number and financial viability of other potentially responsible parties. A portion of the reserve for environmental matters is recognized on a discounted basis, which requires the use of an estimated discount rate and estimates of future cash flows associated with the liability. These liabilities can be affected by the availability of new information, changes in the assumptions on which the accruals are based, unanticipated government enforcement action or changes in applicable government laws and regulations, which could result in higher or lower costs.

Our current estimate of the cost of our share of existing and future respirator liability claims is based on facts and circumstances existing at this time. 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 who contribute to the settlement of respirator claims, (viii) a change in the availability of American Optical’s insurance coverage, and (ix) a determination that our interpretation of the contractual obligations on which we have estimated our share of liability is inaccurate. While we believe the current best estimate is recorded, we cannot determine the impact of these potential developments on our current estimate of our share of liability for these existing and future claims.

Additionally, if the timing of actual payments made for environmental remediation or respirator claims differs significantly from our estimated payment schedules, and we could no longer reasonably predict the timing of such payments, we could then be required to record the reserve amounts on an undiscounted basis on our consolidated balance sheets, causing an immediate impact to our earnings.

Income Taxes

Our business operations are global in nature and we are subject to taxes in numerous jurisdictions. Tax laws and tax rates vary substantially in these jurisdictions and are subject to change given the political and economic climate in those countries. We file our tax returns in accordance with our interpretations of each jurisdiction’s tax laws.

Significant judgment is required in determining our worldwide provision for income taxes and recording the related tax assets and liabilities. In the ordinary course of our business, there are operational decisions, transactions, facts and circumstances, and calculations in which the ultimate tax determination is not certain. Furthermore, our tax positions are periodically subject to challenge by taxing authorities throughout the world. Where appropriate, we reserve for tax matters when we believe that the likelihood of an incremental liability being incurred is probable in accordance with the provisions of FAS No. 5, “Accounting for Contingencies” (“FAS 5”) and FAS No. 109, “Accounting for Income Taxes” (“FAS 109”). Any significant impact as a result of changes in underlying facts, law, tax rates, tax audit, or review could lead to adjustments to our income tax expense, our effective tax rate, or our cash flow. For example, a 1% change in our effective tax rate would change income tax expense for the fiscal year ended September 30, 2007 by approximately $2 million.

Additionally, in accordance with FAS 109 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, 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.

Restructuring Activities

Our consolidated financial statements detail specific charges relating to restructuring activities as well as the actual spending that has occurred against the resulting accruals. Our restructuring charges are estimates based on our preliminary assessments of (1) severance benefits to be granted to employees that are based on known benefit formulas and identified job grades, (2) costs to abandon certain facilities and (3) asset impairments as discussed above under “Valuation of Long-Lived Assets.” Because these accruals are estimates, they are subject to change as a result of deviations from initial restructuring plans or if new information comes to our attention, 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 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

In February 2007, the Financial Accounting Standards Board (“FASB”) issued FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. FAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. FAS 159 is effective for fiscal years beginning after November 15, 2007, which will be fiscal 2009 for us. We are evaluating the impact of FAS 159 on our consolidated financial statements.

In September 2006, the FASB issued FAS No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 provides guidance for using fair value to measure assets and liabilities and requires additional disclosure about the use of fair value measures, the information used to measure fair value, and the effect fair-value measurements have on earnings. The primary areas in which we utilize fair value measures are valuing pension plan assets and liabilities, valuing hedge-related derivative financial instruments, allocating purchase price to the assets and liabilities of acquired companies, and evaluating long-term assets for potential impairment. FAS 157 does not require any new fair value measurements. FAS 157 is effective for us beginning October 1, 2008. We are evaluating the impact of FAS 157 on our consolidated financial statements.

In September 2006, the FASB issued FAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)”

(“FAS 158”). FAS 158 requires an employer to recognize the funded status of its benefit plans, measured as the difference between plan assets at fair value and the projected benefit obligation, in its consolidated balance sheets. FAS 158 also requires an employer to measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year end. As of September 30, 2007, we adopted the balance sheet impact of reflecting the funded status of our plan using the current June 30 measurement date. As required by FAS 158, on or before September 30, 2009, we will change our measurement date to our September 30 year end rather than the current June 30 measurement date. We are continuing to evaluate the impact of the adoption of the change in measurement date related to the second part of FAS 158 on our consolidated financial statements.

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109” (“FIN 48”), which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its consolidated financial statements uncertain tax positions that the company has taken or expects to take on a tax return, including a decision whether or not to file a return in a particular jurisdiction. Under this new guidance, the consolidated financial statements will reflect expected future tax consequences of such positions presuming the taxing authorities’ full knowledge of the position and all relevant facts, but without considering the time value of money. This guidance also revises disclosure requirements and introduces a prescriptive annual, tabular roll-forward of unrecognized tax benefits. FIN 48 is effective for annual periods beginning after December 15, 2006, which will be fiscal 2008 for us. We are continuing to evaluate the impact of FIN 48 on our consolidated financial statements, however a preliminary evaluation indicates that we will record an additional liability in the range of $10 million to $20 million through the consolidated statements of stockholders’ equity in the first quarter of fiscal 2008.

Results of Operations

Cabot is organized into four reportable segments: the Carbon Black Business, the Metal Oxides Business, the Supermetals Business, and the Specialty Fluids Business. The Carbon Black Business is comprised of the rubber blacks, performance products and inkjet colorants product lines as well as the business development activities of Cabot Superior MicroPowders (“CSMP”). The Metal Oxides Business is comprised of the fumed metal oxides and aerogel product lines.

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.

Fiscal Year 2007 compared to Fiscal Years 2006 and 2005—Consolidated

Net Sales and Gross Profit


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Net Sales	$	2,616	$	2,543	$	2,125
Gross Profit	$	505	$	419	$	433

The $73 million increase in sales in 2007 compared to 2006 was primarily due to higher volumes ($52 million) and the positive effect of foreign currency translation on our selling prices ($79 million), principally resulting from the weakening of the U.S. dollar against the Euro. These factors were partially offset by lower pricing ($44 million), principally resulting from the feedstock related pricing mechanism in our rubber blacks contracts and the transition from contracted to market-based sales in the Supermetals Business. Additionally, we had $25 million of revenue related to our transportation of a third party’s cargo in 2006 that did not reoccur in 2007. In 2006, the $418 million increase in sales compared to 2005 was primarily due to higher volumes ($38 million); higher pricing, principally to keep pace with rising carbon black feedstock costs ($246 million); and the favorable impact of consolidating the results of Cabot Japan ($118 million).

Our gross profit margin was 19% in 2007, 16% in 2006 and 20% in 2005. Gross profit increased in 2007 as the impact of higher volumes and lower relative raw material costs more than offset lower pricing. Gross profit decreased in 2006 compared to 2005 primarily due to higher raw material costs and a $27 million payment made to the Sons of Gwalia. These factors were partially offset by higher prices from feedstock related price increases in rubber blacks and performance products.

Selling and Administrative Expense


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Selling and Administrative Expense	$	249	$	235	$	240

The $14 million increase in selling and administrative expense in 2007 compared to 2006 was primarily due to payments associated with settlements of certain carbon black antitrust litigation ($11 million), which were recorded in the consolidated statement of operations as selling and administrative expense, and the unfavorable impact of foreign currency translation. The $5 million decrease in expense in 2006 compared to 2005 was primarily due to lower administrative costs, principally in our Supermetals Business, and a reduction of costs associated with the implementation of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. These savings were partially offset by increased spending on initiatives aimed at standardizing our transactional processes and administering certain functional activities through a shared services model.

Research and Technical Expense


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Research and Technical Expense	$	69	$	58	$	59

The $11 million increase in research and technical expense in 2007 compared to 2006 is due primarily to increased spending associated with new business development opportunities ($7 million combined), including: (i) investments in the development of pigments to serve the high speed inkjet market, (ii) the development activities of CSMP, and (iii) increased spending in our rubber blacks and performance products product lines. In addition, research and technical expense in 2007 includes the acquisition of $4 million of in-process research and development technology in the Supermetals Business. The $1 million decrease in 2006 compared to 2005 was primarily due to reduced research and technical spending in the Supermetals Business partially offset by increased spending for CSMP.

Interest and Dividend Income


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Interest and Dividend Income	$	10	$	5	$	6

Interest and dividend income increased by $5 million in 2007 when compared to 2006 due primarily to higher cash balances available for interest earning investments. Interest and dividend income decreased by $1 million in 2006 compared to 2005 due to lower cash available for interest earning investments, primarily in the first half of 2006, and the liquidation of marketable securities in the first quarter of 2006.

Interest Expense


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Interest Expense	$	34	$	27	$	29

Interest expense increased by $7 million in 2007 compared to 2006 primarily driven by a reduction in capitalized interest on capital projects in 2007 (approximately $2 million), the effect of the appreciation of the Euro (approximately $2 million) and an increase in our debt level during the year (approximately $2 million), principally to fund working capital requirements in China. The $2 million decrease in interest expense in 2006 compared to 2005 was due to the repayment of debt in the U.S. that matured in December 2005, and to the capitalization of interest related to the construction of our new facilities in China and the expansion of our existing carbon black facility in Brazil.

Other Income (Charges)


	Years Ended September 30
	2007		2006			2005
	(Dollars in millions)
Other Income (Charges)	$	5	$	(7	)	$	7

The $12 million increase in other income was primarily due to foreign currency translation gains of approximately $8 million. The $14 million decrease in other income in 2006 was primarily due to foreign currency transaction losses, including a charge of $8 million for the recognition of cumulative foreign currency translation adjustments related to the substantial liquidation of the legal entity through which we had conducted carbon black operations in Altona, Australia.

Benefit (Provision) for Income Taxes


	Years Ended September 30
	2007			2006			2005
	(Dollars in millions)
Benefit (Provision) for Income Taxes	$	(38	)	$	(9	)	$	45
Tax Rate on Income (Loss) from Continuing Operations		23	%		9	%		(48	)%

The provision for income taxes was $38 million for fiscal 2007, resulting in an overall 23% tax rate on income from continuing operations. Excluding $3 million in tax benefits resulting from the settlement of various tax audits, our tax rate would have been approximately 25% for fiscal 2007. Our tax rate varies from the U.S. statutory rate of 35% for a variety of reasons. For example, our legal entity structure provided us with a benefit of approximately $16 million (or 10%) from the U.S. statutory rate owing primarily to the recognition of income in jurisdictions with lower tax rates. In addition, we benefited from approximately $4 million (or 2%) of research and experimentation credits.

The provision for income taxes was $9 million for fiscal 2006, resulting in an overall 9% tax rate on income from continuing operations. Excluding $18 million in tax benefits resulting from the settlement of various tax audits, $3 million in tax benefit from the permanent reinvestment of prior year earnings of a non-U.S. subsidiary, and an $8 million translation charge for the substantial liquidation of our Australian entity that was not tax benefited, our tax rate would have been approximately 29%. Our legal entity structure decreased the amount of tax expense from the U.S. statutory rate by approximately $10 million (or 10%).

The benefit for income taxes was $45 million for fiscal 2005, resulting in a 48% overall tax rate on loss from continuing operations. Excluding the $23 million tax settlement in the fourth quarter and the $90 million goodwill impairment and $121 million long-lived asset impairment charges related to the Supermetals Business in the second and fourth quarters, respectively, our tax rate would have been approximately 19% for fiscal 2005. Our legal entity structure decreased the amount of tax expense from the U.S. statutory rate by approximately $15 million (or 13%). In addition, we recorded tax benefits of $7 million (or 6%) for U.S. research and experimentation credits and export incentives.

In the normal course of business, the tax filings of Cabot and its subsidiaries are examined by various tax authorities, including the Internal Revenue Service (“IRS”). The IRS is currently examining our 2003 and 2004 tax years. We have filed our tax returns in accordance with the tax laws in each jurisdiction and maintain tax reserves for differences between tax obligations as reflected in our tax filings and potential final tax obligations for exposures that can be reasonably estimated. If actual results are significantly different from these estimates, our provision for income taxes could be significantly impacted.

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 2008 which may impact our tax rate in the periods during which these settlements occur.

We expect our tax rate (that which reflects our fundamental tax structure) for fiscal 2008 to be between 26% and 29%, before the results of several ongoing audits.

Equity in Net Income of Affiliates

Our share of earnings from equity affiliates was $12 million in fiscal 2007, 2006 and 2005, as increased earnings from our affiliates in Mexico, Venezuela and Malaysia have offset the equity earnings of Cabot Japan, which is now consolidated. In November 2005 we began consolidating the results of Cabot Japan as a wholly owned entity as a result of acquiring our joint venture partner’s, Showa Denko K.K.’s, 50% interest in that entity.

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 relating to legal and tax settlements, offset by a charge of less than $1 million for legal settlements. During fiscal 2006, we recorded income of $2 million ($0.03 per diluted common share) relating to favorable tax settlements. We did not record income or charges related to discontinued operations in 2005.

Net Income (Loss)

We reported net income for 2007 of $129 million ($1.90 per diluted common share) compared to net income of $88 million ($1.28 per diluted common share) in 2006 and a net loss of $48 million (a loss of $0.84 per common share) in 2005.

Fiscal Year 2007 compared to Fiscal Years 2006 and 2005—By Business Segment

The following discussion of our results includes information on our reportable segment sales and operating profit before taxes (“PBT”). We use segment PBT to measure our consolidated operating results and to assess segment performance. This discussion has been prepared on a basis consistent with segment reporting as outlined in Note U of the Consolidated Financial Statements. (Refer to Note U of the Consolidated Financial Statements for a definition of segment PBT and additional segment information.) When explaining the changes in our PBT period on period, we use several terms. The term “fixed costs” means fixed manufacturing costs, including utilities. The term “inventory related charges” means differences attributable to items such as (i) inventory obsolescence and valuation reserves; (ii) the impact of varying utilization rates on inventory costs; and (iii) other increases or decreases in costs associated with the production of inventory. The term “product mix” refers to the various types and grades of products sold by a particular business or product line during a period, and the positive or negative impact of that mix on the variable margin and profitability of the business or product line.

Total segment PBT, the aggregate of certain items and other unallocated items, and income from continuing operations before income taxes for fiscal years 2007, 2006 and 2005 are set forth in the table below. The details of certain items and other unallocated items are shown in Note U of our Consolidated Financial Statements. These items are not included in segment PBT.

   Years Ended September 30
   2007 2006 2005
   (Dollars in millions)
Total segment PBT
   $ 232 $ 180 $ 179

Certain items
   (34 ) (51 ) (242 )
Other unallocated items
   (30 ) (32 ) (30 )

Income from continuing operations before income taxes
   $ 168 $ 97 $ (93 )

The $52 million increase in total segment PBT in 2007 was primarily driven by higher volumes ($26 million) and the favorable impact of pricing relative to our raw material costs (net favorable impact of $24 million). The $1 million increase in total segment PBT in 2006 compared to 2005 primarily relates to higher volumes in our principal product lines ($21 million); lower manufacturing, administrative and fixed costs ($40 million combined); and the favorable impact of our acquisition and consolidation of the results of Cabot Japan ($12 million). These factors were partially offset by the unfavorable impact of raw material costs relative to pricing ($74 million).

Other unallocated items

Details of other unallocated items for fiscal years 2007, 2006 and 2005 are shown below and in Note U of our Consolidated Financial Statements. These items are not included in segment PBT.


	Years Ended September 30
	2007			2006			2005
	(Dollars in millions)
Interest expense	$	(34	)	$	(27	)	$	(29	)
Equity in net income of affiliated companies		(12	)		(12	)		(12	)
Foreign currency transaction gains (losses)		8			(2	)		2
Other unallocated income		8			9			9

Total other unallocated items	$	(30	)	$	(32	)	$	(30	)

Carbon Black Business

Segment sales and PBT for the Carbon Black Business for fiscal years 2007, 2006 and 2005 are as follows:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Segment Sales	$	2,005	$	1,917	$	1,490
Segment PBT	$	156	$	101	$	94

The $88 million increase in sales in the Carbon Black Business in 2007 compared to 2006 was primarily due to stronger volumes ($63 million) in the rubber blacks and performance products product lines and the positive effect of foreign currency translation on our rubber blacks’ and performance products’ selling prices ($72 million), which was principally related to the weakness of the U.S. dollar against the Euro. These factors were partially offset by lower pricing ($24 million) from the feedstock related pricing mechanism in our rubber blacks contracts. Additionally, we experienced $25 million of revenue associated with our transportation of cargo for a third party in 2006 that did not reoccur in 2007. In 2006, the $427 million increase in sales in the Carbon Black Business from 2005 was primarily due to higher selling prices associated with feedstock driven price increases ($284 million), the favorable impact of our acquisition and consolidation of the results of Cabot Japan ($118 million), higher volumes in rubber blacks and inkjet colorants ($22 million) and the positive impact of foreign currency translation ($7 million).

The $55 million increase in PBT in the Carbon Black Business in 2007 compared to 2006 is primarily due to the positive impact of pricing relative to our raw material costs (net favorable impact of $50 million) in the rubber blacks and performance products product lines, and higher volumes ($20 million). The Business experienced higher fixed costs ($12 million) associated with operating manufacturing units for the full year of 2007 that were not fully operational in 2006, including increased capacity in our inkjet colorants product line to serve the high speed market that was not fully utilized during the year. Additionally, higher technical expenses, principally from increased investment in new business development activities unfavorably impacted the Business during 2007 ($4 million). The $7 million increase in PBT in the Carbon Black Business in 2006 compared to 2005 was primarily due to strong demand in our rubber blacks and inkjet colorants product lines leading to higher volumes ($11 million), the positive effects of our acquisition and consolidation of the results of Cabot Japan ($12 million) and the positive impact of inventory related charges ($9 million). These factors were partially offset by raw material cost increases, principally in our rubber blacks product lines, that could not be fully offset by price increases (net unfavorable impact of $8 million); higher selling, technical and administrative costs ($10 million); higher costs associated with our CSMP business development activities; and an increase in fixed costs ($6 million), including those associated with new production capacity in our inkjet colorants product line that was not fully commercially utilized.

Product Line Sales Summary

The following table sets forth sales by product line for the Carbon Black Business for fiscal years 2007, 2006 and 2005:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Rubber blacks	$	1,416	$	1,378	$	976
Performance products		541		488		469
Inkjet colorants		46		47		39
CSMP		2		4		6

Total Carbon Black Business Sales	$	2,005	$	1,917	$	1,490

Rubber blacks

Volumes grew by 4% during 2007 due principally to growth in China and other emerging markets more than offsetting weakness in the North American region. During the year we announced our intention to close our Waverly, West Virginia carbon black manufacturing plant as a result of declining demand driven by weakness in the North American tire industry. During 2007 performance in the business improved due to strong volumes, the impact of previously announced cost reduction efforts and increased prices on our non-contracted business. Despite a feedstock related benefit in the first half of the fiscal year, the time lag of the feedstock related pricing mechanism on our contracted business negatively impacted performance during the second half of the year. During 2006 strong volumes and price increases in both our contracted and non-contracted business offset higher feedstock and natural gas costs allowing us to maintain relatively stable unit margins. Additionally, the results of Cabot Japan had a positive impact on the product line in 2006.

In order to adjust for changes in feedstock costs and maintain margins over time, we have pricing formulas in our annual and long-term supply contracts. Most of our contracts provide 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. The feedstock adjustments are calculated in the month prior to the beginning of the three-month period in which the price change is effective, and typically are based upon the average of a relevant index over the prior three-month period. Because of these provisions, there is a lag between the time when we incur raw material costs and the time when changes in those costs are reflected in the contract pricing. In periods of volatility in feedstock costs, this lag can cause fluctuations in our financial results, as has been the case over the past few years.

Performance products

In 2007, volumes increased by 2% compared to 2006 due to strong demand. The performance of the product line was favorably impacted by price increases during the year in the face of rising feedstock costs. During 2006, volumes decreased by 5% primarily due to a decline in volume in our lower margin, non-contracted business resulting from price increases we implemented to respond to rising raw material costs. The profitability of the product line was negatively impacted by higher raw material and energy costs and by the unfavorable impact of foreign currency translation adjustments.

During fiscal 2007, we completed the construction of a performance products manufacturing unit at our plant in Tianjin, China with a nameplate capacity of approximately 20,000 metric tons. The unit became operational in September 2007.

Inkjet colorants

Inkjet colorants volumes declined by 4% in 2007 compared to 2006. The product line experienced increased demand in the OEM segment of the small office, home office (SOHO) market and in the high speed market segment. These increases were not enough, however, to offset significant weakness in the aftermarket segment of the SOHO market. The aftermarket has been unfavorably impacted by aggressive competition from the OEM cartridge manufacturers and by improved ink efficiencies, which has led to the use of less ink per cartridge, depressing demand. Volumes for 2006 increased by 36% when compared to 2005, with growth in both the OEM and aftermarket segments. The favorable impact of volume increases was partially offset by a decrease in our average selling price due to the continued shift from experimental stage pricing levels to prices more consistent with commercial sales and some lower selling prices as the business matures. Additionally, higher fixed costs resulting from new production capacity that was not fully commercially utilized unfavorably impacted the product line during both the second half of 2006 and the first half of 2007.

During fiscal 2007, we completed the debottlenecking of our manufacturing unit for the production of colorants to serve the high speed inkjet market. The capacity became operational in the fourth quarter of 2007.

Superior MicroPowders

During fiscal 2007, we continued to make progress on various new business development opportunities particularly in the security inks, catalyst and fuel cell areas. The decrease in sales in CSMP from 2005 through 2007 was due to a transition from government sponsored work to commercial sales.

Outlook for 2008

We anticipate carbon black demand to remain strong in all regions outside of North America, where we remain concerned about lower rubber blacks demand because of continued weakness in the tire industry. We also expect continued strong demand in our performance products product line supported by added volume from our new capacity in China. We are cautious with regard to the impact of rising raw material costs on our rubber blacks and performance products product lines. In the inkjet colorants product line, we believe that there will be an eventual recovery in the aftermarket segment, although the timing and magnitude of such a recovery are uncertain. We anticipate continued volume growth for our products that serve the high speed market segment, although we continue to expect growth in this developing market to be slow at first.

Metal Oxides Business

Segment sales and PBT for the Metal Oxides Business for fiscal years 2007, 2006 and 2005 are as follows:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Segment Sales	$	271	$	254	$	231
Segment PBT	$	36	$	22	$	16

Sales in the Metal Oxides Business increased by $17 million in 2007 compared to 2006 due primarily to higher volumes ($11 million) and the positive impact of foreign currency translation, principally related to the Euro and British pound sterling, on our selling prices ($8 million). In 2006, the $23 million increase in sales in the Metal Oxides Business compared to 2005 was primarily due to higher volumes ($20 million) and a favorable product mix ($3 million) partially offset by the unfavorable impact of foreign currency translation ($2 million).

PBT increased by $14 million during 2007 compared to 2006 due primarily to higher volumes ($8 million) and lower raw material costs ($8 million), partially offset by an unfavorable product mix ($2 million). The $6 million increase in PBT in 2006 in the Metal Oxides Business compared to 2005 was principally due to strong demand in our fumed silica business leading to higher sales volumes ($14 million), which more than offset higher costs ($8 million), principally due to rising energy prices.

Product Line Sales Summary

The following table sets forth sales by product line for the Metal Oxides Business for fiscal years 2007, 2006 and 2005:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Fumed metal oxides	$	270	$	253	$	231
Aerogel		1		1		—

Total Metal Oxides Business Sales	$	271	$	254	$	231

Fumed metal oxides

The fumed metal oxides product line had a strong 2007 with demand driving a 5% increase in volumes compared to 2006. Additionally, the product line benefited from lower hydrogen and natural gas costs and from the incremental margin associated with operating our manufacturing capacity at high utilization rates during the year, including our new capacity in China. During 2006, the fumed metal oxides product line saw a 9% increase in overall volumes driven by growth in the electronics and niche market segments, which more than offset a decline in volumes in the silicones market segment. This volume growth and strong plant utilization more than offset higher hydrogen and natural gas costs during the year.

Aerogel

During the first fiscal quarter of 2007 we temporarily ceased production at our semi-works facility in Frankfurt, Germany in an effort to reduce costs and inventory levels. As a result of these efforts, as well as modestly increased volumes in the daylighting market segment, the product line reduced its unfavorable impact on PBT from $21 million in 2006 to $16 million in 2007.

In May 2006, we entered into a cross license agreement with Aspen Aerogel, Inc. (“Aspen”) where each party granted certain patent rights to the other. In consideration for use of the patents granted by Cabot, the agreement called for us to receive a total of $8 million of cash in ten equal semi-annual payments beginning on September 1, 2006 and the right to receive equity in Aspen. During the first quarter of fiscal

2007, a dispute arose between the parties over the equity consideration. During the fourth quarter of fiscal 2007, Cabot and Aspen entered into a settlement agreement whereby the equity payment by Aspen to Cabot was eliminated. Under the amended license agreement, we are entitled to payments totaling $38 million. We received $2 million and $1 million in fiscal 2007 and 2006, respectively, of installment payments which have been recorded in earnings. The remaining $35 million is payable in installments over the next six years, and will be recognized in earnings if and when collectibility is reasonably assured.

Outlook for 2008

We anticipate demand for our fumed metal oxides products to remain strong, leading to highly utilized manufacturing capacity during the year. As a result of this strong demand, we are exploring the possibility of further expansion in emerging regions. We continue to work on market development in the aerogel product line.

Supermetals Business

Segment sales and PBT for the Supermetals Business for fiscal years 2007, 2006 and 2005 are as follows:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Segment Sales	$	233	$	292	$	346
Segment PBT	$	15	$	41	$	52

Over the past several years, both sales and PBT in the Supermetals Business have been unfavorably impacted by the transition from fixed volume, fixed price contracts to market based arrangements, leading to lower prices and volumes. This transition was completed in December 2006 and since then the Supermetals Business has sold its products under market based arrangements. Sales in the Supermetals Business decreased by $59 million in 2007 compared to 2006 and by $54 million in 2006 compared to 2005. Lower tantalum volumes unfavorably impacted sales by $37 million from 2006 to 2007 and by $4 million from 2005 to 2006. Lower tantalum pricing unfavorably impacted sales by $28 million from 2006 to 2007 and by $50 million from 2005 to 2006.

The $26 million and $11 million decrease in PBT in the Supermetals Business from 2006 to 2007 and 2005 to 2006, respectively, was also heavily influenced by the contract transition. The lower volumes unfavorably impacted the Business by $13 million when comparing 2007 to 2006 and by $4 million when comparing 2006 to 2005; the unfavorable impact of lower pricing was $28 million from 2006 to 2007 and $50 million from 2005 to 2006. Cost reduction initiatives undertaken in 2005 favorably impacted manufacturing and administrative costs by $2 million in 2007 compared to 2006 and by $18 million in 2006 compared to 2005. Lower fixed costs benefited the Business results by $22 million in 2007 compared to 2006 and by $36 million in 2006 compared to 2005.

During 2006, we settled our dispute with the Sons of Gwalia over the price we were to pay for tantalum ore under a then existing supply agreement and entered into a new three-year tantalum ore supply agreement incorporating a reduced term. This agreement significantly reduced annual volume commitments but increased prices compared to the prior agreement. In 2006 we made a lump sum payment of $27 million to terminate the prior supply and other related agreements. Higher ore costs impacted the Business by $7 million in 2007 compared to 2006 and by $8 million in 2006 compared to 2005.

During 2005, the Supermetals Business recorded charges associated with the impairment of its long-lived assets (including goodwill) totaling $211 million. Additionally, during 2005, the Supermetals Business recorded a charge of $15 million associated with on-going cost reduction initiatives, including $8 million of asset write-downs associated with management’s decision to stop manufacturing and selling finished tantalum sputtering targets, $3 million of charges related to severance arrangements and $3 million of charges associated with the write-down of assets related to abandoned research and development projects.

Outlook for 2008

Going forward into 2008, sales in the Supermetals Business will no longer benefit from our fixed price and volume supply contracts. The market for tantalum products faces volatility in the coming year due, in part, to ownership changes of both our largest competitor and the largest supplier of raw materials in the industry. We are experiencing an increasingly competitive marketplace, which could unfavorably impact profitability. In addition, our existing long-term raw material contract, which serves a portion of our needs, expires at the end of December 2008. The cost of additional raw material purchases during the year and beyond is uncertain.

Specialty Fluids Business

Segment sales and PBT for the Specialty Fluids Business for fiscal years 2007, 2006 and 2005 are as follows:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Segment Sales	$	58	$	44	$	40
Segment PBT	$	25	$	16	$	17

The $14 million increase in sales and $9 million increase in PBT during 2007 compared to 2006 was due to an increase in the number of wells using our fluid during the year, both inside and outside the North Sea area. During the year our fluid was used in 31 wells, six of which were outside of the North Sea, compared to 23 wells in 2006, two of which were outside of the North Sea. In 2006, reduced drilling activity in the North Sea decreased PBT by $1 million compared to 2005. Sales increased, however, by $4 million due to a larger percentage of losses by one customer using our fluid, resulting in a higher volume of fluid sold.

Outlook for 2008

We continue to work on market development activities outside of the North Sea. As a result of our success during 2007 and our increased investment in marketing our products outside of the North Sea, we are optimistic about the continued geographic expansion of the Business.

Cash Flow and Liquidity

Overview

Our cash and cash equivalents balances decreased by $35 million during fiscal 2007, from $189 on September 30, 2006 to $154 million on September 30, 2007. In fiscal 2006, these balances increased by $8 million, from $181 million on September 30, 2005 to $189 million on September 30, 2006. The following descriptions of the reasons for these changes in our cash balances refer 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 $309 million in fiscal year 2007 compared to $252 million in fiscal 2006. The positive cash flow was primarily generated from strong net income. While there were no significant working capital movements in 2007, cash flows in 2006 were (i) negatively impacted by an increase in receivables attributable to feedstock related price increases; and (ii) favorably impacted by inventory reductions in the Supermetals and Carbon Black segments, where we reduced finished product and raw material inventory quantities to offset the escalation in the feedstock costs.

Cash Flows from Investing Activities

Cash flows from investing activities consumed $143 million of cash in fiscal year 2007 compared to $165 million in fiscal 2006. Capital expenditures in fiscal 2007 of $141 million included the initial expenditures related to the construction of energy centers at three of our carbon black facilities and spending to complete the on-going construction of our rubber blacks and performance products units in China. During fiscal 2006, capital expenditures included the new rubber blacks, performance products and fumed metal oxides facilities in China and capacity expansion in our inkjet colorants product line in the U.S. and our rubber blacks manufacturing unit in Brazil. Additionally, during fiscal 2006, we purchased the remaining 50% equity interest in Cabot Japan that we did not previously own for $19 million in cash plus other consideration as discussed in Note B. Capital expenditures for fiscal 2008 are expected to be approximately $225 million compared to $141 million for fiscal 2007.

During 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 are 20 years and longer. During fiscal 2006, we had purchases of $20 million and proceeds of $56 million primarily related to these auction rate securities.

Cash Flows from Financing Activities

Cash flows from financing activities consumed $211 million in fiscal 2007 compared to $82 million in fiscal 2006. In both years, financing cash flows were primarily driven by changes in our debt position, dividend payments, and repurchases of our common stock. In 2007, proceeds from long-term debt provided $72 million, offset by repayments of $48 million. In addition, $48 million of dividend payments were made in 2007. These dividends were partially offset by proceeds from sales of common stock of $9 million in connection with employee stock option exercises and from sales of restricted stock, and net borrowings of $7 million from notes payable. In 2006, a portion of the change in debt was related to the assumption of debt from Cabot Japan, where we consolidated $26 million of debt when we increased our ownership interest from 50% to 100%. We repaid $25 million of this debt during fiscal 2006.

During fiscal year 2007, we repurchased approximately 4.6 million shares of our common stock on the open market for a total cost of $190 million. As of September 30, 2007, we have approximately 5.5 million shares remaining for repurchase under the Board of Directors’ share repurchase authorization. Additionally, we repurchased approximately 277,000 shares from employees who sold us shares to satisfy tax withholding obligations for a cost of approximately $11 million and approximately 119,000 forfeited shares under our equity incentive plans for a cost of approximately $1 million.

Additionally, we entered into a $5 million loan agreement with the Commonwealth of Pennsylvania related to waste water improvements at one of our sites. As of September 30, 2007, we drew down approximately $3 million against that agreement.

As of September 30, 2007, our long-term debt obligations totaled $518 million, of which $15 million is current. The current portion includes $11 million of debt in China.

In 2007, 2006 and 2005, we paid cash dividends on our common stock of $0.72, $0.64 and $0.64, respectively, per share of common stock.

We are not involved in any transactions, arrangements or other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of or requirements for capital resources. We are not involved in any trading activities involving commodity contracts that are accounted for at fair value.

Off-balance sheet arrangements

Cabot has no material transactions that meet the definition of an off-balance sheet arrangement.

Contractual Obligations

The following table sets forth our long-term contractual obligations which are described in greater detail below.


	Payments Due by Fiscal Year
	2008		2009		2010		2011		2012		Thereafter		Total
	(Dollars in millions)
Contractual Obligations
Purchase commitments	$	285	$	190	$	128	$	111	$	98	$	731	$	1,543
Long-term debt⁽¹⁾		15		38		159		25		40		241		518
Fixed interest on long-term debt⁽³⁾		18		18		17		15		13		38		119
Variable interest on long-term debt⁽²⁾⁽³⁾		10		9		5		3		3		1		31
Operating leases		25		20		13		12		8		39		117

Total	$	353	$	275	$	322	$	166	$	162	$	1,050	$	2,328

The fair values of long-term investments are dependent on the financial performance of the entities in which the Company invests and the external factors inherent in the markets in which they operate. We consider these factors as well as the forecasted financial performance of the investment entities when assessing the potential impairment of these investments.

~~Financial Instruments~~

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. The fair values of our long-term debt and 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 balance sheet at fair value. The changes in the fair value of derivatives are recorded in earnings or other comprehensive income, based on whether the instrument is designated as part of a hedge transaction and, if so, 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 in the current period. 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 in earnings the gains or losses from changes in the fair value of derivative instruments that are not designated as hedges.

~~Pensions and Other Postretirement Benefits~~

We maintain both defined benefit and defined contribution plans for our employees. In addition, we provide certain health care and life insurance benefits for 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 general economic conditions, including interest rates, expected return on plan assets, and the rate of compensation increases for employees. Projected health care benefits reflect our assumptions about health care cost trends. The cost of providing plan benefits also depends on participant demographic assumptions including assumptions regarding retirements, mortality, employee turnover and plan participation levels. 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~~

Cabot is 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 have an adverse effect on the results of operations.

The most significant reserves that we have established are for environmental remediation and respirator litigation claims. As of September 30, 2006, we had $13 million reserved for various environmental matters. The amount accrued reflects our assumptions about remediation requirements at the contaminated sites, the nature of the remedies, the outcome of discussions with regulatory agencies and other potentially responsible parties at multi-party sites and the number and financial viability of other potentially responsible parties. A portion of the reserve for environmental matters is recognized on a discounted basis, which requires the use of an estimated discount rate and estimates of future cash flows associated with the liability. These liabilities can be affected by the availability of new information, changes in the assumptions on which the accruals are based, unanticipated government enforcement action or changes in applicable government laws and regulations, which could result in higher or lower costs.

As of September 30, 2006, we also had $18 million accrued for respirator liability 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) a continuation in the recent trend of dismissals without payment of pending silica and non-malignant asbestos claims that began this year, (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 who contribute to the settlement of respirator claims, and (viii) a determination that our interpretation of the contractual obligations on which we have estimated our share of liability is inaccurate. While we believe the current best estimate is recorded, 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.

~~Income Taxes~~

We estimate our income taxes in each jurisdiction in which we are subject to tax. This process involves estimating the tax exposure for differences between actual results and estimated results and recording the amount of income taxes payable for the current year and deferred tax assets and liabilities for future tax consequences. A valuation allowance is established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. We evaluate the realizability of our net deferred tax assets on a quarterly basis and valuation allowances are provided as required. In making this assessment, we are required to consider all available positive and negative evidence to determine whether, based on such evidence, it is more likely than not that some portion or all of our net deferred assets will be realized in future periods. This assessment requires significant judgment. In addition, we have made significant estimates involving current and deferred income taxes. We analyze our tax positions and do not recognize current and future tax benefits until it is deemed probable that the tax positions will be sustained in the respective tax jurisdictions.

We have filed our tax returns in accordance with our interpretations of each jurisdiction’s tax laws and have established reserves for potential differences in interpretation of those laws. In the event that actual results are significantly different from these estimates, our provision for income taxes could be significantly impacted. A 1% change in the effective tax rate would change income tax expense for the fiscal year ended September 30, 2006 by approximately $1 million.

~~Significant Accounting Policies~~

~~are as difficult or subjective to measure. However, these policies are important to an understanding of the consolidated financial statements.~~

~~Results of Operations~~

Cabot is organized into four reportable segments: the Carbon Black Business, the Metal Oxides Business, the Supermetals Business (“CSM”), and the Specialty Fluids Business (“CSF”). The Carbon Black Business is comprised of the rubber blacks, performance products and inkjet colorants product lines as well as the business development activities of Cabot Superior MicroPowders (“CSMP”). The Metal Oxides Business is comprised of the fumed metal oxides and aerogel product lines.

Our analysis of financial condition and operating results should be read in conjunction 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.

~~Fiscal Year 2006 compared with Fiscal Years 2005 and 2004—Consolidated~~

~~Net Sales and Gross Profit~~

Years Ended September 30

2006

2005

2004

(Dollars in millions)

Net Sales

$
2,543

$
2,125

$
1,934

Gross Profit

$
419

$
433

$
477

The $418 million increase in sales in 2006 was primarily due to higher volumes ($38 million), higher pricing ($246 million) and the favorable impact of consolidating the results of Cabot Japan ($83 million). These factors were partially offset by the negative impact of foreign currency translation adjustments ($2 million). In 2005, the $191 million increase in sales when compared to fiscal 2004 was due to higher volumes ($104 million), higher pricing ($36 million) and the positive impact of foreign currency translation adjustments ($47 million).

Gross margin was 16% in 2006, 20% in 2005 and 25% in 2004. Gross profit decreased in 2006 primarily due to higher raw material costs in the rubber blacks and performance products product lines of the Carbon Black Business, lower prices and higher ore costs in the Supermetals Business, and a $27 million payment made to the Sons of Gwalia to terminate the then existing supply and other related agreements. These factors were partially offset by higher prices from feedstock related price increases in rubber blacks and performance products. The decrease in gross profit in 2005, when compared to 2004, primarily resulted from higher raw material costs in rubber blacks and performance products and lower prices in the Supermetals Business. These factors were partially offset by higher prices from feedstock related price increases in rubber blacks and performance products.

~~Selling and Administrative Expense~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Selling and Administrative Expense

$
235

$
240

$
217

The $5 million decrease in expense in 2006 compared to 2005 was primarily due to lower administrative costs ($11 million), principally in the Supermetals Business, including savings associated with our shared services initiative. Additionally, we experienced a reduction of costs associated with the implementation of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 ($3 million). These savings were partially offset by increased spending on our business process excellence (“BPE”) and shared

services initiatives, which are aimed at standardizing our transactional processes and administering certain functional activities through a shared services model ($9 million). The $23 million increase in 2005 compared to 2004 was primarily due to planned increases in personnel costs ($2 million), incremental costs associated with a labor dispute at our Supermetals facility in Boyertown, Pennsylvania ($8 million), an increase in costs related to the implementation of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 ($5 million) and an increase in spending related to the Company’s BPE initiative ($3 million).

~~Research and Technical Expense~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Research and Technical Expense

$
58

$
59

$
53

The $1 million decrease in 2006 compared to 2005 was primarily due to reduced research and technical spending in the Supermetals Business partially offset by increased spending in the development activities of CSMP. The $6 million increase in 2005 compared to 2004 was principally due to increased spending in the development activities of CSMP.

~~Interest and Dividend Income~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Interest and Dividend Income

$
5

$
6

$
6

Interest and dividend income decreased by $1 million in 2006 due to lower cash available for interest earning investments, primarily in the first half, and the liquidation of marketable securities in the first quarter of 2006.

~~Interest Expense~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Interest Expense

$
27

$
29

$
30

The $2 million decrease in interest expense in 2006 compared to 2005 was due to the repayment of debt in the U.S., which matured in December 2005, and to the capitalization of interest related to the construction of our new facilities in China and the expansion of our existing carbon black facility in Brazil. The decrease in 2005 when compared to 2004 was primarily due to the capitalization of interest related to the construction of our new carbon black facility in China and the expansion of our existing facility in Brazil, which was partially offset by increases in interest expense due to increases in our average debt outstanding year over year.

~~Other Income/(Expense)~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Income (Expense)

$
(7
)

$
7

$
(19
)

The $14 million decrease in other income in 2006 was primarily due to foreign currency transaction gains and losses, including a charge of $8 million for the recognition of cumulative foreign currency translation adjustments related to the substantial liquidation of the legal entity through which we conducted carbon black operations in Altona, Australia.

The $26 million increase in other income in 2005, when compared to 2004, was primarily due to the inclusion of $15 million of expense related to certain items in 2004. These certain items included $12 million related to the write-down of our investment in the Sons of Gwalia as well as $3 million of charges related to currency translation adjustments in 2004. Also contributing to the increase in 2005 was $2 million of income related to insurance recoveries and $2 million of income related to foreign currency translation adjustments during 2005.

~~Effective Tax Rate~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

(Provision) Benefit for Income Taxes

$
(9
)

$
45

$
(39
)

Effective Tax Rate on Income (Loss) from Continuing Operations

9
%

(48
)%

24
%

The provision for income taxes was $9 million for fiscal 2006, resulting in a 9% effective tax rate on income from continuing operations. Excluding $18 million in tax benefits resulting from the settlement of various tax audits during the year, the permanent reinvestment of prior year earnings of a non-U.S. subsidiary, which reduced tax expense by $3 million in the third quarter, and a $8 million translation charge for the substantial liquidation of our Australian entity during the fourth quarter that was not tax benefited, the effective tax rate would have been approximately 29% for fiscal 2006.

The benefit for income taxes was $45 million for fiscal 2005, resulting in a 48% effective tax rate on loss from continuing operations. Excluding the $23 million tax settlement in the fourth quarter and the $90 million goodwill impairment and $121 million long-lived asset impairment charges related to the Supermetals Business in the second and fourth quarters, respectively, the effective tax rate would have been approximately 19% for fiscal 2005.

The provision for income taxes was $39 million for fiscal 2004, resulting in a 24% effective tax rate on income from continuing operations. The income tax rate reflects the U.S. statutory rate of 35% increased by a charge for a valuation allowance on the Sons of Gwalia investment loss and reduced for earnings in non-U.S. jurisdictions that were taxed at rates lower than the U.S. rate, benefits from extraterritorial income exclusion, benefits from U.S. research and experimentation credits, and the benefit from a tax audit filing resolved in 2004.

The increase in the effective tax rate in 2006 from 2005 was principally the result of the expiration of the U.S. research and experimentation credit, the phase out of the extraterritorial income exclusion and an increase in foreign losses for which a current tax benefit was not available.

In the normal course of business, the tax filings of Cabot and its subsidiaries are examined by various tax authorities, including the Internal Revenue Service (“IRS”). In September 2006, the IRS concluded its examination of the 2000 to 2002 tax years. The settlement of this audit resulted in the recording of a tax benefit of $12 million for continuing operations and $2 million for discontinued operations, recorded in the fourth quarter of fiscal year 2006. Additionally, during fiscal 2006, there was a tax benefit of $4 million from the settlement of foreign tax audits. The tax benefits were related to the reversal of previously recorded reserves. The IRS is currently auditing the 2003 and 2004 fiscal years.

Cabot has filed its tax returns in accordance with the tax laws in each jurisdiction and maintains tax reserves for differences between tax expense as finally determined and estimated tax expense for exposures that can be reasonably estimated. In the event that actual results are significantly different from these estimates, Cabot’s provision for income taxes could be significantly impacted.

In addition, we 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 2007 which may impact our effective tax rate in the periods during which these settlements occur.

We have deferred tax assets in the U.S. of $99 million that we believe are more likely than not recoverable through expected future taxable operating income in the U.S. However, recovery is dependent on achieving our forecast of future taxable operating income over an extended period of time. As of September 30, 2006, we would need to generate approximately $284 million in cumulative future U.S. taxable operating income at various times over approximately 20 years to realize all of our net U.S. deferred tax assets. 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 U.S. deferred tax assets. Any increase in a valuation allowance would result in additional income tax expense, lower stockholders’ equity and could have a significant impact on our earnings in future periods.

~~We expect our effective tax rate for fiscal 2007 to be between 28% and 31%, before the results of several on-going audits.~~

~~Equity in Net Income of Affiliates~~

Our share of earnings from equity affiliates was $12 million in 2006 and 2005 and $6 million in 2004. In November 2005 we began consolidating the results of Cabot Japan as a wholly owned entity as a result of acquiring our joint venture partner’s, Showa Denko K.K.’s, 50% interest in that entity. The increase in 2005 compared to 2004 was due to improved operating results in our affiliates in Mexico, Malaysia, Venezuela and Japan.

~~Discontinued Operations~~

During 2006 we recorded income from discontinued operations of $2 million ($0.03 per diluted common share) relating to the favorable settlement of a tax audit recognized during the fourth quarter from our discontinued liquified natural gas business. We did not record income or charges related to discontinued operations in 2005. In 2004, we recorded income of $2 million ($0.03 per diluted common share) related to previously divested businesses. This amount consisted of $1 million related to insurance proceeds and $1 million from the reversal of tax reserves related to previously divested businesses.

~~Net Income (Loss)~~

We reported net income for 2006 of $88 million ($1.28 per diluted common share) compared to a net loss of $48 million (a loss of $0.84 per common share) in 2005 and net income of $124 million ($1.82 per diluted common share) in 2004. The following earnings summary highlights the after-tax impact of certain items and income from discontinued operations:

Years Ended September 30

2006

2005

2004

Amounts per Diluted Common Share

Net income (loss)

$
1.28

$
(0.84
)
$
1.82

Certain items and discontinued operations

Certain items after-tax

$
(0.54
)
$
(2.95
)
$
(0.23
)
Cumulative effect of changes in accounting principles

$
(0.03
)
—

—

Discontinued operations after-tax

$
0.03

—

$
0.03

~~Fiscal Year 2006 compared to Fiscal Years 2005 and 2004—By Business Segment~~

The following discussion of our results includes information on diluted earnings per share, segment and product line sales, and segment operating profit before taxes (“PBT”). We use segment PBT to measure our consolidated operating results and to assess segment performance. This discussion has been prepared on a basis consistent with segment reporting as outlined in Note U of the Consolidated Financial Statements. (Refer to Note U of the Consolidated Financial Statements for a definition of segment PBT and additional segment information.) We use the term “Inventory Change” to measure the impact on per-unit fixed and variable costs associated with increasing or decreasing inventory levels relative to such increases or decreases in the comparative period. The fixed and variable costs associated with changes in inventory are excluded from “Raw Material Costs” and “Fixed Costs” as presented in the tables below. “Fixed Costs” as presented in the tables below refers to fixed manufacturing costs, including utilities. “Selling Price Mix” as presented in the discussion of fumed metal oxides refers to the impact on profitability of changes in the mix of products sold and their prices in comparative periods.

Total segment PBT, the aggregate of certain items and other unallocated items, and income from continuing operations before income taxes for fiscal years 2006, 2005 and 2004 are set forth in the table below. The details of certain items and other unallocated items are shown below and in Note U of our Consolidated Financial Statements. These items are not included in segment PBT.

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Total segment PBT

$
180

$
179

$
215

Certain items

(51
)

(242
)

(18
)

Other unallocated items

(32
)

(30
)

(33
)

Income from continuing operations before income taxes

$
97

$
(93
)

$
164

~~Details of the certain items for fiscal years 2006, 2005 and 2004 are as follows:~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions, pre-tax)

Gwalia settlement payment

$
(27
)

$
—

$
—

Restructuring initiatives

(21
)

(16
)

(6
)

Cost reduction initiatives

(3
)

(15
)

—

Goodwill impairment charges

—

(90
)

—

Long-lived asset impairment charges

—

(121
)

—

Reserve for respirator claims

—

—

2

Investment impairment charges

—

—

(12
)

Other non-operating items

—

—

(2
)

Total certain items, pre-tax

$
(51
)

$
(242
)

$
(18
)

~~Certain items for fiscal year 2006, 2005 and 2004 are recorded in the consolidated statements of operations as follows:~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions, pre-tax)

Statement of operations line item:

Net sales and other operating revenues

$
1

$
—

$
—

Cost of sales

(35
)

(26
)

(5
)

Selling and administrative expenses

(9
)

(3
)

2

Research and technical expenses

—

(2
)

—

Goodwill impairment charge

—

(90
)

—

Long-lived asset impairment charge

—

(121
)

—

Other income (expense)

(8
)

—

(15
)

Total certain items, pre-tax

$
(51
)

$
(242
)

$
(18
)

~~Details of other unallocated items for fiscal years 2006, 2005 and 2004 are as follows:~~

Years Ended September 30

2006

2005

2004

(Dollars in millions)

Interest expense

$
(27
)
$
(29
)
$
(30
)
Equity in net income of affiliated companies

(12
)
(12
)
(6
)
Foreign currency transaction gains (losses)

(2
)
2

(2
)
Other unallocated income

9

9

5

Total other unallocated items

$
(32
)
$
(30
)
$
(33
)

~~The impact of various factors on total segment PBT for 2006 when compared to 2005, and for 2005 when compared to 2004, are as follows:~~

2006 vs. 2005

2005 vs. 2004

(Dollars in millions)

Raw Material Costs

$
(284
)

$
(70
)

Selling Prices

210

33

Fixed Costs

28

—

Volumes

18

62

Acquisition of Cabot Japan

12

—

Selling, Technical and Administrative Costs

10

(12
)

Foreign Currency Translation Adjustments

1

4

Inventory Change and Other Inventory Charges

(1
)

(53
)

The $1 million increase in total segment PBT in 2006 when compared to 2005 primarily relates to continued strong demand and higher volumes in our principal businesses, lower manufacturing and administrative costs in the Supermetals Business and the favorable impact of our acquisition and consolidation of the results of Cabot Japan. These factors were partially offset by lower prices and higher ore costs in the Supermetals Business and higher raw material costs in rubber blacks and performance products. The $36 million decrease in total segment PBT in 2005 when compared to 2004 principally related to higher raw material costs, higher per unit costs of production due to lower production rates resulting from inventory drawdowns, and higher selling and administrative costs. These factors were partially offset by higher volumes, higher pricing and the positive impact of foreign currency translation adjustments.

~~Carbon Black Business~~

~~Segment sales and PBT for the Carbon Black Business for fiscal years 2006, 2005 and 2004 are as follows:~~

Years Ended September 30

2006

2005

2004

(Dollars in millions)

Segment Sales

$
1,917

$
1,490

$
1,325

Segment PBT

$
105

$
94

$
114

~~The impact of various factors on segment sales in the Carbon Black Business for 2006 when compared to 2005, and for 2005 when compared to 2004, are as follows:~~

2006 vs. 2005

2005 vs. 2004

(Dollars in millions)

Selling Prices

$
284

$
60

Acquisition of Cabot Japan

83

—

Volumes

22

54

Foreign Currency Translation Adjustments

7

42

The $427 million increase in sales in the Carbon Black Business in 2006 from 2005 was primarily due to higher volumes in rubber blacks and inkjet colorants, higher selling prices associated with feedstock driven price increases, the positive impact of foreign currency translation adjustments, and the favorable impact of our acquisition and consolidation of the results of Cabot Japan. In 2005, the $165 million increase in sales when compared to 2004 was due to higher volumes, higher prices and the positive impact of foreign currency translation adjustments.

~~The impact of various factors on segment PBT in the Carbon Black Business for 2006 when compared to 2005, and for 2005 when compared to 2004, are as follows:~~

2006 vs. 2005

2005 vs. 2004

(Dollars in millions)

Raw Materials Costs

$
(267
)

$
(73
)

Selling Prices

259

60

Acquisition of Cabot Japan

12

—

Volumes

11

15

Selling, Technical and Administrative Costs

(10
)

—

Inventory Change and Other Inventory Charges

9

(21
)

Fixed Costs

(6
)

—

The $11 million increase in PBT in the Carbon Black Business in 2006 was principally due to strong demand in our rubber blacks and inkjet colorants product lines leading to higher volumes and the positive

effects of our acquisition and consolidation of the results of Cabot Japan. These factors were partially offset by raw material cost increases in excess of price increases, higher selling, technical and administrative costs, higher costs associated with our CSMP business development activities and an increase in fixed costs associated with new production capacity in our inkjet colorants product line that is not yet being fully commercially utilized. The $20 million decrease in PBT in 2005 when compared to 2004 was principally due to raw material cost increases in excess of price increases and higher inventory related charges, partially offset by higher volumes.

~~Product Line Sales Summary~~

~~The following table sets forth sales by product line for the Carbon Black Business for 2006, 2005 and 2004:~~

Years Ended September 30

2006

2005

2004

(Dollars in millions)

Rubber blacks

$
1,378

$
976

$
863

Performance products

488

469

427

Inkjet colorants

47

39

31

CSMP

4

6

4

Total Carbon Black Business Sales

$
1,917

$
1,490

$
1,325

~~Rubber blacks~~

Volumes grew by 4% during 2006, excluding the impact of Cabot Japan, due to growth in China and other developing regions and a less than typical seasonal slowdown in the fourth quarter, particularly in Europe. During 2006 strong volumes and price increases in both our contracted and non-contracted business offset higher feedstock and natural gas costs allowing us to maintain relatively stable unit margins. Additionally, the results of Cabot Japan had a positive impact on the profitability of the product line in 2006.

~~During 2005, the profitability of this product line was negatively impacted by higher raw material and other energy costs, principally during the second half of the year, when compared to 2004.~~

Historically, we have been able to recover increased feedstock costs and, therefore, maintain margins through the operation of pricing formulas in our annual and long-term supply contracts. Most of our contracts provide 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. The feedstock adjustments are calculated in the month prior to the beginning of the three-month period in which the price change is effective, and typically are based upon the average of a relevant index over the prior three-month period. Because of these provisions, there is a lag between the time when we incur raw material costs and the time when changes in those costs are reflected in the contract pricing.

~~Performance products~~

During 2006, volumes decreased by 5% primarily due to a decline in volume in our lower margin, non-contracted business resulting from price increases we implemented to respond to rising raw material costs. The profitability of the product line was also negatively impacted by higher raw material and energy costs and by the unfavorable impact of foreign currency translation adjustments. However, during the second half of the year, we saw an increase in unit margins due to price increases we implemented throughout the year in response to higher feedstock costs.

During 2005, volumes grew by 5% when compared to 2004 primarily due to an increase in sales in the Asia Pacific and China regions. The profitability of the product line was negatively impacted, however, by higher raw material and other energy costs. Raw material cost increases outpaced both contracted and non-contracted price increases during the fiscal year.

~~Inkjet colorants~~

Inkjet colorants reported a 21% increase in revenue from 2005 to 2006 due to higher volumes. Volumes for 2006 increased 36% when compared to 2005. The favorable impact of volume increases was partially offset by a decrease in our average selling price due to the continued shift from experimental stage pricing levels to prices more consistent with commercial sales and some lower selling prices as the business grows. Additionally, higher fixed costs resulting from new production capacity that is not yet being fully commercially utilized unfavorably impacted the profitability of the product line during the second half of 2006. The profitability increased solidly, however, as compared to 2005.

Inkjet colorants reported a 26% increase in revenue from 2004 to 2005 due to strong volumes in both the OEM and aftermarket segments. Volumes for 2005 increased by 30% when compared to 2004. The profitability impact of increasing volumes in 2005 was partially offset by ongoing investment in both manufacturing and research and development to support the growth of this product line.

~~Outlook for 2007~~

We anticipate global demand to remain strong, but are cautious concerning demand in North America. Rubber blacks volumes in the first quarter of 2007 are being negatively impacted by a labor stoppage at our customer, Goodyear, in North America. The magnitude of this impact will be determined by the duration of the strike. Additionally, recent announcements of tire manufacturing capacity closures indicate a softening of demand in this important region. We are optimistic about the continued high utilization of our new carbon black capacity in China, and expect that our carbon black expansion in Brazil will begin commercial production by the second half of 2007. In performance products, the return of unit margins to levels prior to the recent increase in energy costs and the stabilization of volumes make us optimistic that the results of this product line will improve during 2007. In the inkjet colorants product line, we anticipate reduced growth in the small office, home office (“SOHO”) market segment due to softening in the aftermarket segment as OEM’s attempt to recapture business from aftermarket cartridge manufacturers. We anticipate printer launches in the high-speed market segment during the second half of 2007, which could have a significant impact on the volume and performance of the inkjet colorants product line over the medium to long term. However, we expect volume growth in this developing market to be slow at first.

~~Metal Oxides Business~~

~~Segment sales and PBT for the Metal Oxides Business for fiscal years 2006, 2005 and 2004 are as follows:~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Segment Sales

$
254

$
231

$
221

Segment PBT

$
18

$
16

$
18

~~The impact of various factors on segment sales in the Metal Oxides Business for 2006 when compared to 2005, and for 2005 when compared to 2004 are as follows:~~

2006 vs. 2005

2005 vs. 2004

(Dollars in millions)

Volumes

$
20

$
7

Selling Price Mix

3

(3
)

Foreign Currency Translation Adjustments

(2
)

4

In 2006, the $23 million increase in sales in the Metal Oxides Business when compared to 2005 was primarily due to higher volumes and favorable selling price mix partially offset by the unfavorable impact of foreign currency translation adjustments. The $10 million increase in sales in 2005 as compared to 2004 was principally due to higher volumes and the positive impact of foreign currency translation adjustments partially offset by a negative price mix.

~~The impact of various factors on PBT in the Metal Oxides Business for 2006 when compared to 2005, and for 2005 when compared to 2004 are as follows:~~

2006 vs. 2005

2005 vs. 2004

(Dollars in millions)

Volumes

$
14

$
6

Raw Materials

(8
)

—

Fixed Costs

(2
)

—

Selling, Technical and Administrative Costs

(2
)

—

Selling Price Mix

—

(3
)

Inventory Change

—

(3
)

Inventory Write-offs

—

(1
)

The $2 million increase in PBT in 2006 in the Metal Oxides Business as compared to 2005 was principally due to strong demand in our fumed silica business leading to higher sales volumes, which more than offset higher costs from rising energy prices. The $2 million decrease in PBT in 2005 from 2004 was principally due to negative price mix, higher per-unit costs of production, resulting from lower operating rates due to inventory drawdowns, and inventory write-offs related to off-quality material, partially offset by higher volumes.

~~Product Line Sales Summary~~

~~The following table sets forth sales by product line for the Metal Oxides Business for 2006, 2005 and 2004:~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Fumed metal oxides

$
253

$
231

$
221

Aerogel

1

—

—

Total Metal Oxides Business Sales

$
254

$
231

$
221

~~Fumed metal oxides~~

During 2006, the fumed metal oxides product line saw an increase in overall volumes of 9% driven by growth in the electronics and niche market segments, which more than offset a decline in volumes in the silicones market segment. This volume growth and strong plant utilization, including at our new plant in

~~Jiangxi, China, which is now operating in excess of 90% of its designed capacity, more than offset higher hydrogen and natural gas costs during the year.~~

During 2005, volumes increased by 3% as reduced demand from a single customer in the electronics segment was more than offset by higher volumes to other market segments. The resulting negative price mix combined with higher energy costs, higher per-unit fixed costs of production due to inventory drawdowns, and write-offs associated with off-quality material, to adversely impact the profitability of the product line during 2005.

~~Aerogel~~

Although volume growth has been slower than anticipated, the aerogel product line made progress in operating the plant at higher rates during the second half of the year. Additionally, market development progress continues in both the daylighting and oil and gas insulation markets. Manufacturing and product development spending for this opportunity totaled $21 million in 2006 and the assets of the product line totaled $28 million at September 30, 2006.

During the third quarter of 2006, we entered into a cross license agreement with Aspen Aerogel, Inc. where each party granted certain patent rights to the other. In consideration for use of the patents granted by Cabot, the agreement calls for us to receive $8 million of cash in ten equal semi-annual payments beginning on September 1, 2006 and the right to receive equity in Aspen. During the fourth quarter of 2006 the first installment payment was received and recorded in income. The remaining $7.2 million will be recognized when collection is reasonably assured. No amount has been recorded to date for the equity related consideration because of the contingent nature of this arrangement.

~~Outlook for 2007~~

We remain optimistic about continued strong demand to support our new fumed silica capacity and anticipate strong utilization of our facilities through at least the first half of 2007. In the aerogel product line, we continue to work on market development in both the daylighting and oil and gas insulation markets.

~~Supermetals Business~~

~~Segment sales and PBT for the Supermetals Business for fiscal years 2006, 2005 and 2004 are as follows:~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Segment Sales

$
292

$
346

$
338

Segment PBT

$
41

$
52

$
77

~~The impact of various factors on segment sales in the Supermetals Business for 2006 when compared to 2005, and for 2005 when compared to 2004 are as follows:~~

2006 vs. 2005

2005 vs. 2004

(Dollars in millions)

Prices

$
(50
)

$
(23
)

Volumes

(4
)

28

In the Supermetals Business, the $54 million decrease in sales from 2005 to 2006 was driven by lower volumes and lower prices as the business transitions from fixed price, fixed volume contracts to market-based arrangements. The $8 million increase in sales from 2004 to 2005 was driven by increased volumes as

~~we were able to more than offset lower contract volumes with market-based volumes. These increased volumes were partially offset by lower prices.~~

~~The impact of various factors on PBT in the Supermetals Business for 2006 when compared to 2005, and for 2005 when compared to 2004 are as follows:~~

2006 vs. 2005

2005 vs. 2004

(Dollars in millions)

Selling Prices

$
(50
)

$
(23
)

Fixed Costs

36

—

Selling, Technical and Administrative Costs

18

(8
)

Inventory Change

(10
)

(19
)

Raw Materials

(8
)

—

Volumes

(4
)

29

The $11 million decrease in PBT in the Supermetals Business from 2005 to 2006 was primarily due to lower volumes and lower pricing as a more significant portion of our sales in this Business during the year were made under market-based arrangements. During the year we also paid higher raw material costs under our new three-year tantalum ore supply contract with the Sons of Gwalia than under our previous agreement. Higher per unit costs of production resulting from lower operating rates due to inventory drawdowns were partially offset by lower manufacturing and administrative costs from initiatives undertaken in 2005. Additionally, lower fixed costs, principally depreciation, benefited the Business results during 2006. The $25 million decrease in PBT from 2004 to 2005 was principally due to lower pricing, higher per unit costs of production resulting from lower operating rates, and incremental costs from a labor dispute at our Boyertown, Pennsylvania facility, which are included in fixed costs. These factors were partially offset by higher volumes.

During 2006, we settled our dispute with the Sons of Gwalia over the price we were to pay for tantalum ore under a then existing supply agreement. Under the settlement, the companies entered into a new three-year tantalum ore supply agreement that incorporates a reduced term, significantly reduced annual volume commitments and higher prices than under the prior agreement, and we made a lump sum payment of $27 million to terminate the prior supply and other related agreements.

During 2005, the Supermetals Business recorded charges associated with the impairment of its long-lived assets (including goodwill) totaling $211 million. Additionally, during 2005, the Supermetals Business recorded a charge of $15 million associated with on-going cost reduction initiatives in that Business, including $8 million of asset write-downs associated with management’s decision to stop manufacturing and selling finished tantalum sputtering targets, $3 million of charges related to severance arrangements and $3 million of charges associated with the write-down of assets related to abandoned research and development projects.

~~Outlook for 2007~~

While we anticipate a step down in profitability of the Supermetals Business beginning in the second quarter of 2007 as the last of our significant fixed-price, fixed-volume contracts expires in December 2006, we anticipate the Business to remain profitable. While we will continue to experience high ore costs in 2007 under our contract with the Sons of Gwalia , we expect these costs to be partially offset by benefits from cost reduction efforts we initiated in 2006. Additionally, we are committed to generating cash in excess of PBT through a continuation of our efforts to improve working capital.

~~Specialty Fluids Business~~

~~Segment sales and PBT for the Specialty Fluids Business for fiscal years 2006, 2005 and 2004 are as follows:~~

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Segment Sales

$
44

$
40

$
27

Segment PBT

$
16

$
17

$
6

Sales in the Specialty Fluids Business increased 10% ($4 million) in 2006 when compared to 2005 driven mainly by higher volumes of fluid sold resulting from a higher percentage of fluid losses by a customer, which more than offset fewer rental days. In 2005, sales increased by $13 million when compared to 2004 due to an increase in the number of customers, an increase in the number of on-going and completed jobs during the year and an increase in the average amount of fluid utilized per job. The percentage of fluid lost in jobs performed in 2006, which is highly dependent upon the size and types of jobs, was approximately 18%, compared to 13% in 2005.

The PBT for this Business decreased by $1 million in 2006 when compared to 2005 principally due to reduced drilling activity in the North Sea. In particular, lower rental revenues were due to one large job in the second half of 2005 that was not replicated in 2006. In general, rental revenues have a higher profit margin than fluid sold. Therefore, despite an increase in overall revenues during the year this decrease in rental revenues unfavorably impacted segment PBT. During the year the Business successfully completed one appraisal well in Argentina, which has led to the planning of two additional wells there. Segment PBT increased by $11 million in 2005 when compared to 2004 due to increased fluid utilization, a larger number of jobs completed and higher prices. Utilization of our total available fluid inventory was 12% in 2006, compared to 14% in 2005 and 9% in 2004. During 2006 we completed 23 jobs, compared to 26 jobs in 2005 and 15 jobs in 2004.

~~Outlook for 2007~~

We continue to work on market development activities outside of the North Sea. As a result of our success to date in Argentina we are increasingly optimistic about the continued growth of this Business in 2007 and thereafter.

~~Cash Flow and Liquidity~~

~~Overview~~

Our cash balance increased by $8 million in 2006, from $181 million on September 30, 2005 to $189 million on September 30, 2006. The increase in cash was largely due to a significant reduction in inventories and increased net income before adding back non-cash items. These increases were partially offset by four major uses of cash during this year: increases in accounts receivable mainly resulting from feedstock related price increases, the acquisition of the remaining 50% of our carbon black joint venture in Japan, a settlement payment of $27 million to the Sons of Gwalia in our Supermetals Business and capital spending to expand capacity in emerging markets and to comply with environmental requirements. During 2005, the cash balance increased by $22 million, from $159 million on September 30, 2004 to $181 million on September 30, 2005. In 2004 our cash balance decreased by $88 million, from $247 million on September 30, 2003. The following descriptions of the reasons for these changes in our cash balances refer to the various sections of our Consolidated Statements of Cash Flows, which appears in Item 8 of this annual report on Form 10-K for the fiscal year ended September 30, 2006.

~~Cash Flows from Operating Activities~~

Cash provided from 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 $252 million during the fiscal year 2006 compared to $218 million during fiscal 2005. The increase in 2006 versus 2005 was primarily due to inventory reductions in our Carbon Black and Supermetals Businesses more than offsetting an increase in accounts receivable and lower net income, which included the $27 million settlement payment to the Sons of Gwalia. The asset and goodwill impairment charges in 2005 did not affect overall operating cash flows during that year, but lowered net income by $176 million, through the deferred tax benefit (increase of $45 million) and asset impairment charge (decrease of $221 million). Cash from operating activities decreased during fiscal 2005 to $218 million from $241 million in fiscal 2004. After excluding the effect of the non-cash impairment charges, net income in 2005 and 2004 was approximately equal.

~~Cash Flows from Investing Activities~~

Cash flows from investing activities consumed $165 million of cash in 2006 as compared to $119 million in 2005 and $226 million in 2004. The increased use of cash in investing activities during fiscal 2006 of $46 million was primarily due to a lower level of net redemption of marketable securities investments of $36 million in 2006 compared to $70 million in 2005. In addition, Cabot purchased the remaining 50% equity interest in Cabot Japan that we did not previously own. Cash consumed in 2005 dropped by $107 million from the $226 million consumed in 2004 primarily due to net redemption of marketable securities of $175 million in 2005. This benefit was partly offset by a $67 million increase in capital expenditures in 2005. In both 2005 and 2006, capital spending increased due to construction of facilities at our new Tianjin, China carbon black facility and our new Jiangxi, China metal oxides facility as well as an expansion of our Maua, Brazil carbon black facility and our Haverhill, Massachusetts inkjet colorants facility. Capital expenditures for 2007 are expected to be approximately $150 million and include replacement projects, plant expansions and the completion of projects started in fiscal year 2006.

~~Cash Flows from Financing Activities~~

Cash flows from financing activities consumed $82 million in 2006, $75 million in 2005, and $101 million in 2004. In all three years, financing cash flows were primarily driven by changes in our debt position, dividend payments, and repurchases of our common stock. In 2006, a portion of our debt change was related to the assumption of debt from Cabot Japan, where we consolidated $26 million of debt when we increased our ownership interest from 50% to 100%. The Company repaid $25 million of this debt during fiscal 2006.

In May 2004, the Board of Directors authorized Cabot to purchase up to 5 million shares of our common stock. Under that and the prior repurchase authorization, which was terminated in May 2004, we repurchased approximately 1.1 million, 1.6 million, and 1.7 million shares of our common stock for approximately $40 million, $52 million, and $54 million in 2006, 2005, and 2004, respectively. Approximately 1.6 million shares of common stock are available to be purchased under the current Board of Directors share repurchase authorization.

During 2006, 2005 and 2004, we paid cash dividends of $0.64, $0.64, and $0.60, respectively, per share of common stock. On December 8, 2006 we paid a quarterly dividend of $0.18 per share to holders of the Company’s common stock on November 24, 2006. This represented a $0.02 per share increase in the quarterly dividends paid in 2006 and 2005.

~~requirements for capital resources. We are not involved in any trading activities involving commodity contracts that are accounted for at fair value.~~

Management expects cash on hand, cash from operations and present financing arrangements, including our unused lines of credit, to be sufficient to meet our cash requirements for at least the next twelve months and the foreseeable future.

~~Contractual Obligations~~

~~The following table sets forth our long-term contractual obligations which are described in greater detail below.~~

Payments Due by Fiscal Year

2007

2008

2009

2010

2011

Thereafter

Total

(Dollars in millions)

Contractual Obligations

Purchase commitments

$
227

$
235

$
132

$
96

$
94

$
700

$
1,484

Long-term debt(1)

34

12

46

90

38

273

493

Fixed interest on long-term debt

26

24

23

20

18

56

167

Operating leases

20

12

10

10

7

36

95

Total

$
307

$
283

$
211

$
216

$
157

$
1,065

$
2,239

⁽¹⁾ ��

Includes capital lease obligations of $3$2 million over the years presented.

~~Purchase commitments~~⁽²⁾

~~We have long-term purchase commitments for raw materials with various key suppliers in~~Variable interest is based on the ~~Carbon Black, Metal Oxides~~variable debt outstanding and ~~Supermetals Businesses.~~

~~Off-balance sheet arrangements~~

~~Cabot has no material transactions that meet the definition~~prevailing variable interest rates as of ~~an off-balance sheet arrangement.~~

~~Long-term debt and fixed interest~~

At September 30, ~~2006, our long-term debt totaled $493 million, which matures at various times over~~2007.

⁽³⁾

Includes the next 21 years. Included in this amount is $79 million of Japanese yen based long-term debt. All other long-term debt is denominated in U.S. dollars, however, a $175 million bond issued in U.S. dollars was swapped to a Euro-based debt instrument. The repayment schedule above does not include the effectimpact of interest rate swaps ~~which had a favorable fair value of $1 million at September 30, 2006. The weighted-average interest rate on long-term debt is 5.5%.~~

~~Under our revolving credit facility we may borrow up~~that either change fixed rates to floating rates or floating rates to fixed rates.

Purchase commitments

We have long-term purchase commitments for raw materials with various key suppliers in the Carbon Black, Metal Oxides and Supermetals Businesses.

Long-term debt and fixed interest

At September 30, 2007, our long-term debt totaled $518 million, which matures at various times over the next twenty years. Of this $518 million, $349 million was issued as fixed interest rate debt and includes the effect of interest rate swaps that change fixed rate to floating rate. These swaps had a total positive fair value of $1 million on September 30, 2007. The weighted-average interest rate on fixed rate long-term debt is 5.2% including the effects of the interest rate swaps. The remaining $169 million of long term debt was issued or was swapped to variable rate debt. This includes $38 million fixed-to-floating swaps on two medium term notes and a fixed-to-floating swap on $35 million of our Eurobond. These swaps had a total negative fair value of $1 million on September 30, 2007. The weighted-average interest rate on variable interest rate long-term debt is 6.3% including the effects of the interest rate swaps and is based on the prevailing variable interest rates as of September 30, 2007.

Under our 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 of 2010. As of September 30, 2007 we have outstanding borrowings of $145 million, and $15 million in standby letters of credit under this agreement. The remaining availability under the revolving credit facility as of September 30, 2007 is approximately $240 million. The credit facility contains various affirmative, negative and financial covenants which are customary for financings of this type, including financial covenants for certain maximum indebtedness and minimum cash flow requirements. As of September 30, 2007, we were in compliance with all of the covenants.

At September 30, 2007, in addition to the $15 million of standby letters of credit issued under our revolving credit facility, we have provided standby letters of credit and bank guarantees totaling $37 million, which expire in fiscal 2008.

A downgrade of one level in our credit rating is not anticipated, but should it occur, it would not affect our ability to borrow money under our revolving credit facility. It could, however, affect the cost of any new funding.

Operating Leases

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

Restructurings

As of September 30, 2007, we have $4 million of total restructuring costs in accrued expenses in the consolidated balance sheet related to the upcoming closure of our plant in Waverly, West Virginia, our 2006 cost reduction initiatives and our Altona, Australia plant closure. We made cash payments of $12 million during fiscal 2007 related to restructuring costs. We expect to make cash payments related to these restructuring activities of $6 million during fiscal 2008 and $2 million during fiscal 2009.

Employee Benefit Plans

We provide defined benefit plans for all U.S. and some foreign employees. We have an unfunded status as of September 30, 2007 for consolidated defined benefit plans of $13 million and postretirement benefit plans of $103 million. Our U.S. qualified defined benefit plan is overfunded by approximately $24 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 of 2010. As of September 30, 2006 we have 9.3 billion Japanese yen ($79 million) borrowings outstanding and $13 million in standby letters of credit under this agreement. The remaining availability under the revolving credit facility as of September 30, 2006 is approximately $307 million. The credit facility contains various affirmative, negative and financial covenants which are customary for financings of this type, including financial covenants for certain maximum indebtedness and minimum cash flow requirements. As of September 30, 2006, we were in compliance with all of our covenants.

At September 30, 2006, in addition to the $13 million of standby letters of credit issued under our revolving credit facility, we have provided standby letters of credit totaling $17 million, which expire in fiscal 2007.

A downgrade of one level in our credit rating is not anticipated, but should it occur, it would not cause a significant impact on the commitments or sources of capital described above and would not have a material impact on our results of operations.

~~Operating leases~~

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

~~Restructuring~~

In September 2006, we announced a number of cost reduction initiatives. These initiatives include streamlining Cabot’s sales, manufacturing, technical service and certain functional groups through a workforce reduction. Implementation of these initiatives began in September 2006 and is expected to conclude during the course of fiscal year 2007. The total number of employees impacted by the cost reductions is expected to be approximately 130 people, with the majority having left the Company on or before September 30, 2006. Termination and related benefits costs associated with this restructuring have been and will be recorded in accordance with FAS 112, “ Employers’ Accounting for Postemployment Benefits” (“FAS 112”) or FAS 146, “Accounting for the Costs Associated with Exit or Disposal Activities” (“FAS 146”), as appropriate. The total charge related to these initiatives was $10 million for the twelve months ended September 30, 2006. We expect to record an additional $3 million in connection with the restructuring and make cash payments of $12 million during fiscal 2007.

In October 2004, we initiated a plan to shut down our Altona, Australia carbon black manufacturing facility due to our raw materials supplier’s indication that it would cease supply in September 2005, as well as the decline of the carbon black business in Australia. Production at this facility ceased on October 3, 2005. As of September 30, 2006, substantial liquidation of the entity has been completed, therefore, an $8 million non-cash charge for the cumulative foreign currency translation adjustment has been realized. We have recorded $28 million of charges related to this closure in the consolidated statements of operations since October 2004, and have $2 million of remaining reserves recorded as of September 30, 2006. The total charges are expected to be partially offset by gains on the sale of the land on which the facility was located, which is estimated to be between $7 million and $10 million and is expected to occur during fiscal 2007. We expect that the remaining $2 million of reserves will be paid during fiscal 2007 in connection with the closure, demolition, remediation and restoration of the property.

In fiscal 2003, we initiated a European restructuring plan to reduce costs, enhance customer service and create a stronger and more competitive organization. The European restructuring initiatives were primarily related to the Carbon Black Business and included the closure of our carbon black manufacturing facility in Zierbena, Spain, the consolidation of administrative services for all European

businesses in one shared service center, the implementation of a consistent staffing model for all manufacturing facilities in Europe, and the discontinuance of two energy projects. As of September 30, 2006, we have recorded $55 million of European restructuring charges, of which less than $1 million remains to be paid out during fiscal 2007.

At September 30, 2006, $12 million of restructuring costs remain in accrued expenses in the consolidated balance sheet. We made cash payments of $14 million in 2006, $10 million in 2005 and $15 million in 2004 related to restructuring costs, and expect to make cash payments of $15 million in fiscal 2007 related to severance and employee benefits charges and site remediation costs.

~~Employee Benefit Plans~~

We provide defined benefit plans for all U.S. and some foreign employees. We have an unfunded status of approximately $151 million as of September 30, 2006 for consolidated defined benefit plans and postretirement benefit plans. For further information regarding our employee benefit plans, refer to Note M in our Consolidated Financial Statements.

~~Defined Benefit Plans~~

~~At September 30, 2006, the funded status of the defined benefit pension plans are comprised of the following:~~

U.S.

Foreign

Total

(Dollars in millions)

Fair value of plan assets at September 30, 2006

$
135

$
181

$
316

Projected benefit obligation at September 30, 2006

$
131

$
233

$
364

Funded status at September 30, 2006

$
4

$
(52
)

$
(48
)

Our significant foreign plans are for employees in The Netherlands, the United Kingdom and Canada, which collectively represented 80% of the consolidated projected benefit obligation of total foreign plan pension obligations at September 30, 2006. For those significant foreign plans, the fair value of assets was approximately $18 million below the projected benefit obligation. We are significantly underfunded in the foreign defined benefit plan obligations because we are not required to fund certain foreign plans. We contributed an aggregate amount of $9 million in 2006 to these significant foreign plans and expect to contribute approximately $8 million in 2007 to those plans. Contributions to foreign plans are made in foreign currencies and, therefore, are subject to fluctuations in exchange rates.

We also have assets of $13 million at September 30, 2006 that we have designated to fund pension obligations for a foreign plan. These assets are not included in the pension plan assets as of September 30, 2006. These assets do not qualify as plan assets under FAS No. 87, “Employers’ Accounting for Pensions”, because they are not specifically segregated or restricted for use to fund the defined benefit plan obligation, and, accordingly, the assets are not shown in the funded status at September 30, 2006. These assets are included in other long term assets on the consolidated balance sheets.

Cabot made a discretionary contribution of less than $1 million in fiscal 2006 to fund benefit payments under Cabot’s Supplemental Cash Balance Plan (“SCBP”), a U.S. defined benefit Supplemental Executive Retirement Plan. We routinely review the funding status of the defined benefit plans to determine when a contribution will improve the overall position of the plan and as a result we expect to make a $1 million contribution to fund benefit payments under the SCBP in fiscal 2007.

~~Postretirement Benefit Plans~~

~~At September 30, 2006, the funded status of the postretirement benefit plans are comprised of the following:~~

U.S.

Foreign

Total

(Dollars in millions)

Fair value of plan assets at September 30, 2006

$
—

$
—

$
—

Projected benefit obligation at September 30, 2006

$
(86
)

$
(17
)

$
(103
)
Funded status at September 30, 2006

$
(86
)

$
(17
)

$
(103
)

Cabot’s postretirement benefit plans provide certain health care and life insurance benefits for retired employees. Typical of such plans, the Cabot postretirement plans are unfunded. ~~Costs associated with these plans are recorded as expense in the statement of operations when claims or insurance premiums come due.~~ In the U.S., Cabot established a per retiree cap on the amount Cabot would contribute to retiree medical costs to limit the Company’s financial responsibility for these costs and to mitigate the risk of potential escalation in costs borne by Cabot for retiree medical coverage. We paid benefits under these plans of $6 million in the U.S. and less than $1 million outside of the U.S. during fiscal 2007.

The following table represents the estimated future contributions to our employee benefit plans.


	2008⁽¹⁾
	(Dollars in millions)
Foreign defined benefit plans	$	13
Supplemental cash balance plan		1
U.S. postretirement benefit plans		8
Foreign postretirement benefit plans		1

Total	$	23

⁽¹⁾

Future contributions under these plans ~~of $8 million in the U.S.~~for fiscal 2009 and ~~less than $1 million outside of the U.S. during fiscal 2006. We expect to pay $8 million under the U.S. plans and $1 million under the foreign plans during 2007.~~

~~Environmental and Litigation~~

Cabot has a $13 million reserve for environmental matters as of September 30, 2006 for remediation costs at various environmental sites. These sites are primarily associated with businesses divested in prior years. We anticipate that the expenditures at these sites willthereafter cannot be made over a number of years, and will not be concentrated in any one year. Additionally, we have recorded an $18 million reserve for respirator claims as of September 30, 2006 and we estimate total payments of approximately $12 million over the next five years. We have other litigation costs associated with lawsuits arising in the ordinary course of business including claims filed against the Company in connection with certain discontinued operations.reasonably estimated.

Environmental and Litigation

Cabot has an $11 million reserve as of September 30, 2007 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, we have recorded an $18 million reserve for respirator claims as of September 30, 2007. We have other litigation costs associated with lawsuits arising in the ordinary course of business including claims filed against the Company in connection with certain discontinued operations.

The following table represents the estimated future undiscounted payments related to the above items.


	Future Payments by Fiscal Year
	2008		2009		2010		2011		2012		Thereafter		Total
	(Dollars in millions)
Environmental	$	2	$	2	$	2	$	2	$	2	$	3	$	13
Litigation—respirator		3		2		2		1		1		17		26

Total	$	5	$	4	$	4	$	3	$	3	$	20	$	39

Carbon Black Feedstock Costs

An escalation of carbon black feedstock costs could lead to an increase in our cash requirements. While such increased costs are generally recovered through higher selling prices, there is a period of several months between when cash is paid for inventory purchases and when it is received for subsequent sales. This can lead to temporary uses of working capital.

Cash and Marketable Securities

We have had no material losses on our cash and marketable securities investments during fiscal 2007, and our September 30, 2007 balances correctly reflect the market value of our investments. We have given consideration to the turbulent credit markets in making this assessment.

Repatriation of Foreign Currency

As of September 30, 2007, we had cash at a Venezuelan subsidiary of approximately $12 million which has been translated at the official exchange rate. We continue to be concerned about our ability to repatriate this cash as we have not received approval to formally exchange this cash at the official rate. If we are unable to repatriate this cash at the official exchange rate or if the official exchange rate devalues, we may incur additional reductions to our earnings and cash balances.

Sale of Assets

During the first quarter of fiscal 2008, we completed the sale of the land on which our Altona, Australia carbon black plant was located. The gain on the sale of the land is approximately $13 million, after tax, net of settlement costs. The gain will be recorded during the first quarter of fiscal 2008 and the proceeds are expected to be received during the first quarter of fiscal 2008. Additionally, during the fourth quarter of fiscal 2007 we sold our technical facility building in Leiden, Netherlands, resulting in a gain of approximately $2 million that was recorded during the fourth quarter of fiscal 2007. Proceeds from the sale were received during the first quarter of fiscal 2008.

Outlook

Management expects cash on hand, cash from operations and present financing arrangements, including our unused committed and uncommitted lines of credit, to be sufficient to meet our cash requirements for at least the next twelve months and the foreseeable future.

~~Newly Issued Accounting Pronouncements~~
In September 2006, the SEC issued SAB No. 108 (Topic 1N), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the current year’s financial statements are materially misstated. SAB 108 is effective for the Company beginning October 1, 2007. The adoption of SAB 108 is not expected to have a material impact on the Company’s consolidated financial statements.
In September 2006, the FASB issued FAS No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 provides guidance for using fair value to measure certain assets and liabilities and requires additional disclosure about the use of fair value measures and the effect fair-value measurements have on earnings. The primary areas in which the Company utilizes fair value measures are valuing pension plan assets and liabilities, valuing hedge-related derivative financial instruments, allocating purchase price to the assets and liabilities of acquired companies, and evaluating long-term assets for potential impairment. FAS 157 does not require any new fair value measurements. FAS 157 is effective for the Company beginning October 1, 2008. The Company is currently evaluating the impact of FAS 157 on its financial statements.

In September 2006, the FASB issued FAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“FAS 158”). FAS 158 requires an employer to recognize the funded status of a benefit plan, measured as the difference between plan assets at fair value and the projected benefit obligation, in its statement of financial position. FAS 158 also requires an employer to measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end. FAS 158 is effective for the Company for its fiscal year ended September 30, 2007. The Company is currently evaluating the impact of FAS 158 on its financial statements.
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109” (“FIN 48”), which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return, including a decision whether or not to file a return in a particular jurisdiction. Under this new guidance, the financial statements will reflect expected future tax consequences of such positions presuming the taxing authorities’ full knowledge of the position and all relevant facts, but without considering time values. This guidance also revises disclosure requirements and introduces a prescriptive, annual, tabular roll-forward of unrecognized tax benefits. FIN 48 is effective for annual periods beginning after December 15, 2006, which will be fiscal 2008 for Cabot. Cabot is in the process of evaluating the impact of adoption of FIN 48 on its consolidated financial statements.
In June 2006, the FASB ratified the consensus reached by the EITF in Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)” (“EITF 06-3”). The scope of this issue includes any tax assessed by a governmental authority that is directly imposed on a revenue-producing activity between a seller and a customer and may include, but is not limited to, sales, use, value-added, and some excise taxes. EITF 06-3 requires the disclosure of the method of accounting for the applicable assessed taxes and the amount of assessed taxes that are included in revenues if they are accounted for under the gross method and are significant. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The Company does not expect the adoption of EITF 06-3 in fiscal 2007 to have an impact on its consolidated financial statements.
In October 2004, the American Jobs Creation Act of 2004 (“AJCA”) was signed into law. Among other things, the AJCA allowed U.S. companies a one-time election to repatriate certain earnings from their foreign subsidiaries in 2006 at an effective tax rate of 5.25%. The Company did not believe there to be a material benefit available to it given Cabot’s particular circumstances and the various requirements under the law and, accordingly, did not elect to repatriate any foreign earnings.
54

Item 7A.
Quantitative and Qualitative Disclosures About Market Risk

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 Cabot’s financial risk management policy.

By using derivative instruments, we are subject to credit and market risk. The fair market value of the derivative instruments is determined by a quoted market price and reflects the asset or (liability) position as of September 30, 2007. If a counterparty fails to fulfill its performance obligations under a derivative contract, our credit risk 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 transactions with major financial institutions of investment grade credit rating. 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, 2007, we had long term debt, including the current portion, totaling $518 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. Additionally, in certain regions where we have stable cash flows and low interest rates relative to the incremental corporate borrowing rate, we generally lock-in a fixed interest rate on our debt in that region. This has been achieved by entering into floating-to-fixed interest rate swap agreements. 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, 2007.

Description

Notional Amount

Receive

Pay

Fiscal Year
Entered Into

Maturity
(Fiscal Year)

Fair Market
Value at
September 30,
2007

(USD)

Interest Rate

Swaps—Fixed

to Variable

USD 8 million

8.28% Fixed

US-6 month
LIBOR + 3.14%

2007

2012

—

USD 30 million

7.18% Fixed

US-6 month
LIBOR + 2.42%

2006

2009

—

USD 35 million

5.25% Fixed

US-6 month
LIBOR + 0.62%

2003

2013

(1 million)

Interest Rate

Swaps—Variable

to Fixed

JPY 9.3 Billion

JPY-6 month
LIBOR

0.85% Fixed

2006

2010

1 million

Foreign Currency Risk

Cabot’s international operations are subject to certain risks, including currency exchange rate fluctuations and government actions. In general, we endeavor to match the currency in which we issue debt to the currency of our major, stable cash receipts. In some situations 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. In one case, we have borrowed against our revolving credit facility in Japanese yen. This debt is designated as a net investment hedge to offset currency fluctuations associated with the investments we have made in our Japanese subsidiaries. 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, 2007.

Description

Notional Amount

Receive

Pay

Fiscal Year
Entered Into

Maturity

(Fiscal Year)

Fair Market
Value at
September 30,
2007

(USD)

Cross Currency

Swaps

USD 140 million
swapped to

EUR 124 million

5.25% Fixed

5.0% Fixed

2003

2013

(40 million)

USD 35 million
swapped to

EUR 31 million

US-6 month
LIBOR

EUR-6 month
LIBOR

2003

2013

(9 million)

USD 41 million
swapped to

JPY 5.0 Billion

US-3 month
LIBOR

JPY-3 month
LIBOR + 0.04%

2002

2009

(3 million)

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 2007 and 2006, none of our forward contracts were designated as FAS 133 hedging instruments. As of September 30, 2007, we had $13 million in net foreign currency forward contracts, which were denominated in Japanese yen, British pound sterling, Canadian dollar, and Australian dollar.

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. During 2006, we purchased a series of call options to buy the Australian dollar at agreed strike prices to mitigate the currency risk associated with a three-year tantalum ore supply agreement denominated in Australian dollars. The principal terms of the call options are outlined in the table below.

Description

Notional Amount

Weighted
Average Strike

Price

Option Frequency

Year
Entered
Into

Maturity
(Fiscal
Year)

Fair Market
Value at
September 30,
2007

AUD Call Options

AUD 67 million

0.748 USD/AUD

Monthly

2006

2009

USD 8 million

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 and prices may have an impact on future cash flow 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 Cabot’s financial risk management policy.
By using derivative instruments, we are subject to credit and market risk. The fair market value of the derivative instruments is determined by a quoted market price and reflects the asset or (liability) position as of September 30, 2006. If a counterparty fails to fulfill its performance obligations under a derivative contract, our credit risk 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 transactions with major financial institutions of investment grade credit rating. 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, 2006, we had long term debt, including the current portion, totaling $493 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. Additionally, in certain regions where we have stable cash flows and low interest rates relative to the incremental corporate borrowing rate, we generally lock-in a fixed interest rate on our debt in that region. This has been achieved by entering into floating-to-fixed interest rate swap agreements. 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, 2006.
Description

Notional
Amount

Receive

Pay

Year
Entered
Into

Maturity

Fair Market
Value at
September 30, 2006

(USD)
Interest Rate
Swaps – Fixed to
Variable

USD 30 million

7.08% Fixed

US-6 month LIBOR + 2.44%

2002

2007

—

USD 30 million

7.18% Fixed

US-6 month LIBOR + 2.42%

2006

2009

—

USD 35 million

5.25% Fixed

US-6 month LIBOR + 0.62%

2003

2013

(1 million)

Interest Rate
Swaps – Variable to
Fixed

JPY 5.0 Billion

JPY-6 month LIBOR

0.84% Fixed

2006

2010

—

JPY 4.3 Billion

JPY-6 month LIBOR

0.86% Fixed

2006

2010

—

~~Foreign Currency Risk~~
Cabot’s international operations are subject to certain risks, including currency exchange rate fluctuations and government actions. In general, we endeavor to match the currency in which we issue debt to the currency of our major, stable cash receipts. In some situations 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. In one case, we have borrowed against our revolving credit facility in Japanese yen. This debt is designated as a net investment hedge to offset currency fluctuations associated with the investments we have made in our Japanese subsidiaries. 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, 2006.
Description

Notional
Amount

Receive

Pay

Year
Entered
Into

Maturity

Fair Market
Value at
September 30,
2006

(USD)
Cross Currency Swaps

USD 140 million swapped to

5.25% Fixed

2003

2013

(28 million)

EUR 124 million

5.0% Fixed

USD 35 million
swapped to

US-6 month LIBOR

2003

2013

(4 million)

EUR 31 million

EUR-6 month EUR LIBOR

USD 41 million
swapped to

US-3 month LIBOR

2002

2008

(2 million)

JPY 5.0 Billion

JPY-3 month LIBOR + 0.04%

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 2006 and 2005, none of our forward contracts were designated as hedging instruments. Our forward foreign exchange contracts are denominated primarily in the Euro, Japanese yen, British pound sterling, Canadian dollar, Australian dollar and Indonesian rupiah.
In certain situations where we have a long-term commitment denominated in a foreign currency we will enter into either forwards or option contracts to buy the currency in the case where we have a payable or sell the currency in the case where we have a receivable. In this manner we offset the currency risk associated with the long-term obligation. During 2006, we entered into a series of call options to buy the Australian dollar to mitigate the currency risk associated with our new three-year tantalum ore supply agreement. The principal terms of the call options are outlined in the table below.
Description

Notional
Amount

Weighted
Average Strike
Price

Option Frequency

Year
Entered
Into

Maturity
Year

Fair Market
Value at
September 30,
2006
AUD Call Options

AUD 116 million

0.750 USD/AUD

Monthly

2006

2009

USD 2 million
56

Item 8.
Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS


Description		Page
(1)	Consolidated Statements of Operations for each of the fiscal years ended September 30, 2007, 2006 and 2005	54
(2)	Consolidated Balance Sheets at September 30, 2007 and 2006	55
(3)	Consolidated Statements of Cash Flows for each of the fiscal years ended September 30, 2007, 2006 and 2005	57
(4)	Consolidated Statements of Changes in Stockholders’ Equity for each of the fiscal years ended September 30, 2007, 2006 and 2005	58
(5)	Notes to Consolidated Financial Statements	61
(6)	Reports of Independent Registered Public Accounting Firms	107

CABOT CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS


	Years Ended September 30
	2007			2006			2005
	(In millions, except per share amounts)
Net sales and other operating revenues	$	2,616		$	2,543		$	2,125
Cost of sales		2,111			2,124			1,692

Gross profit		505			419			433
Selling and administrative expenses		249			235			240
Research and technical expenses		69			58			59
Goodwill impairment charge		—			—			90
Long-lived asset impairment charge		—			—			121

Income (loss) from operations		187			126			(77	)
Interest and dividend income		10			5			6
Interest expense		(34	)		(27	)		(29	)
Other income (charges)		5			(7	)		7

Income (loss) from continuing operations before taxes, equity in net income of affiliated companies and minority interest		168			97			(93	)
Benefit (provision) for income taxes		(38	)		(9	)		45
Equity in net income of affiliated companies, net of tax of $2, $3 and $2		12			12			12
Minority interest in net income, net of tax of $6, $3 and $3		(15	)		(12	)		(12	)

Income (loss) from continuing operations		127			88			(48	)
Income from discontinued businesses, net of tax		2			2			—

Income (loss) before cumulative effect of changes in accounting principles		129			90			(48	)
Loss from cumulative effect of changes in accounting principles, net of tax of $1		—			(2	)		—

Net income (loss)		129			88			(48	)
Dividends on preferred stock, net of tax of $1, $1 and $1		(1	)		(2	)		(3	)

Income (loss) available to common shares	$	128		$	86		$	(51	)

Weighted-average common shares outstanding, in millions:
Basic		62			60			60

Diluted		68			68			60

Income (loss) per common share:
Basic:
Continuing operations	$	2.03		$	1.42		$	(0.84	)
Income from discontinued businesses		0.03			0.03			—

Income (loss) before cumulative effect of changes in accounting principles	$	2.06		$	1.45		$	(0.84	)
Loss from cumulative effect of changes in accounting principles		—			(0.03	)		—

Net income (loss) per share—basic	$	2.06		$	1.42		$	(0.84	)

Diluted:
Continuing operations	$	1.87		$	1.28		$	(0.84	)
Income from discontinued businesses		0.03			0.03			—

Income (loss) before cumulative effect of changes in accounting principles	$	1.90		$	1.31		$	(0.84	)
Loss from cumulative effect of changes in accounting principles		—			(0.03	)		—

Net income (loss) per share—diluted	$	1.90		$	1.28		$	(0.84	)

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

CABOT CORPORATION

CONSOLIDATED BALANCE SHEETS

ASSETS


	September 30
	2007			2006
	(In millions, except share and per share amounts)
Current assets:
Cash and cash equivalents	$	154		$	189
Short-term marketable securities investments		2			1
Accounts and notes receivable, net of reserve for doubtful accounts of $6 and $6		563			534
Inventories		442			420
Prepaid expenses and other current assets		72			75
Deferred income taxes		35			36
Assets held for sale		7			—

Total current assets		1,275			1,255

Investments:
Equity affiliates		65			59
Long-term marketable securities and cost investments		3			3

Total investments		68			62

Property, plant and equipment		2,823			2,531
Accumulated depreciation and amortization		(1,807	)		(1,567	)

Net property, plant and equipment		1,016			964

Goodwill		34			31
Intangible assets, net of accumulated amortization of $10 and $9		4			5
Assets held for rent		42			40
Deferred income taxes		120			100
Other assets		77			77

Total assets	$	2,636		$	2,534

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

CABOT CORPORATION

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS’ EQUITY


	September 30
	2007			2006
	(In millions, except share and per share amounts)
Current liabilities:
Notes payable to banks	$	67		$	58
Accounts payable and accrued liabilities		427			384
Income taxes payable		36			27
Deferred income taxes		2			2
Current portion of long-term debt		15			34

Total current liabilities		547			505

Long-term debt		503			459
Deferred income taxes		16			20
Other liabilities		300			286
Commitments and contingencies (Note S)
Minority interest		76			68
Stockholders’ equity:
Preferred stock:
Authorized: 2,000,000 shares of $1 par value
Series B ESOP Convertible Preferred Stock 7.75% Cumulative:
Authorized: 200,000 shares
Issued: None and 55,895 shares		—			56
Outstanding: None and 38,734 shares (aggregate redemption value of $39 at $1,000 per share)
Less cost of zero and 17,161 shares of preferred treasury stock		—			(38	)
Common stock:
Authorized: 200,000,000 shares of $1 par value
Issued: 65,424,674 and 63,579,040 shares		65			64
Outstanding: 65,279,803 and 63,432,651 shares
Less cost of 144,871 and 146,389 shares of common treasury stock		(5	)		(5	)
Additional paid-in capital		—			7
Retained earnings		1,119			1,160
Deferred employee benefits		(34	)		(38	)
Notes receivable for restricted stock		(19	)		(20	)
Accumulated other comprehensive income		68			10

Total stockholders’ equity		1,194			1,196

Total liabilities and stockholders’ equity	$	2,636		$	2,534

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

CABOT CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS


	Years Ended September 30
	2007			2006			2005
	(In millions)
Cash Flows from Operating Activities:
Net income (loss)	$	129		$	88		$	(48	)
Adjustments to reconcile net income (loss) to cash provided by operating activities:
Depreciation and amortization		149			131			142
Deferred tax (provision) benefit		(27	)		2			(57	)
Cumulative effect of accounting changes		—			2			—
Equity in net income of affiliated companies		(12	)		(12	)		(12	)
Minority interest in net income		15			12			12
Asset impairment charges		—			8			221
Non-cash compensation		23			26			27
Expense of acquired in-process research and development		4			—			—
Other non-cash charges, net		2			1			(4	)
Changes in assets and liabilities, net of acquisitions and the effect of consolidation of equity affiliates:
Accounts and notes receivable		(6	)		(58	)		(39	)
Inventories		(8	)		82			(9	)
Prepaid expenses and other current assets		16			(22	)		5
Accounts payable and accrued liabilities		20			24			26
Income taxes payable		2			(41	)		11
Other liabilities		(11	)		2			(48	)
Cash dividends received from equity affiliates		7			5			3
Other		6			2			(12	)

Cash provided by operating activities		309			252			218

Cash Flows from Investing Activities:
Additions to property, plant and equipment		(141	)		(188	)		(186	)
Acquisition of interest in equity affiliate		—			(19	)		—
Acquisition of in-process research and development		(4	)		—			—
Proceeds from sales of property, plant and equipment		5			9			1
Increase in assets held for rent		(3	)		(3	)		(4	)
Purchase of marketable securities investments		(95	)		(20	)		(94	)
Proceeds from maturity of marketable securities investments		95			56			164

Cash used in investing activities		(143	)		(165	)		(119	)

Cash Flows from Financing Activities:
Borrowings under financing arrangements		70			31			1
Repayments under financing arrangements		(55	)		(7	)		(7	)
Proceeds from long-term debt		72			34			90
Repayments of long-term debt		(47	)		(44	)		(88	)
Increase in notes payable to banks, net		(8	)		—			15
Repayments of debt related to Cabot Japan		(1	)		(25	)		—
Proceeds from cash contributions received from minority interest stockholders		—			2			6
Proceeds from sales of common stock		9			9			5
Purchases of common stock		(202	)		(39	)		(52	)
Cash dividends paid to minority interest stockholders		(12	)		(7	)		(8	)
Cash dividends paid to stockholders		(48	)		(43	)		(43	)
Proceeds from restricted stock loan repayments		11			7			6

Cash used in financing activities		(211	)		(82	)		(75	)

Effect of exchange rate changes on cash		10			3			(2	)

Increase (decrease) in cash and cash equivalents		(35	)		8			22
Cash and cash equivalents at beginning of year		189			181			159

Cash and cash equivalents at end of year	$	154		$	189		$	181

Income taxes paid	$	39		$	18		$	34
Interest paid		30			28			26
Restricted stock issued for notes receivable, net of forfeitures		10			7			6

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)


	Preferred Stock, net of Treasury Stock					Common Stock, net of Treasury Stock					Additional Paid-In Capital			Retained Earnings			Unearned Compensation			Deferred Employee Benefits			Notes Receivable for Restricted Stock			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity			Total Comprehensive Income
	Shares		Cost			Shares		Cost			Additional Paid-In Capital			Retained Earnings			Unearned Compensation			Deferred Employee Benefits			Notes Receivable for Restricted Stock			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity			Total Comprehensive Income
2005
Balance at September 30, 2004	47		$	26		62,893		$	58		$	52		$	1,218		$	(49	)	$	(45	)	$	(19	)	$	(50	)	$	1,191
Net loss															(48	)																$	(48	)
Foreign currency translation adjustments, net of tax of $—																											22						22
Changes in unrealized loss on derivative instruments, net of tax of $3																											(6	)					(6	)
Minimum pension liability adjustment, net of tax of $3																											(5	)					(5	)

Other comprehensive income																																	11

Comprehensive income																														(37	)	$	(37	)

Common dividends paid															(40	)														(40	)
Issuance of stock under employee compensation plans, net of forfeitures						1,280			1			26						(19	)					(8	)					—
Tax benefit on vesting of restricted stock												2																		2
Purchase and retirement of common stock						(1,884	)		(2	)		(50	)																	(52	)
Preferred stock conversion	(3	)		(3	)	531			1			2																		—
Preferred dividends paid to Employee Stock Ownership Plan, net of tax benefit of $1															(3	)														(3	)
Principal payment by Employee Stock Ownership Plan under guaranteed loan																					3									3
Amortization of unearned compensation																		27												27
Notes receivable for restricted stock—payments and forfeitures																								8						8

Balance at September 30, 2005	44		$	23		62,820		$	58		$	32		$	1,127		$	(41	)	$	(42	)	$	(19	)	$	(39	)	$	1,099

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)


	Preferred Stock, net of Treasury Stock					Common Stock, net of Treasury Stock					Additional Paid-In Capital			Retained Earnings			Unearned Compensation			Deferred Employee Benefits			Notes Receivable for Restricted Stock			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity			Total Comprehensive Income
	Shares		Cost			Shares		Cost			Additional Paid-In Capital			Retained Earnings			Unearned Compensation			Deferred Employee Benefits			Notes Receivable for Restricted Stock			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity			Total Comprehensive Income
2006
Balance at September 30, 2005	44		$	23		62,820		$	58		$	32		$	1,127		$	(41	)	$	(42	)	$	(19	)	$	(39	)		1,099
Net income															88																	$	88
Foreign currency translation adjustments, net of tax of $5																											29						29
Changes in unrealized gain on derivative instruments, net of tax of $3																											6						6
Minimum pension liability adjustment, net of tax of $6																											14						14

Other comprehensive income																																	49

Comprehensive income																														137		$	137

Common dividends paid															(41	)														(41	)
Issuance of stock under employee compensation plans, net of forfeitures						1,089			1			42												(10	)					33
Purchase and retirement of common and treasury stock						(1,233	)		(1	)		(38	)																	(39	)
Preferred stock conversion	(5	)		(5	)	757			1			4																		—
Preferred dividends paid to Employee Stock Ownership Plan, net of tax benefit of $1															(2	)														(2	)
Principal payment by Employee Stock Ownership Plan under guaranteed loan																					4									4
Reversal of unearned compensation upon the implementation of FAS 123 (R)												(29	)		(12	)		41												—
Cumulative effect of change in accounting principle												(4	)																	(4	)
Notes receivable for restricted stock—payments and forfeitures																								9						9

Balance at September 30, 2006	39		$	18		63,433		$	59		$	7		$	1,160		$	—		$	(38	)	$	(20	)	$	10		$	1,196

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)


	Preferred Stock, net of Treasury Stock					Common Stock, net of Treasury Stock					Additional Paid-in Capital			Retained Earnings			Deferred Employee Benefits			Notes Receivable for Restricted Stock			Accumulated Other Comprehensive Income			Total Stockholders’ Equity			Total Comprehensive Income
	Shares		Cost			Shares		Cost			Additional Paid-in Capital			Retained Earnings			Deferred Employee Benefits			Notes Receivable for Restricted Stock			Accumulated Other Comprehensive Income			Total Stockholders’ Equity			Total Comprehensive Income
2007
Balance at September 30, 2006	39		$	18		63,433		$	59		$	7		$	1,160		$	(38	)	$	(20	)	$	10		$	1,196
Net income															129														$	129
Foreign currency translation adjustment, net of tax of $12																								51						51
Change in unrealized gain on derivative instruments, net of tax of $4																								8						8
Minimum pension liability, net of tax of $3																								6						6

Other comprehensive income																														65

Comprehensive income																											194		$	194

Common dividends paid															(47	)											(47	)
Issuance of stock under employee compensation plans, net of forfeitures						1,041			1			26									(11	)					16
Amortization of share-based compensation												23															23
Tax benefit on vesting of restricted stock												6															6
Purchase and retirement of common and treasury stock						(4,864	)		(5	)		(96	)		(101	)											(202	)
Preferred stock conversion	(39	)		(18	)	5,670			5			34			(21	)											—
Preferred dividends paid to Employee Stock Ownership Plan, net of tax benefit of $1															(1	)											(1	)
Principal payment by Employee Stock Ownership Plan under guaranteed loan																		4									4
Notes receivable for restricted stock—payments and forfeitures																					12						12
Effect of the adoption of FAS 158, net of tax of $1																								(7	)		(7	)

Balance at September 30, 2007	—		$	—		65,280		$	60		$	—		$	1,119		$	(34	)	$	(19	)	$	68		$	1,194

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

Notes to Consolidated Financial Statements

Note A. Significant Accounting Policies

The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States. The significant accounting policies of Cabot Corporation (“Cabot” or “the Company”) are described below.

Principles of Consolidation

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

Basis of Presentation

Certain amounts in the fiscal 2006 and 2005 cash flow presentation have been reclassified to conform to the fiscal 2007 cash flow presentation. There have been no changes to operating, investing or financing cash flows as a result of these reclassifications.


	Year Ended September 30, 2006
	As previously reported			As reclassified
Cash flows from operating activities
Cash dividends received from equity affiliates	$	—		$	5
Other		7			2

Total	$	7		$	7

Cash flows from financing activities
Borrowings under financing arrangements	$	65		$	31
Repayments under financing arrangements		(51	)		(7	)
Proceeds from long-term debt		—			34
Repayments of long-term debt		—			(44	)

Total	$	14		$	14


	Year Ended September 30, 2005
	As previously reported			As reclassified
Cash flows from operating activities
Cash dividends received from equity affiliates	$	—			3
Other		(9	)		(12	)

Total	$	(9	)	$	(9	)

Cash flows from financing activities
Borrowings under financing arrangements	$	91		$	1
Repayments under financing arrangements		(95	)		(7	)
Proceeds from long-term debt		—			90
Repayments of long-term debt		—			(88	)

Total	$	(4	)	$	(4	)

Cash and Cash Equivalents

Cash equivalents include all highly liquid investments with a maturity of three months or less at date of acquisition. The cash balance excludes checks issued but not paid of $5 million and $8 million that are included in notes payable to banks on the consolidated balance sheets at September 30, 2007 and 2006, respectively.

Inventories

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

Investments

The Company has investments in equity affiliates and marketable securities. As circumstances warrant, all investments are subject to periodic impairment reviews. Unless consolidation is required, investments in equity affiliates, where Cabot generally owns between 20% and 50% of the affiliate, are accounted for using the equity method. Cabot records its share of the equity affiliate’s results of operations based on its percentage of ownership of the affiliate. Dividends received from equity affiliates are a return on investment and are recorded as a reduction to the equity investment value. All investments in marketable securities are classified as available-for-sale and are recorded at their fair market values with the corresponding unrealized holding gains or losses, net of taxes, recorded as a separate component of other comprehensive income within stockholders’ equity. Unrealized losses that are determined to be other than temporary, based on current and expected market conditions, are recognized in net income. The fair value of marketable securities is determined based on quoted market prices at the balance sheet dates. The cost of marketable securities sold is determined by the specific identification method. Investments that do not have readily determinable market values are recorded at cost. Short-term investments consist of investments in marketable securities with maturities of one year or less.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Depreciation of property, plant and equipment is calculated using the straight-line method over the estimated useful lives. The depreciable lives for buildings, machinery and equipment, and other fixed assets are twenty to twenty-five years, ten to twenty years, and three to twenty-five years, respectively. The cost and accumulated depreciation for property, plant and equipment sold, retired, or otherwise disposed of are removed from the consolidated balance sheets and resulting gains or losses are included in income from continuing operations in the consolidated statements of operations.

Expenditures for repairs and maintenance are charged to expenses as incurred. Expenditures for major renewals and betterments, which significantly extend the useful lives of existing plant and equipment, are capitalized and depreciated.

Cabot capitalizes interest cost in accordance with Financial Accounting Standard (“FAS”) No. 34, “Capitalization of Interest Cost.” This statement establishes standards for capitalizing interest cost as part of the historical cost of acquiring and constructing certain assets that require a period of time to get them ready for their intended use. During fiscal years 2007, 2006 and 2005, Cabot capitalized $1 million, $3 million, and $2 million, respectively, of interest cost as part of the cost of constructing manufacturing lines in China, Brazil and the U.S. These amounts will be amortized over the life of the related assets.

Goodwill and Other Intangible Assets

impairment at least annually. The annual review consists of the comparison of each reporting unit’s carrying value to its fair value, which is performed as of March 31. The fair value of a reporting unit is based on discounted estimated future cash flows. The assumptions used to estimate fair value include management’s best estimates of future growth rates, capital expenditures, discount rates and market conditions over an estimate of the remaining operating period. If an impairment exists, a loss is recorded to write-down the value of goodwill to its implied fair value.

Cabot’s intangible assets are primarily comprised of patented and unpatented technology and other intellectual property. Finite lived intangible assets are amortized over their estimated useful lives. Amortization expense was $1 million in each of fiscal years 2007, 2006, and 2005.

Assets Held for Rent

Assets held for rent represent cesium formate product in the Specialty Fluids Business that will be rented to customers in the normal course of business. Assets held for rent are stated at average cost. At September 30, 2007 and 2006 Cabot had assets held for rent of $42 million and $40 million, respectively.

Assets Held for Sale

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

During the fourth quarter of fiscal 2007, the Company classified $7 million of land acquired in connection with the purchase of Showa Cabot K.K. (see further discussion in Note B) as assets held for sale.

Asset Retirement Obligations

Cabot accounts for asset retirement obligations in accordance with FAS No. 143, “Accounting for Asset Retirement Obligations” (“FAS 143”) and Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). Pursuant to FAS 143, companies are required to estimate incremental costs for special handling, removal and disposal 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. FIN 47 clarified that ARO liabilities and costs must be recognized when the timing and/or settlement can be reasonably estimated. If it is unclear when or if an ARO will be triggered, companies are required to use probability weighting for possible timing scenarios to determine the amounts that should be recognized in the company’s 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 which could give rise to an ARO, and (d) other factors outside a company’s control, including changes in regulations, costs and interest rates. AROs have not been recognized for certain of the Company’s facilities because either the present value of the obligation cannot be reasonably estimated due to an indeterminable facility life, or the Company does 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 the estimates considered by the Company, which may, in turn, impact the Company’s 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.

The Company adopted FIN 47 in the fourth quarter of 2006, which resulted in the recognition of an ARO reserve of $7 million and an after tax charge of $4 million. This charge is reflected as a cumulative effect of a change in accounting principle in the consolidated statements of operations. As of September 30, 2007, the ARO reserves were $10 million. The increase in the reserve during 2007 was due to the accretion of current year costs, as well as changes to certain cost estimates and estimated retirement date of certain facilities. The pro forma effect of applying this guidance in all prior periods presented was determined not to be material.

Impairment of Long-Lived Assets

Cabot’s long-lived assets include property, plant and equipment, long-term investments and intangible assets. The carrying values of long-lived assets are reviewed for impairment whenever events or changes in business circumstances indicate that the carrying amount of an asset may not be recoverable. An asset impairment is recognized when the carrying value of the asset is not recoverable based on the undiscounted estimated future cash flows to be generated by the asset. Cabot’s estimates reflect management’s assumptions about selling prices, production and sales volumes, costs and market conditions over an estimate of the remaining operating period. If an impairment is indicated, the asset is written down to fair value. In circumstances when an asset does not have separate identifiable cash flows, an impairment charge is recorded when Cabot is no longer using the asset.

Foreign Currency Translation

The functional currency of the majority of Cabot’s foreign subsidiaries is the local currency in which the subsidiaries operate. Assets and liabilities of foreign subsidiaries are translated into U.S. dollars at exchange rates in effect at the balance sheet dates. Income and expense items are translated at average monthly exchange rates during the year. Unrealized currency translation adjustments are accumulated as a separate component of other comprehensive income within stockholders’ equity. Realized and unrealized foreign currency gains and losses arising from transactions denominated in currencies other than the subsidiary’s functional currency are reflected in net income with the exception of (i) intercompany transactions considered to be of a long-term investment nature; and (ii) foreign currency borrowings designated as net investment hedges. Gains or losses arising from these transactions are also included as a component of other comprehensive income. Certain gains and losses are offset by derivative instruments held, as discussed in Note K. Included in other charges are net foreign currency transaction gains of $7 million in 2007, losses of $1 million in 2006 and gains of $2 million in 2005. Cabot recorded a loss of $8 million in 2006 and a gain of $2 million in 2005 related to currency translation adjustments recorded upon substantial liquidation of certain Cabot subsidiaries. There were no substantial liquidations of Cabot subsidiaries during 2007.

Financial Instruments

Cabot’s financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, short-term and long-term debt, and derivative instruments. The carrying values of Cabot’s financial instruments approximate fair value, with the exception of long-term debt that has not been designated with a fair value hedge. This portion of long-term debt is recorded at face value. The fair values of derivative instruments are based on quoted market prices. Derivative financial instruments are used to manage certain of Cabot’s foreign currency and interest rate exposures, which exist as part of the Company’s on-going business operations. Cabot does not enter into financial instruments for speculative purposes, nor does Cabot hold or issue any financial instruments for trading purposes. Derivative financial instruments are accounted for in accordance with FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by FAS No. 138, “Accounting for Derivative Instruments and Hedging

Activities” and related interpretations (“FAS 133”), and are measured and recorded at fair value on the consolidated balance sheets. Cabot formally documents the relationships between hedging instruments and hedged items, as well as its risk management objective.

Hedge accounting is followed for derivatives that have been designated and qualify as fair value, cash flow or net investment hedges. For fair value hedges, the Company records in earnings (i) changes in the fair value of highly effective derivatives and (ii) changes in the fair value of the hedged liabilities that are attributable to the hedged risks. For cash flow hedges, changes in the fair value of the effective portion of the derivatives’ gains or losses are reported in other comprehensive income and changes in the fair value of the ineffective portion are reported in earnings. For net investment hedges, changes in the fair value of the effective portion of the derivatives’ gains or losses are reported as foreign currency translation gains or losses in other comprehensive income while changes in the ineffective portion are reported in earnings. 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 item. From time to time, the Company may enter into certain derivative instruments that may not be designated as hedges under FAS 133. Although these derivatives do not qualify for hedge accounting, Cabot believes that such instruments are closely correlated with the underlying exposure, thus managing the associated risk. The gains or losses from changes in the fair value of derivative instruments that are not accounted for as hedges are recognized in earnings.

Revenue Recognition

Cabot derives most of its revenues from the sale of rubber blacks, performance products, fumed metal oxides, 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 terms. Customers are also billed and revenue is recognized, typically at the end of the job, for cesium formate product that is not returned. Other operating revenues, which represent less than ten percent of total revenues, include tolling, servicing and royalties for licensed technology.

Cabot’s revenue recognition policies are in compliance with Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which establishes criteria that must be satisfied before revenue is realized or realizable and earned. Cabot recognizes revenue when persuasive evidence of a sales arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable. Cabot generally is able to ensure that products meet customer specifications prior to shipment. If the Company is unable to determine that the product has met the specified objective criteria prior to shipment, the revenue is deferred until product acceptance has occurred.

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

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

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

Accounts and notes receivable as of September 30, 2007 and 2006 primarily include trade accounts receivable, which arise in the normal course of business, of $540 million and $508 million, respectively,

income tax receivables of $5 million and $18 million, respectively, and the current portion of notes receivable of $24 million and $14 million, respectively. Trade receivables are recorded at the invoiced amount and do not bear interest. Trade receivables in China may be settled with the receipt of bank issued non-interest bearing notes. These China notes totaled 170 million Chinese Renminbi (RMB) ($23 million) and 100 million RMB ($13 million) as of September 30, 2007 and 2006, respectively, and are included in accounts and notes receivable. Cabot periodically sells a portion of the trade receivables in China at a discount. These transactions are accounted for as sales under the provisions of FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”). The difference between the proceeds from the sale and the carrying value of the receivables is recognized as a loss on the sale of receivables and is included in other income (charges) in the accompanying consolidated statements of operations. During fiscal years 2007 and 2006, the Company recorded charges of $2 million and $1 million, respectively, for the sale of these receivables.

Cabot maintains allowances for doubtful accounts based on an assessment of the collectibility of specific customer accounts, the aging of accounts receivable and other economic information on both a 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 2007 and 2006 were not material. There is no off-balance sheet credit exposure related to customer receivable balances.

Stock-based Compensation

On October 1, 2005, Cabot adopted FAS No. 123(R), “Accounting for Stock-Based Compensation,” using the modified prospective method, which resulted in the provisions of FAS 123(R) being applied to the consolidated financial statements on a going-forward basis beginning in fiscal year 2006. The table in Note N presents 2005 compensation expense that would have been recorded in earnings had the fair value provisions been adopted in fiscal 2005. FAS 123(R) requires companies to recognize stock-based awards granted to employees as compensation expense on a fair value method. Under the fair value recognition provisions of FAS 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the service period, which generally represents the vesting period, and includes an estimate of the awards that will be forfeited. Cabot calculates the fair value of its stock options using the Black-Scholes option pricing model and the fair value of restricted stock using the intrinsic value method.

Research and Technical Expenses

Research and technical expenses disclosed in the consolidated statements of operations are expensed as incurred in accordance with FAS No. 2, “Accounting for Research and Development Costs.” Research and technical expenses include salaries, equipment and material expenditures, and contractor fees.

Income Taxes

Deferred income taxes are determined based on the estimated future tax effects of differences between financial statement carrying amounts and the tax bases of existing assets and liabilities. Deferred tax assets are recognized to the extent that realization of those assets is considered to be more likely than not. A valuation allowance is established for deferred taxes when it is more likely than not that all or a portion of the deferred tax assets will not be realized. Provisions are made for the U.S. income tax liability and additional non-U.S. taxes on the undistributed earnings of non-U.S. subsidiaries, except for amounts Cabot has designated to be indefinitely reinvested.

Accumulated Other Comprehensive Income

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

minimum pension liability adjustments and the effect of the adoption of FAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“FAS 158”).

Environmental Costs

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

Use of Estimates

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

Newly Issued Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. FAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. FAS 159 is effective for fiscal years beginning after November 15, 2007, which will be fiscal 2009 for Cabot. The Company is evaluating the impact of FAS 159 on its consolidated financial statements.

In September 2006, the FASB issued FAS No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 provides guidance for using fair value to measure assets and liabilities and requires additional disclosure about the use of fair value measures, the information used to measure fair value, and the effect fair-value measurements have on earnings. The primary areas in which the Company utilizes fair value measures are valuing pension plan assets and liabilities, valuing hedge-related derivative financial instruments, allocating purchase price to the assets and liabilities of acquired companies, and evaluating long-term assets for potential impairment. FAS 157 does not require any new fair value measurements. FAS 157 is effective for the Company beginning October 1, 2008. The Company is evaluating the impact of FAS 157 on its consolidated financial statements.

In September 2006, the FASB issued FAS 158. FAS 158 requires an employer to recognize the funded status of a benefit plan, measured as the difference between plan assets at fair value and the projected benefit obligation (“PBO”), in its consolidated balance sheets. FAS 158 also requires an employer to

measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year end. As of September 30, 2007, Cabot adopted the balance sheet impact of reflecting the funded status of the plan using the current June 30 measurement date. As required by FAS 158, on or before September 30, 2009, Cabot will change its measurement date to the Company’s September 30 year end rather than the current June 30 measurement date. The Company is continuing to evaluate the impact of the adoption of the change in measurement date related to the second part of FAS 158 on its consolidated financial statements. Refer to Note M for further information related to the Company’s pension and post-retirement plans.

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109” (“FIN 48”), which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its consolidated financial statements uncertain tax positions that the company has taken or expects to take on a tax return, including a decision whether or not to file a return in a particular jurisdiction. Under this new guidance, the consolidated financial statements will reflect expected future tax consequences of such positions presuming the taxing authorities’ full knowledge of the position and all relevant facts, but without considering the time value of money. This guidance also revises disclosure requirements and introduces a prescriptive annual, tabular roll-forward of unrecognized tax benefits. FIN 48 is effective for annual periods beginning after December 15, 2006, which will be fiscal 2008 for Cabot. The Company continues to evaluate the impact of FIN 48 on its consolidated financial statements, however a preliminary evaluation indicates that Cabot will record an additional liability in the range of $10 million to $20 million, which will be recorded through the consolidated statements of stockholders’ equity during the first quarter of fiscal 2008.

Note B. Acquisitions

AP Materials

On August 31, 2007, Cabot exercised an option to purchase substantially all of the assets of AP Materials, Inc., a development stage enterprise with proprietary flame synthesis technology, for a total purchase price of approximately $4 million.

This transaction has been accounted for in accordance with FAS No. 142, “Goodwill and Other Intangible Assets,” (“FAS 142”). Based on an evalution prepared with the assistance of an independent valuation consultant, the total purchase price of $4 million represented the estimated fair value of the in-process research and development project that had not yet reached technological feasibility and had no alternative future use. Accordingly, the amount was immediately expensed and recorded in research and technical expense in the consolidated statement of operations.

The estimated fair value of this project was determined using the discounted cash flow method. The discount rates used take into account the stage of completion and the risks associated with the successful development and commercialization of the purchased in-process research and development project.

Cabot Japan K.K.

Cabot had a 50:50 joint venture arrangement with Showa Denko K.K. in an entity called Showa Cabot K.K. (“SCK”). On November 8, 2005, Cabot purchased Showa Denko K.K.’s 50% joint venture interest in SCK for $19 million and renamed the entity Cabot Japan K.K. (“Cabot Japan”). As a result of the acquisition and consolidation of Cabot Japan, Cabot assumed the remaining 50% of SCK’s debt obligations of $13 million for total debt of $26 million at the date of acquisition. In addition, Cabot assumed $8 million of Showa Cabot’s pension liabilities.

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

The fair value of the assets acquired and liabilities and debt assumed represents the 50% of SCK that Cabot purchased in 2006. The following table summarizes the purchased 50% of the fair values of the assets acquired and liabilities assumed at the date of acquisition:


	2006 (Dollars in millions)
Cash paid	$	19

Accounts receivable	$	20
Inventories		5
Deferred income taxes		1
Investments in marketable securities		1
Property, plant and equipment		33

Total assets acquired	$	60

Accounts payable and accrued expenses		26
Notes payable		13
Pension obligation		8

Total liabilities assumed	$	47

Net assets acquired	$	13

Goodwill	$	6

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


	Twelve Months Ended September 30
	2006			2005
	(In millions, except per share amounts)
Net Sales	$	2,555		$	2,259

Income from continuing operations	$	90		$	(43	)
Income from discontinued businesses, net of tax		2			—
Cumulative effect of accounting changes, net of tax		(2	)		—
Dividends on preferred stock, net of tax benefit		(2	)		(3	)

Net income (loss)	$	88		$	(46	)

Net income (loss) per common share:
Basic:
Continuing operations	$	1.42		$	(0.79	)
Income from discontinued businesses		0.03			—
Loss from cumulative effect of changes in accounting principles		(0.03	)		—

Net income (loss) per share—basic	$	1.42		$	(0.79	)

Diluted:
Continuing operations	$	1.29		$	(0.79	)
Income from discontinued businesses		0.03			—
Loss from cumulative effect of changes in accounting principles		(0.03	)		—

Net income (loss) per share—diluted	$	1.29		$	(0.79	)

Note C. Discontinued Operations

In fiscal year 2007, Cabot recorded income from discontinued operations of $2 million which included tax benefits of $3 million relating to legal and tax settlements, offset by a charge of less than $1 million for legal settlements. During fiscal 2006, the Company recorded income of $2 million relating to favorable tax settlements.

Cabot did not have income or charges related to discontinued operations in fiscal year 2005.

Note D. Long-Lived Asset Impairment

During the second quarter of fiscal year 2005, management determined, based on a combination of factors associated with the anticipated future performance of the Supermetals Business, that the long-lived assets (including goodwill) of this Business may not be recoverable and thus an impairment analysis was performed. These factors included the continuing trend toward the use of smaller tantalum capacitors in electronic devices, resulting in significantly less tantalum powder being required for each capacitor, the continued high inventory levels in the supply chain and the expected decrease in tantalum powder sales volume and pricing as the Business was transitioning from fixed volume, fixed price contracts to market based volumes and pricing. The impairment analysis indicated that the estimated undiscounted cash flows of the Business, determined to be the lowest level of identifiable cash flows, were sufficient to recover the carrying value of the long-lived assets over their remaining useful lives. However, based on the estimated discounted cash flows of the Business, it was determined that the fair value of this reporting unit was below its carrying amount and that a full impairment of the goodwill existed. Accordingly, the Company was required to write-off the entire $90 million goodwill balance of the reporting unit during the second quarter of fiscal 2005.

During the fourth quarter of fiscal year 2005, events occurred that required management to re-evaluate the anticipated future performance of the Supermetals Business. These events included the decision by management in August 2005 to exit the manufacture and sale of finished tantalum sputtering targets, which was previously forecasted to be an important contributor to the future cash flows of the Business, and the increased likelihood of higher tantalum ore costs under the Company’s purchase commitments with the Sons of Gwalia. These factors, combined with significantly lower market prices for tantalum powder than anticipated when the impairment analysis was performed in the second quarter of fiscal 2005, led management to believe that the Business’s remaining long-lived assets, after the goodwill write-off, may not be recoverable, and that a further impairment analysis was necessary. In this analysis, the carrying amount of the Business’s long-lived assets (consisting primarily of property, plant and equipment) was compared to the sum of the estimated undiscounted cash flows expected from the Business’s use of the assets over their remaining useful lives. This comparison indicated that the carrying value of the long-lived assets was in excess of their undiscounted cash flows and, therefore, an impairment existed. The Company, with the assistance of independent valuation specialists, determined the fair value of the Business’s long-lived assets using estimated discounted cash flows that the Company believed would be forecasted by a purchaser of the Business. Since this analysis indicated that a full write-down of the long-lived assets was warranted, and to ensure that individual assets were not written down below their fair market value, the Company engaged independent valuation specialists to perform appraisals of individual assets. The excess of the carrying amount of the assets over their fair market value resulted in a $121 million charge that was recorded in the fourth quarter of fiscal year 2005.

During fiscal year 2005, the Supermetals Business also recorded a charge of $15 million associated with on-going cost reduction initiatives. These charges included $8 million of asset write downs associated with management’s decision to stop manufacturing and selling finished tantalum sputtering targets to the semiconductor industry and to instead focus on the sale of tantalum plate and ingot to sputtering target manufacturers, as well as $3 million of severance charges and $3 million of charges related to the write down of assets associated with abandoned research and development projects.

The impairment charges recorded during fiscal 2005 in the Supermetals Business are reported as a component of loss from continuing operations in the accompanying consolidated statements of operations.

Note E. Inventories

Inventories, net of LIFO reserves, are as follows:


	September 30
	2007		2006
	(Dollars in millions)
Raw materials	$	154	$	131
Work in process		77		109
Finished goods		184		139
Other		27		41

Total	$	442	$	420

Inventories valued under the LIFO method comprised approximately 23% and 29% of total inventories in 2007 and 2006, respectively. At September 30, 2007 and 2006, the LIFO reserve recorded was $95 million and $76 million, respectively. Other inventory is comprised of certain spare parts and supplies.

During fiscal years 2007 and 2006, inventory quantities were reduced at the Company’s U.S. Supermetals site. Additionally, during fiscal 2006 inventory quantities were reduced at the Company’s U.S. Carbon Black operations. These reductions led to a liquidation of LIFO inventory quantities at the U.S. Supermetals site during fiscal 2007 and 2006, and in the U.S. Carbon Black operations during fiscal 2006. These LIFO layer liquidations resulted in a decrease of cost of goods sold of $4 million and $6 million and an increase of net income of $3 million, or $0.04 per share and $4 million, or $0.06 per share for the years ended September 30, 2007 and 2006, respectively. There was no liquidation of LIFO layers in inventories in 2005.

Note F. Investments

Equity Affiliates—Cabot has investments in equity affiliates in the Carbon Black and Metal Oxides Businesses. These investments are accounted for using the equity method. Cabot does not disclose its equity affiliate financial statements separately by entity because none of them are individually material to the consolidated financial statements. The following summarized results of operations and financial position include Cabot’s equity based affiliates for the periods presented below (except Cabot Japan, of which 50% was included for the 2005 pre-acquisition periods):


	September 30
	2007		2006		2005
	(Dollars in millions)
Condensed Income Statement Information:
Net sales	$	261	$	248	$	297
Gross profit		71		49		86
Net income		26		18		23

Condensed Balance Sheet Information:
Current assets	$	93	$	96	$	124
Non-current assets		87		90		126
Current liabilities		33		51		113
Non-current liabilities		20		21		17
Net assets		127		114		120

At September 30, 2007 and 2006, Cabot had equity affiliate investments of $65 million and $59 million, respectively. Dividends received from these investments were $10 million, $5 million and $3 million in 2007, 2006 and 2005, respectively.

Marketable Securities—Cabot holds short-term and long-term investments in available-for-sale marketable securities. These investments had a fair market value of $4 million and $3 million at September 30, 2007 and 2006, respectively, which includes $1 million of unrealized gains in each year that have been excluded from earnings and reported as a separate component of other comprehensive income within stockholders’ equity. During fiscal 2007 and 2006, Cabot purchased $95 million and $20 million of available-for-sale securities, respectively. Proceeds from sales of available-for-sale securities were $95 million and $56 million in 2007 and 2006, respectively. There were no gross realized gains (losses) from the sale of available-for-sale securities in fiscal 2007 and 2006. Additionally, the Company did not record any unrealized losses to earnings from impaired investments during fiscal 2007 and 2006. The majority of available-for-sale marketable securities that matured were auction rate securities and as of September 30, 2007 the Company did not hold any investments in auction rate securities. At September 30, 2007 and 2006, $2 million and $1 million, respectively, are classified as short-term investments and $2 million are classified as long-term investments for both periods.

No divdends were received from available-for-sale marketable securities during the years ended September 30, 2007, 2006 and 2005.

Cost Investments—Cabot had cost-based investments in the amount of $1 million at both September 30, 2007 and 2006, which are classified as long-term. No sales of cost-based investments occurred during fiscal 2007, 2006 and 2005.

Note G. Property, Plant and Equipment

Property, plant and equipment is summarized as follows:


	September 30
	2007			2006
	(Dollars in millions)
Land and improvements	$	71		$	72
Buildings		397			384
Machinery and equipment		2,093			1,795
Other		134			95
Construction in progress		128			185

Total property, plant and equipment		2,823			2,531
Less: accumulated depreciation		(1,807	)		(1,567	)

Net property, plant and equipment	$	1,016		$	964

Depreciation expense was $148 million, $130 million and $141 million for fiscal 2007, 2006 and 2005, respectively.

Note H. Goodwill and Other Intangible Assets

At September 30, 2007 and 2006, Cabot had goodwill balances of $34 million and $31 million, respectively. The carrying amount of goodwill attributable to each reportable segment with goodwill balances and the changes in those balances during the years ended September 30, 2007 and 2006 are as follows:


	Carbon Black Business		Metal Oxides Business		Total
	(Dollars in millions)
Balance at September 30, 2005	$	15	$	10	$	25
Increase for acquisition of SCK		6		—		6

Balance at September 30, 2006	$	21	$	10	$	31
Foreign currency translation adjustment		2		1		3

Balance at September 30, 2007	$	23	$	11	$	34

As required by FAS 142, impairment tests are performed at least annually. The Company performed its annual FAS No. 142 impairment assessment as of March 31, 2007 and determined that there was no impairment.

Cabot does not have any indefinite-lived intangible assets. Finite-lived intangible assets consist of the following:


	Years Ended September 30
	2007							2006
	Gross Carrying Value		Accumulated Amortization			Net Intangible Assets		Gross Carrying Value		Accumulated Amortization			Net Intangible Assets
	(Dollars in millions)
Patents	$	13	$	(9	)	$	4	$	13	$	(8	)	$	5
Other intellectual property		1		(1	)		—		1		(1	)		—

Total	$	14	$	(10	)	$	4	$	14	$	(9	)	$	5

Intangible assets are amortized over their estimated useful lives, which range from two to fifteen years, with a weighted average amortization period of ten years. Amortization expense amounted to less than $1 million in 2007, 2006 and 2005, respectively, and is included in cost of goods sold. Amortization expense is estimated to be less than $1 million in each of the next five years.

In May 2006, Cabot entered into a cross license agreement with Aspen Aerogel, Inc. (“Aspen”) where each party granted certain patent rights to the other. In consideration for use of the patents granted by Cabot, the agreement called for Cabot to receive a total of $8 million of cash in ten equal semi-annual payments beginning on September 1, 2006 and the right to receive equity in Aspen. During the first quarter of fiscal 2007, a dispute arose between the parties over the equity consideration. During the fourth quarter of fiscal 2007, Cabot and Aspen entered into a settlement agreement whereby the equity payment by Aspen to Cabot was eliminated. Under the amended license agreement, Cabot is entitled to payments totaling $38 million. The Company received $2 million and $1 million in fiscal years 2007 and 2006, respectively, of installment payments which have been recorded in earnings. The remaining $35 million is payable in installments over the next six years, and will be recognized in earnings if and when collectibility is reasonably assured.

Note I. Accounts Payable, Accrued Liabilities and Other Liabilities

Accounts payable and accrued liabilities included in current liabilities consisted of the following:


	September 30
	2007		2006
	(Dollars in millions)
Accounts payable	$	305	$	252
Accrued employee compensation		45		36
Accrued restructuring		4		9
Other accrued liabilities		73		87

Total	$	427	$	384

Other long-term liabilities consisted of the following:


	September 30
	2007		2006
	(Dollars in millions)
Employee benefit plan liabilities	$	130	$	123
Non-current tax liabilities		46		45
Financial instrument liabilities		52		34
Other accrued liabilities		72		84

Total	$	300	$	286

Note J. Debt and Other Obligations

The Company’s long-term debt, the calendar year in which it matures and their respective interest rates are summarized below:


	September 30
	2007			2006
	(Dollars in millions)
Variable Rate Debt:
$400 million Revolving Credit Facility
Yen drawdown, due 2010, 1.36%	$	80		$	79
US Dollar drawdown, due 2010, 5.61%		50			—
US Dollar drawdown, due 2010, 5.44%		15			—
Chinese Renminbi Notes, due 2007 – 2012, 5.7% to 7.1%⁽¹⁾		31			—

Total variable rate debt		176			79

Fixed Rate Debt:
Medium Term Notes (average stated rate):
Notes due 2012 – 2022, 8.28%	$	44		$	44
Notes due 2009 – 2011, 7.21%		45			75
Notes due 2027, 7.28%		8			8
Note due 2027, 6.57%		1			1
Notes due 2018, 7.42%		30			30

Total Medium Term Notes		128			158
Euro Bond, due 2013, 5.25%, net of discount		174			173
Guarantee of ESOP Note, due 2013, 8.29%		34			38
Japanese Yen Debt, due 2008, 1.2%		—			1
Chinese Renminbi Notes, due 2008 – 2011, 5.2% to 6.2%⁽¹⁾		—			41
Other, due 2014 and 2027, 7.75% and 2%		4			1

Total fixed rate debt		340			412
Capital lease, due 2006 – 2021		2			2

		518			493
Less current portion of long-term debt		(15	)		(34	)

Total long-term debt	$	503		$	459

⁽¹⁾

~~INDEX TO FINANCIAL STATEMENTS~~

Description

Page
(1)

Consolidated Statements of Operations for each of the fiscal years ended September 30, 2006, 2005 and 2004

58

(2)

Consolidated Balance Sheets at September 30, 2006 and 2005

59

(3)

Consolidated Statements of Cash Flows for each of the fiscal years ended September 30, 2006, 2005 and 2004

61

(4)

Consolidated Statements of Changes in Stockholders’ Equity for each of the fiscal years ended September 30, 2006, 2005 and 2004

62

(5)

Notes to Consolidated Financial Statements

65

(6)

Report of Independent Registered Public Accounting Firm

115

~~CABOT CORPORATION~~
~~CONSOLIDATED STATEMENTS OF OPERATIONS~~

Years Ended September 30

2006

2005

2004

(In millions, except
per share amounts)

Net sales and other operating revenues

$
2,543

$
2,125

$
1,934

Cost of sales

2,124

1,692

1,457

Gross profit

419

433

477

Selling and administrative expenses

235

240

217

Research and technical expenses

58

59

53

Goodwill impairment charge

—

90

—

Long-lived asset impairment charge

—

121

—

Income (loss) from operations

126

(77
)
207

Interest and dividend income

5

6

6

Interest expense

(27
)
(29
)
(30
)
Other income (charges)

(7
)
7

(19
)
Income (loss) from continuing operations before taxes, equity in net income of affiliated companies and minority interest

97

(93
)
164

Benefit (provision) for income taxes

(9
)
45

(39
)
Equity in net income of affiliated companies, net of tax of $3, $2 and $4

12

12

6

Minority interest in net income, net of tax of $3, $3 and $1

(12
)
(12
)
(9
)
Income (loss) from continuing operations

88

(48
)
122

Income from discontinued businesses, net of tax

2

—

2

Income (loss) before loss from cumulative effect of changes in accounting principle

90

(48
)
124

Loss from cumulative effect of changes in accounting principles, net of tax of $1

(2
)
—

—

Net income (loss)

88

(48
)
124

Dividends on preferred stock, net of tax of $1, $1 and $1

(2
)
(3
)
(3
)
Income (loss) available to common shares

$
86

$
(51
)
$
121

Weighted-average common shares outstanding, in millions:

Basic

60

60

59

Diluted

68

60

68

Income (loss) per common share:

Basic:

Continuing operations

$
1.42

$
(0.84
)
$
2.04

Income from discontinued businesses

0.03

—

0.03

Income (loss) before loss from cumulative effect of changes in accounting principle

$
1.45

$
(0.84
)
$
2.07

Loss from cumulative effect of changes in accounting principles

(0.03
)
—

—

Net income (loss) per share—basic

$
1.42

$
(0.84
)
$
2.07

Diluted:

Continuing operations

$
1.28

$
(0.84
)
$
1.79

Income from discontinued businesses

0.03

—

0.03

Income before (loss) from cumulative effect of changes in accounting principle

$
1.31

$
(0.84
)
$
1.82

Loss from cumulative effect of changes in accounting principles

(0.03
)
—

—

Net income (loss) per share—diluted

$
1.28

$
(0.84
)
$
1.82

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

~~CABOT CORPORATION~~
~~CONSOLIDATED BALANCE SHEETS~~
~~ASSETS~~

September 30

2006

2005

(In millions, except
share and per share amounts)

Current assets:

Cash and cash equivalents

$
189

$
181

Short-term marketable securities investments

1

30

Accounts and notes receivable, net of reserve for doubtful accounts of $6 and $4

534

430

Inventories

420

493

Prepaid expenses and other current assets

75

80

Deferred income taxes

36

27

Assets held for sale

—

5

Total current assets

1,255

1,246

Investments:

Equity affiliates

59

63

Long-term marketable securities and cost investments

3

6

Total investments

62

69

Property, plant and equipment

2,531

2,264

Accumulated depreciation and amortization

(1,567
)

(1,430
)

Net property, plant and equipment

964

834

Goodwill

31

25

Intangible assets, net of accumulated amortization of $10 and $9

5

6

Assets held for rent

40

37

Deferred income taxes

100

108

Other assets

77

49

Total assets

$
2,534

$
2,374

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

~~CABOT CORPORATION~~
~~CONSOLIDATED BALANCE SHEETS~~
~~LIABILITIES AND STOCKHOLDERS’ EQUITY~~

September 30

2006

2005

(In millions, except
share and per share amounts)

Current liabilities:

Notes payable to banks

$
58

$
34

Accounts payable and accrued liabilities

384

321

Income taxes payable

27

30

Deferred income taxes

2

1

Current portion of long-term debt

34

47

Total current liabilities

505

433

Long-term debt

459

463

Deferred income taxes

20

15

Other liabilities

286

307

Commitments and contingencies (Note S)

Minority interest

68

57

Stockholders’ equity:

Preferred stock:

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

Series B ESOP Convertible Preferred Stock 7.75% Cumulative:

Authorized: 200,000 shares

Issued and outstanding: 38,734 and 43,907 shares (aggregate redemption value of $39 and $44)

56

61

Less cost of 17,161 shares of preferred treasury stock

(38
)

(38
)

Common stock:

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

Issued: 63,432,651 and 62,819,751 shares

64

63

Less cost of 146,389 and 152,121 shares of common treasury stock

(5
)

(5
)

Additional paid-in capital

7

32

Retained earnings

1,160

1,127

Unearned compensation

—

(41
)

Deferred employee benefits

(38
)

(42
)

Notes receivable for restricted stock

(20
)

(19
)

Accumulated other comprehensive income (loss)

10

(39
)

Total stockholders’ equity

1,196

1,099

Total liabilities and stockholders’ equity

$
2,534

$
2,374

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

~~CABOT CORPORATION~~
~~CONSOLIDATED STATEMENTS OF CASH FLOWS~~

Years Ended September 30

   2006

   2005

   2004

(In millions)

Cash Flows from Operating Activities:

Net income (loss)

$
88

$
(48
)

$
124

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

Depreciation and amortization

131

142

134

Deferred tax benefit

2

(57
)

—

Cumulative effect of accounting changes

2

—

—

Equity in net income of affiliated companies

(12
)

(12
)

(7
)

Minority interest income

12

12

9

Asset impairment charges

8

221

15

Non-cash compensation

26

27

25

Other non-cash charges, net

1

(4
)

5

Changes in assets and liabilities, net of acquisitions and the effect of consolidation of equity affiliates:

Accounts and notes receivable

(58
)

(39
)

(45
)

Inventories

82

(9
)

(20
)

Prepaid expenses and other current assets

(22
)

5

—

Accounts payable and accrued liabilities

24

26

7

Income taxes payable

(41
)

11

4

Other liabilities

2

(48
)

(15
)

Other, net

7

(9
)

5

Cash provided by operating activities

252

218

241

Cash Flows from Investing Activities:

Additions to property, plant and equipment

(188
)

(186
)

(119
)

Proceeds from sales of property, plant and equipment

9

1

4

Increase in assets held for rent

(3
)

(4
)

(4
)

Purchase of marketable securities investments

(20
)

(94
)

(110
)

Acquisition of interest in equity affiliate

(19
)

—

(2
)

Proceeds from maturity of marketable securities investments

56

164

5

Cash used in investing activities

(165
)

(119
)

(226
)

Cash Flows from Financing Activities:

Borrowings under financing arrangements

65

91

11

Repayments under financing arrangements

(51
)

(95
)

(47
)

Repayments of debt related to Cabot Japan

(25
)

—

—

Increase in notes payable to banks, net

—

15

13

Purchases of preferred and common stock

(39
)

(52
)

(54
)

Sales of preferred and common stock

9

5

9

Proceeds from cash contributions received from minority interest shareholders

2

6

—

Cash dividends paid to stockholders

(43
)

(43
)

(40
)

Cash dividends paid to minority interest stockholders

(7
)

(8
)

(6
)

Proceeds from restricted stock loan repayments

7

6

13

Cash used in financing activities

(82
)

(75
)

(101
)

Effect of exchange rate changes on cash

3

(2
)

(2
)

Increase (decrease) in cash and cash equivalents

8

22

(88
)

Cash and cash equivalents at beginning of year

181

159

247

Cash and cash equivalents at end of year

$
189

$
181

$
159

Income taxes paid

$
18

$
34

$
36

Interest paid

28

26

27

Restricted stock issued for notes receivable, net of forfeitures

7

6

13

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

~~CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY~~
~~Years ended September 30~~
~~(In millions, except per shares~~Debt is designated as variable in ~~thousands)~~2007 due to frequent changes during fiscal year 2007 in the official Chinese benchmark rate upon which the debt’s interest rate is determined. Prior to 2007, the benchmark rate had not materially changed for several years.

$400 million Revolving Credit Facility—Cabot has a $400 million revolving credit facility that permits the Company to borrow funds on an unsecured basis in various currencies at floating interest rates. These floating interest rates are dependent upon the currency in which our borrowings are denominated. Generally the rates are determined based upon LIBOR plus a spread, which is based on the Company’s credit rating. The credit facility expires on August 3, 2010. Cabot drew down a total of $65 million during fiscal 2007 for general working capital purposes, in addition to its 9.3 billion yen ($80 million) draw down in fiscal 2005. Additionally, the Company has $15 million of committed but undrawn letters of credit against this facility. The Company has approximately $240 million remaining availability under the revolving credit facility as of September 30, 2007. The revolving credit facility agreement contains affirmative, negative and financial covenants, including financial covenants for certain maximum indebtedness and minimum cash flow requirements. As described in Note K, the Company has entered into fixed interest rate swaps to hedge against the variability of cash flows caused by changes in interest rates

associated with a portion of these variable rate borrowings. The Company has also designated the 9.3 billion yen debt as a net investment hedge.

Chinese Renminbi Debt—The Company’s consolidated Chinese subsidiaries had $31 million of unsecured long-term debt outstanding at September 30, 2007. The financing has been used to fund capital expenditures at the Company’s newly constructed Carbon Black and Metal Oxides facilities located in Tianjin and Jiangxi Province.

Medium Term Notes—At September 30, 2007 and 2006, there were $128 million and $158 million, respectively, of medium term notes outstanding issued to numerous lenders with various fixed interest rates and maturity dates. In fiscal year 2007, Cabot repaid $30 million of these medium term notes as they matured. The weighted average maturity of the total outstanding medium term notes is 8 years with a weighted average interest rate of 7.63%. As described in Note K, the Company has entered into variable interest rate swaps for certain designated medium term notes to offset the changes in the fair value of the underlying debt.

Under a 1998 shelf registration, there is $400 million of unused debt capacity at September 30, 2007 and 2006, respectively. The Company has no current plans to offer additional securities under the registration statement.

Euro Bond—A European subsidiary issued a $175 million bond with a fixed coupon rate of 5.25%. The bond matures on September 1, 2013, with interest due on March 1 and September 1 of each year. A discount of approximately $1 million was recorded at issuance and is being amortized over the life of the bond. Amortization of the discount was immaterial for fiscal 2007, 2006 and 2005. As described in Note K, the Company has entered into cross-currency swaps and a floating interest rate swap to hedge the variability in cash flows for changes in the exchange rates and to offset a portion of the changes in the fair value of the underlying debt.

ESOP Debt—In November 1988, Cabot’s Employee Stock Ownership Plan (“ESOP”) borrowed $75 million from an institutional lender in order to finance its purchase of 75,000 shares of Cabot’s Series B ESOP Convertible Preferred Stock. This debt bears interest at 8.29% per annum and is to be repaid in equal quarterly installments through December 31, 2013. Cabot, as guarantor, has reflected the outstanding balance of $34 million and $38 million as long-term debt in the consolidated balance sheets at September 30, 2007 and 2006, respectively. An equal amount, representing deferred employee benefits, has been recorded as a reduction to stockholders’ equity.

Capital Lease Obligations—A majority owned joint venture has capital lease obligations for certain equipment with a net present value of $2 million. Cabot will make payments totaling $3 million over the next fourteen years, including $1 million of imputed interest. Cabot has assets under capital leases of which the original costs at both September 30, 2007 and 2006 were $2 million. The accumulated depreciation of assets under capital leases was $1 million at both September 30, 2007 and 2006. The amortization related to those assets under capital lease is included in depreciation expense.

The aggregate principal amounts of long-term debt and capital lease obligation due in each of the five years from fiscal 2008 through 2012 and thereafter are as follows:


Fiscal Years Ended	(Dollars in millions)
2008	$	15
2009		38
2010		159
2011		25
2012		40
Thereafter		241

Total	$	518

At September 30, 2007, the Company had provided standby letters of credit that were outstanding and not drawn totaling $52 million, which expire in fiscal 2008.

Short-term Notes Payable to Banks—The Company has short-term notes payable to banks of $67 million and $58 million as of September 30, 2007 and 2006, respectively. Of the 2007 balance, $58 million, or 87%, represents unsecured bank debt owed by our Chinese subsidiaries. The weighted-average interest rate on short-term notes is 5.5% and 7% as of September 30, 2007 and 2006, respectively.

As of September 30, 2007 and 2006, the amount of notes outstanding to banks includes $5 million and $8 million, respectively, for checks issued but not drawn and $7 million and $8 million, respectively, for notes issued by banks in China, which are non-interest bearing balances.

Cabot’s consolidated China subsidiaries have unused and committed debt facilities of RMB 74 million ($10 million). The facilities are being used to fund overall working capital needs in China.

Note K. Derivatives and Hedging Relationships

Interest Rate Swaps

The Company has entered into interest rate swaps as a hedge of the underlying debt instruments described in Note J to effectively change the characteristics of the interest rate and manage its interest rate exposures without changing the debt instrument. The Company manages its interest rate exposures by maintaining a mix of fixed and floating rate debt to minimize interest expense and interest rate volatility.

The following is a description/summary of the derivative financial instruments the Company has entered into to manage certain of its interest rate exposures:


Description	Borrowing	Notional Amount	Receive	Pay	Fiscal Year Entered Into	Maturity (Fiscal Year)	Fair Market Value at September 30		FAS 133 Hedge Designation	Earnings Impact of Ineffectiveness Gain/ (Loss)
Description	Borrowing	Notional Amount	Receive	Pay	Fiscal Year Entered Into	Maturity (Fiscal Year)	2007	2006	FAS 133 Hedge Designation	2007	2006
							(USD in millions)			(USD in millions)
Interest Rate Swaps—Variable to Fixed	Revolving Credit Facility	JPY 9.3 billion	JPY-6 month LIBOR	0.85% Fixed	2006	2010	$ 1	—	Cash Flow^(a)	—	—

Interest Rate Swaps—Fixed to Variable	Medium Term Notes	USD 8 million	8.28% Fixed	US-6 month LIBOR + 3.14%	2007	2012	—	—	Fair Value^(b)	—	—

	Medium Term Notes	USD 30 million	7.18% Fixed	US-6 month LIBOR + 2.42%	2006	2009	—	—	Fair Value^(b)	—	—

	Eurobond (20% of $175 million)	USD 35 million	5.25% Fixed	US-6 month LIBOR + 0.62%	2003	2013	$(1)	$(1)	Fair Value^(b)	$(1)	—

^(a)

~~Preferred Stock, net of Treasury Stock~~

~~Common Stock, net of Treasury Stock~~

~~Additional~~
~~Paid-In~~

~~Retained~~

~~Unearned~~

~~Deferred~~
~~Employee~~

~~Notes~~
~~Receivable~~
~~for~~
~~Restricted~~

~~Accumulated~~
~~Other~~
~~Comprehensive~~

~~Total~~
~~Stockholders’~~

~~Total~~
~~Comprehensive~~

~~Shares~~

~~Cost~~

~~Shares~~

~~Cost~~

~~Capital~~

~~Earnings~~

~~Compensation~~

~~Benefits~~

~~Stock~~

~~Loss~~

~~Equity~~

~~Income~~

~~2004~~

Balance at September 30, 2003

53

$
32

62,080

$
57

$
14

$
1,160

$
(36
)

$
(48
)

$
(21
)

$
(79
)

1,079

Net income

124

$
124

Foreign currency translation adjustments

27

27

Change in unrealized loss on available-for-sale securities

(7
)

(7
)
Changes in unrealized loss on derivative instruments

(5
)

(5
)
Minimum pension liability adjustment

14

14

Other comprehensive income

29

Comprehensive income

153

$
153

Common dividends paid

(37
)

(37
)

Issuance of stock under employee compensation plans, net of forfeitures

1,823

2

55

(38
)

(13
)

6

Tax benefit on vesting of restricted stock

4

4

Purchase and retirement of common stock

(1,882
)
(2
)

(26
)

(26
)

(54
)

Preferred stock conversion

(6
)
(6
)
872

1

5

—

Preferred dividends paid to Employee Stock Ownership Plan, net of tax benefit of $1

(3
)

(3
)

Principal payment by Employee Stock Ownership Plan under guaranteed loan

3

3

Amortization of unearned compensation

25

25

Notes receivable for restricted stock—payments and forfeitures

15

15

Balance at September 30, 2004

47

$
26

62,893

$
58

$
52

$
1,218

$
(49
)

$
(45
)

$
(19
)

$
(50
)

$
1,191

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

~~CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY~~
~~Years ended September 30~~
~~(In millions, except per shares in thousands)~~

~~Preferred~~
~~Stock, net of~~
~~Treasury Stock~~

~~Common~~
~~Stock, net of~~
~~Treasury Stock~~

~~Additional~~
~~Paid-In~~

~~Retained~~

~~Unearned~~

~~Deferred~~
~~Employee~~

~~Notes~~
~~Receivable~~
~~for~~
~~Restricted~~

~~Accumulated~~
~~Other~~
~~Comprehensive~~

~~Total~~
~~Stockholders’~~

~~Total~~
~~Comprehensive~~

~~Shares~~

~~Cost~~

~~Shares~~

~~Cost~~

~~Capital~~

~~Earnings~~

~~Compensation~~

~~Benefits~~

~~Stock~~

~~Loss~~

~~Equity~~

~~Income~~

~~2005~~

Balance at September 30, 2004

47

$
26

62,893

$
58

$
52

$
1,218

$
(49
)

$
(45
)

$
(19
)

$
(50
)

$
1,191

Net loss

(48
)

$
(48
)
Foreign currency translation adjustments

22

22

Changes in unrealized loss on derivative instruments

(6
)

(6
)
Minimum pension liability adjustment

(5
)

(5
)
Other comprehensive income

11

Comprehensive income

(37
)

$
(37
)
Common dividends paid

(40
)

(40
)

Issuance of stock under employee compensation plans, net of forfeitures

1,280

1

26

(19
)

(8
)

—

Tax benefit on vesting of restricted stock

2

2

Purchase and retirement of common stock

(1,884
)
(2
)

(50
)

(52
)

Preferred stock conversion

(3
)
(3
)
531

1

2

—

Preferred dividends paid to Employee Stock Ownership Plan, net of tax benefit of $1

(3
)

(3
)

Principal payment by Employee Stock Ownership Plan under guaranteed loan

3

3

Amortization of unearned compensation

27

27

Notes receivable for restricted stock—payments and forfeitures

8

8

Balance at September 30, 2005

44

$
23

62,820

$
58

$
32

$
1,127

$
(41
)

$
(42
)

$
(19
)

$
(39
)

$
1,099

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

~~CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY~~
~~Years ended September 30~~
~~(In millions, except per shares in thousands)~~

~~Preferred Stock, net of~~
~~Treasury Stock~~

~~Common Stock, net of~~
~~Treasury Stock~~

~~Additional~~
~~Paid-In~~

~~Retained~~

~~Unearned~~

~~Deferred~~
~~Employee~~

~~Notes~~
~~Receivable~~
~~for~~
~~Restricted~~

~~Accumulated~~
~~Other~~
~~Comprehensive~~

~~Total~~
~~Stockholders’~~

~~Total~~
~~Comprehensive~~

~~Shares~~

~~Cost~~

~~Shares~~

~~Cost~~

~~Capital~~

~~Earnings~~

~~Compensation~~

~~Benefits~~

~~Stock~~

~~Income (Loss)~~

~~Equity~~

~~Income~~

~~2006~~

Balance at September 30, 2005

44

$
23

62,820

$
58

$
32

$
1,127

$
(41
)

$
(42
)

$
(19
)

$
(39
)

1,099

Net income

88

$
88

Foreign currency translation adjustments

29

29

Changes in unrealized gain on derivative instruments

6

6

Minimum pension liability adjustment

14

14

Other comprehensive income

49

Comprehensive income

137

$
137

Common dividends paid

(41
)

(41
)

Issuance of stock under employee compensation plans, net of forfeitures

1,089

1

42

(10
)

33

Purchase and retirement of common and treasury stock

(1,233
)
(1
)

(38
)

(39
)

Preferred stock conversion

(5
)
(5
)
757

1

4

—

Preferred dividends paid to Employee Stock Ownership Plan, net of tax benefit of $1

(2
)

(2
)

Principal payment by Employee Stock Ownership Plan under guaranteed loan

4

4

Reversal of unearned compensation upon the implementation of FAS 123 (R)

(29
)

(12
)

41

—

Cumulative effect of change in accounting principle

(4
)

(4
)

Notes receivable for restricted stock—payments and forfeitures

9

9

Balance at September 30, 2006

39

$
18

63,433

$
59

$
7

$
1,160

$
—

$
(38
)

$
(20
)

$
10

$
1,196

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

~~Notes to Consolidated Financial Statements~~

~~Note A. Significant Accounting Policies~~

~~Principles of Consolidation~~

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

~~Cash and Cash Equivalents~~

Cash equivalents include all highly liquid investments with a maturity of three months or less at date of acquisition. The cash balance excludes checks issued but not paid of $8 million and $9 million that are included in notes payable to banks on the consolidated balance sheets at September 30, 2006 and 2005, respectively.

~~Inventories~~

~~Investments~~

The Company has investments in equity affiliates and marketable securities as well as investments accounted for at cost. As circumstances warrant, all investments are subject to periodic impairment reviews. Unless consolidation is required, investments in equity affiliates, where Cabot generally owns between 20% and 50% of the affiliate, are accounted for using the equity method. Cabot records its share of the equity affiliate’s results of operations based on its percentage of ownership of the affiliate. Dividends received from equity affiliates are a return on investment and recorded as a reduction to the equity investment value. All investments in marketable securities are classified as available-for-sale and are recorded at their fair market values with the corresponding unrealized holding gains or losses, net of taxes, recorded as a separate component of other comprehensive income (loss) within stockholders’ equity. Unrealized losses that are determined to be other than temporary, based on current and expected market conditions, are recognized in net income. The fair value of marketable securities is determined based on quoted market prices at the balance sheet dates. The cost of marketable securities sold is determined by the specific identification method. Investments that do not have readily determinable market values are recorded at cost. Short-term investments consist of investments in marketable securities with maturities of one year or less.

~~Property, Plant and Equipment~~

Property, plant and equipment are recorded at cost. Depreciation of property, plant and equipment is calculated using the straight-line method over the estimated useful lives. The depreciable lives for buildings, machinery and equipment, and other fixed assets are twenty to twenty-five years, ten to twenty years, and three to twenty years, respectively. The cost and accumulated depreciation for property, plant and equipment sold, retired, or otherwise disposed of are relieved from the accounts and resulting gains or

~~losses are included in income (loss) from continuing operations in the consolidated statements of operations.~~

Cabot capitalizes interest cost in accordance with Financial Accounting Standard (“FAS”) No. 34, “Capitalization of Interest Cost.” This statement establishes standards for capitalizing interest cost as part of the historical cost of acquiring and constructing certain assets that require a period of time to get them ready for their intended use. During 2006 and 2005, Cabot capitalized $3 million and $2 million, respectively, of interest cost as part of the cost of constructing its manufacturing lines in China, Brazil and the U.S. which will be amortized over the life of the related assets. There was no interest cost capitalized during 2004.

~~Goodwill and Other Intangible Assets~~

Goodwill is comprised of the cost of business acquisitions in excess of the fair value assigned to the net tangible and identifiable intangible assets acquired. Goodwill is not amortized but is reviewed for impairment at least annually. The annual review consists of the comparison of each reporting unit’s carrying value to its fair value. The fair value of a reporting unit 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 is recorded to write-down the value of goodwill to its implied fair value.

Cabot’s intangible assets are primarily comprised of patented and unpatented technology and minimum pension liability adjustments. Finite lived intangible assets are amortized over their estimated useful lives. Amortization expense was $1 million, $1 million and $2 million in 2006, 2005 and 2004, respectively.

~~Assets Held for Rent~~

Assets held for rent represent cesium formate product in the Specialty Fluids Business that will be rented to customers in the normal course of business. Assets held for rent are stated at average cost. At September 30, 2006 and 2005 Cabot had assets held for rent of $40 million and $37 million, respectively.

~~Assets Held for Sale~~

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

During the fourth quarter of fiscal 2005, the Company classified $5 million of property, plant and equipment related to the Supermetals direct finished tantalum sputtering target business as assets held for sale (see further discussion in Note D). The Company recorded an impairment charge of $8 million, representing the amount by which their carrying value exceeded their fair value. This impairment charge is reported as a component of cost of sales in the accompanying consolidated statements of operations. During the second quarter of fiscal 2006, Cabot sold these assets to Tosoh SMD, a division of Tosoh Corporation. There was no gain or loss recognized upon completion of the sale.

~~Asset Retirement Obligations~~

Cabot accounts for asset retirement obligations in accordance with FAS No. 143, “Accounting for Asset Retirement Obligations” (“FAS 143”) and Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). Pursuant to FAS 143, companies are required to estimate 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. FIN 47 clarified that ARO liabilities and costs must be recognized when the timing and/or settlement can be reasonably estimated. If it is unclear when or if an ARO will be triggered, companies are required to use probability weighting for possible timing scenarios to determine the amounts that should be recognized in the company’s 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 which could give rise to an ARO, and (d) other factors outside a company’s control, including changes in regulations, costs and interest rates. As such, actual costs and the timing of such costs may vary significantly from the estimates, judgments, and probable scenarios considered by the Company, which could, in turn, have a material impact on the Company’s future financial statements.

FIN 47 was adopted in the fourth quarter of 2006 and resulted in the recognition of an ARO reserve of $7 million and an after tax charge of $4 million, which is reflected as a cumulative effect of a change in accounting principle in the Consolidated Statements of Operations. AROs have not been recognized for certain of the Company’s facilities because either the fair value cannot be reasonably estimated due to an indeterminable settlement date of the obligation, or the Company currently does not have a legal obligation associated with the retirement of those facilities. The pro forma effect of applying this guidance in all prior periods presented was determined not to be material.

Cabot also had $1 million and $5 million of ARO reserves at September 30, 2006 and 2005, respectively, related to the closure of the Zierbana, Spain and Altona, Australia facilities as discussed in the restructuring footnote at Note O. In addition, Cabot had $1 million and $3 million of ARO reserves at September 30, 2006 and 2005, respectively, related to the decommissioning of storage bins used in the Supermetals Business. The $2 million change in this reserve during 2006 was entirely due to a change in estimate based on management’s decision not to decommission the storage bins.

~~Impairment of Long-Lived Assets~~

Cabot’s long-lived assets include property, plant and equipment, long-term investments and other intangible assets. The carrying values of long-lived assets are reviewed for impairment whenever events or changes in business circumstances indicate that the carrying amount of an asset may not be recoverable. An asset impairment is recognized when the carrying value of the asset is not recoverable based on the undiscounted estimated cash flows to be generated by the assets. Cabot’s estimates reflect management’s assumptions about selling prices, production and sales volumes, costs and market conditions over an estimate of the remaining operating period. If an impairment is indicated, the asset is written down to fair value. In circumstances when an asset does not have separate identifiable cash flows, an impairment charge is recorded when Cabot abandons the utilization of the asset.

~~Foreign Currency Translation~~

gains and losses arising from transactions denominated in currencies other than the subsidiary’s functional currency are reflected in net income. Certain gains and losses are offset by derivative instruments held, as discussed in Note K. Included in other charges are net foreign currency transaction losses of $1 million in 2006, gains of $2 million in 2005 and losses of $2 million in 2004. Cabot recorded a loss of $8 million in 2006, a gain of $2 million in 2005 and a loss of $3 million in 2004 related to currency translation adjustments recorded upon substantial liquidation of certain Cabot subsidiaries.

~~Financial Instruments~~

Cabot’s financial instruments consist primarily of cash and cash equivalents, short-term and long-term debt, and derivative instruments. The carrying values of Cabot’s financial instruments approximate fair value with the exception of long-term debt. The fair values of long-term debt and derivative instruments are based on quoted market prices. Derivative financial instruments are used to manage certain of Cabot’s foreign currency and interest rate exposures, which exist as part of the Company’s on-going business operations. Cabot does not enter into financial instruments for speculative purposes, nor does Cabot hold or issue any financial instruments for trading purposes. Derivative financial instruments are accounted for in accordance with FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by FAS No. 138, “Accounting for Derivative Instruments and Hedging Activites” and related interpretations (“FAS 133”), and are measured and recorded at fair value on the balance sheet. Cabot formally documents the relationships between hedging instruments and hedged items, as well as its risk management objective. Hedge accounting is followed for derivatives that have been designated and qualify as fair value, cash flow or net investment hedges. For fair value hedges, changes in the fair value of highly effective derivatives, along with changes in the fair value of the hedged liabilities that are attributable to the hedged risks, are recorded in current period earnings. For cash flow hedges, changes in the fair value of the effective portion of the derivatives’ gains or losses are reported in other comprehensive income (loss), and the ineffective portion is reported in earnings. For net investment hedges, changes in the fair value of the effective portion of the derivatives’ gains or losses are reported as foreign currency translation gains or losses in other comprehensive income (loss), and the ineffective portion is reported in earnings. 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 item. From time to time, the Company may enter into certain derivative instruments that may not be designated as hedges under FAS 133. Although these derivatives are not designated as hedges, Cabot believes that such instruments are closely correlated with the underlying exposure, thus managing the associated risk. The gains or losses from changes in the fair value of derivative instruments that are not designated as hedges are recognized in earnings.

~~Revenue Recognition~~

Cabot derives most of its revenues from the sale of rubber blacks, performance products, fumed metal oxides, 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 represents less than ten percent of total revenues, include tolling, servicing and royalties for licensed technology.

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

Under certain multi-year supply contracts with declining prices and minimum volumes, Cabot recognizes revenue based on the estimated average selling price over the contract lives. At September 30, 2006 and 2005, Cabot had less than $1 million and $1 million, respectively, of deferred revenue related to certain supply agreements representing the difference between the billed price and the estimated average selling price. The deferred revenue will be recognized as the customer purchases the contracted minimum volumes through the first quarter of fiscal 2007.

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

Accounts and notes receivable as of September 30, 2006 and 2005, primarily include trade accounts receivable, which arise in the normal course of business of $508 million and $405 million, respectively, income tax receivables of $19 million and $23 million, respectively, and the current portion of notes receivable of $13 million and $6 million, respectively. Trade receivables are recorded at the invoiced amount and do not bear interest. Trade receivables in China may be settled with the receipt of bank issued non-interest bearing notes. These China notes totaled 100 million RMB ($13 million) and 42 million RMB ($5 million) as of September 30, 2006 and 2005, respectively, and are included in accounts and notes receivable. Cabot periodically sells a portion of the trade receivables in China at a discount. These transactions are accounted for as sales under the provisions of FAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”). The difference between the proceeds from the sale and the carrying value of the receivables is recognized as a loss on the sale of receivables and is included in other income (charges) in the accompanying consolidated statements of operations.

Cabot maintains allowances for doubtful accounts based on an assessment of the collectibility of specific customer accounts, the aging of accounts receivable and other economic information on both a historical and prospective basis. Customer account balances are charged against the allowance when it is probable the receivable will not be recovered. Write-offs in fiscal 2006 and 2005 were not material. There is no off-balance sheet credit exposure related to customer receivable balances.

~~Stock-based Compensation~~

On October 1, 2005, Cabot adopted FAS No. 123 (R), “Accounting for Stock-Based Compensation,” using the modified prospective method, which resulted in the provisions of FAS 123 (R) being applied to the consolidated financial statements on a going-forward basis beginning in fiscal year 2006. Prior periods have not been adjusted and, therefore, the results for 2006 are not necessarily comparable to the same period in prior years. However, the impact to prior periods would have been immaterial. FAS 123 (R) requires companies to recognize stock-based awards granted to employees as compensation expense on a fair value method. Under the fair value recognition provisions of FAS 123 (R), stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as

expense over the service period, which generally represents the vesting period, and includes an estimate of the awards that will be forfeited. Cabot calculates the fair value of its stock options using the Black-Scholes option pricing model and the fair value of restricted stock is based on intrinsic value.

~~Research and Technical Expenses~~

~~Income Taxes~~

~~Comprehensive Income~~

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

~~Environmental Costs~~

~~Use of Estimates~~

~~Newly Issued Accounting Pronouncements~~

In September 2006, the SEC issued SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the current year’s financial statements are materially misstated. SAB 108 is effective for the Company beginning October 1, 2007. The adoption of SAB 108 is not expected to have a material impact on the Company’s consolidated financial statements.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued FAS No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 provides guidance for using fair value to measure assets and liabilities and requires additional disclosure about the use of fair value measures, the information used to measure fair value, and the effect fair-value measurements have on earnings. The primary areas in which the Company utilizes fair value measures are valuing pension plan assets and liabilities, valuing hedge-related derivative financial instruments, allocating purchase price to the assets and liabilities of acquired companies, and evaluating long-term assets for potential impairment. FAS 157 does not require any new fair value measurements. FAS 157 is effective for the Company beginning October 1, 2008. The Company is currently evaluating the impact of FAS 157 on its consolidated financial statements.

In September 2006, the FASB issued FAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“FAS 158”). FAS 158 requires an employer to recognize the funded status of a benefit plan, measured as the difference between plan assets at fair value and the projected benefit obligation, in its statement of financial position. FAS 158 also requires an employer to measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end. FAS 158 is effective for the Company for its fiscal year ended September 30, 2007. The Company is currently evaluating the impact of FAS 158 on its consolidated financial statements.

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement 109” (“FIN 48”), which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return, including a decision whether or not to file a return in a particular jurisdiction. Under this new guidance, the financial statements will reflect expected future tax consequences of such positions presuming the taxing authorities’ full knowledge of the position and all relevant facts, but without considering time values. This guidance also revises disclosure requirements and introduces a prescriptive, annual, tabular roll-forward of unrecognized tax benefits. FIN 48 is effective for annual periods beginning after December 15, 2006, which will be fiscal 2008 for Cabot. Cabot is in the process of evaluating the impact of adoption of FIN 48 on its consolidated financial statements.

In June 2006, the FASB ratified the consensus reached by the EITF in Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)” (“EITF 06-3”). The scope of this issue includes any tax assessed by a governmental authority that is directly imposed on a revenue-producing activity between a seller and a customer and may include, but is not limited to, sales, use, value-added, and some excise taxes. EITF 06-3 requires the disclosure of the method of accounting for the applicable assessed taxes and the amount of assessed taxes that are included in revenues if they are accounted for under the gross method and are significant. EITF 06-3 is effective for interim and annual reporting periods beginning after December 15, 2006. The Company does not expect the adoption of EITF 06-3 in fiscal 2007 to have an impact on its consolidated financial statements.

~~In October 2004, the American Jobs Creation Act of 2004 (“AJCA”) was signed into law. Among other things, the AJCA allowed U.S. companies a one-time election to repatriate certain earnings from~~

their foreign subsidiaries in 2006 at an effective tax rate of 5.25%. The Company did not believe there to be a material benefit available to it given Cabot’s particular circumstances and the various requirements under the law and, accordingly, did not elect to repatriate any foreign earnings.

~~Note B. Acquisitions~~

Cabot had a 50:50 joint venture arrangement with Showa Denko K.K. in an entity called Showa Cabot K.K. (“SCK”). On November 8, 2005, Cabot purchased Showa Denko K.K.’s 50% joint venture interest in SCK for $19 million and renamed the entity Cabot Japan K.K (“Cabot Japan”). As a result of the acquisition and consolidation of Cabot Japan, Cabot assumed the remaining 50% of SCK’s debt obligations of $13 million for total debt of $26 million at the date of acquisition. In addition, Cabot assumed $8 million of Showa Denko K.K.’s pension liabilities which represents 100% of the obligation at the date of acquisition.

The fair value of the assets acquired and liabilities and debt assumed represents the 50% of SCK that Cabot purchased. The following table summarizes the purchased 50% of the fair values of the assets acquired and liabilities assumed at the date of acquisition:

(Dollars in millions)

Cash paid

$
19

Accounts receivable

$
20

Inventories.

5

Deferred income taxes

1

Investments in marketable securities.

1

Property, plant and equipment

33

Total assets acquired

$
60

Accounts payable and accrued expenses

26

Notes payable.

13

Pension obligation.

8

Total liabilities assumed.

$
47

Net assets acquired.

$
13

Goodwill

$
6

Twelve Months Ended
September 30

2006

2005

(In millions, except
per share amounts)

Net Sales

$
2,555

$
2,259

Income from continuing operations

$
90

$
(43
)

Discontinued Operations, net of tax

2

—

Cumulative effect of accounting changes, net of tax

(2
)

—

Dividends on preferred stock, net of tax benefit

(2
)

(3
)

Net income (loss)

$
88

$
(46
)

Net income (loss) per common share:

Basic:

Continuing operations

$
1.42

$
(0.79
)

Income from discontinued businesses

0.03

—

Loss from cumulative effect of changes in accounting principles

(0.03
)

—

Net income (loss) per share—basic

$
1.42

$
(0.79
)

Diluted:

Continuing operations

$
1.29

$
(0.79
)

Income from discontinued businesses

0.03

—

Loss from cumulative effect of changes in accounting principles

(0.03
)

—

Net income (loss) per share—diluted

$
1.29

$
(0.79
)

~~Note C. Discontinued Operations~~

~~In fiscal 2006, Cabot recorded a $2 million benefit from a favorable tax audit settlement related to the Company’s discontinued liquified natural gas business.~~

~~Cabot did not have income or charges related to discontinued operations in fiscal year 2005.~~

~~In fiscal 2004, Cabot recorded benefits of $1 million related to insurance proceeds and $1 million related to the reversal of tax reserves related to previously divested businesses.~~

~~Note D. Long-Lived Asset Impairment~~

assets over their remaining useful lives. However, based on the estimated discounted cash flows of the Business, it was determined that the fair value of this reporting unit was below its carrying amount and that a full impairment of the goodwill existed. Accordingly, the Company was required to write-off the entire $90 million goodwill balance of the reporting unit during the second quarter of fiscal 2005.

During the fourth quarter of fiscal year 2005, events occurred that required management to re-evaluate the anticipated future performance of the Supermetals Business. These events included the decision by management in August 2005 to exit the manufacture and sale of finished tantalum sputtering targets, which was previously forecasted to be an important contributor to the future cash flows of the Business, and the increased likelihood of higher tantalum ore costs under the Company’s purchase commitments with the Sons of Gwalia, as discussed in Note S. These factors, combined with significantly lower market prices for tantalum powder than anticipated when the impairment analysis was performed in the second quarter of fiscal 2005, led management to believe that the Business’s remaining long-lived assets, after the goodwill write-off, may not be recoverable, and that a further impairment analysis was necessary. In this analysis, the carrying amount of the Business’s long-lived assets (consisting primarily of property, plant and equipment) was compared to the sum of the estimated undiscounted cash flows expected from the Business’s use of the assets over their remaining useful lives. This comparison indicated that the carrying value of the long-lived assets was in excess of their undiscounted cash flows and, therefore, an impairment existed. The Company, with the assistance of independent valuation specialists, determined the fair value of the Business’s long-lived assets using estimated discounted cash flows that the Company believed would be forecasted by a purchaser of the Business. Since this analysis indicated that a full write-down of the long-lived assets was warranted, and to ensure that individual assets were not written down below their fair market value, the Company engaged independent valuation specialists to perform appraisals of individual assets. The excess of the carrying amount of the assets over their fair market value resulted in a $121 million charge that was recorded in the fourth quarter of fiscal year 2005.

During fiscal year 2005, the Supermetals Business also recorded a charge of $15 million associated with on-going cost reduction initiatives in that Business. These charges included $8 million of asset write downs associated with management’s decision to stop manufacturing and selling finished tantalum sputtering targets to the semiconductor industry and to instead focus on the sale of tantalum plate and ingot to sputtering target manufacturers, as well as $3 million of charges related to severance and $3 million of charges related to the write down of assets related to abandoned research and development projects.

~~The impairment charges recorded during fiscal 2005 in the Supermetals Business are reported as a component of loss from continuing operations in the accompanying consolidated statements of operations.~~

~~Note E. Inventories~~

~~Inventories, net of LIFO reserves, are as follows:~~

September 30

2006

2005

(Dollars in millions)

Raw materials

$
131

$
169

Work in process

109

134

Finished goods

139

151

Other

41

39

Total

$
420

$
493

Inventories valued under the LIFO method comprised approximately 29% and 27% of total inventories in 2006 and 2005, respectively. At September 30, 2006 and 2005, the LIFO reserve recorded was $76 million and $73 million, respectively. Other inventory is comprised of spare parts and supplies.

During the year ended September 2006, inventory quantities were reduced at the Company’s U.S. Supermetals site and at U.S. Carbon Black operations. This reduction led to a liquidation of LIFO inventory quantities carried at lower costs that were prevailing in prior years, as compared with the cost of current fiscal year purchases through September 30, 2006. This resulted in a decrease of cost of goods sold of $6 million and an increase of net income by approximately $4 million, or $0.06 per share, for the year ended September 30, 2006. There were no significant liquidations of LIFO layers in inventories in 2005 or 2004.

~~Note F. Investments~~

~~Equity Affiliates~~—Cabot has investments in equity affiliates that consist of several joint ventures in the Carbon Black and Metal Oxides Businesses. These investments are accounted for using the equity method. Cabot does not disclose its equity affiliate financial statements separately by entity because none of them are individually material to the consolidated financial statements. Cabot Japan was a 50% joint venture in the Carbon Black Segment and was included as an equity affiliate until November 8, 2005 when Cabot purchased the remaining 50% and the entity was then consolidated. The following summarized results of operations and financial position include Cabot’s equity based affiliates for the periods presented below (except Cabot Japan, of which 50% was included for the 2005 and 2004 pre-acquisition periods):

September 30

2006

2005

2004

(Dollars in millions)

Condensed Income Statement Information:

Net sales

$
234

$
297

$
247

Gross profit

65

86

63

Net income

20

23

15

Condensed Balance Sheet Information:

Current assets

$
96

$
124

$
138

Non-current assets

90

126

132

Current liabilities

51

113

119

Non-current liabilities

21

17

43

Net assets

114

120

108

At September 30, 2006 and 2005, Cabot had equity affiliate investments of $59 million and $63 million, respectively. Dividends received from these investments were $5 million, $3 million and $2 million in 2006, 2005 and 2004, respectively. The Company did not make any equity affiliate contributions during fiscal 2006 and 2005.

~~Marketable Securities~~—Cabot holds short-term and long-term investments in available-for-sale marketable securities. These investments had a fair market value of $3 million and $35 million at September 30, 2006 and 2005, respectively, which includes $1 million and zero of unrealized gains, respectively, that have been excluded from earnings and reported as a separate component of other comprehensive income (loss) within stockholders’ equity. During fiscal 2006 and 2005, Cabot purchased $20 million and $94 million of available-for-sale securities, respectively. Proceeds from sales of available-for-sale securities were $56 million and $164 million in 2006 and 2005, respectively. There were no gross realized gains (losses) from the sale of available-for-sale securities in fiscal 2006 and 2005. At September 30, 2006 and 2005, $1 million and $30 million, respectively, are classified as short-term investments and $2 million and $5 million, respectively, are classified as long-term investments.

During fiscal 2004, a pre-tax impairment charge of $12 million was recorded in other income (charges) to write off the Company’s investment in the Sons of Gwalia stock. The Sons of Gwalia stock was suspended from trading after the company appointed voluntary administrators under the Australian Corporation Act (similar to U.S. bankruptcy).

~~No dividends were received from available-for-sale marketable securities during the years ended September 2006, 2005 and 2004.~~

~~Cost Investments~~—Cabot had cost-based investments in the amount of $1 million at September 30, 2006 and 2005, which are classified as long-term. No sales of cost-based investments occurred during fiscal 2006, 2005 and 2004.

~~Note G. Property, Plant and Equipment~~

~~Property, plant and equipment is summarized as follows:~~

September 30

2006

2005

(Dollars in millions)

Land and improvements

$
72

$
55

Buildings

384

340

Machinery and equipment

1,795

1,620

Other

95

95

Construction in progress

185

154

Total property, plant and equipment

2,531

2,264

Less: accumulated depreciation

(1,567
)

(1,430
)

Net property, plant and equipment

$
964

$
834

~~Depreciation expense was $130 million, $141 million and $132 million for fiscal 2006, 2005 and 2004, respectively.~~

~~Note H. Goodwill and Other Intangible Assets~~

At September 30, 2006 and 2005, Cabot had goodwill balances of $31 million and $25 million, respectively. The foreign currency translation impact on the goodwill balances was less than $1 million during fiscal 2006. The carrying amount of goodwill attributable to each reportable segment with goodwill balances and the changes in those balances during the year ended September 30, 2006 are as follows:

Carbon Black
Business

Metal Oxides
Business

Total

(Dollars in millions)

Balance at September 30, 2005

$
15

$
10

$
25

Increase for Acquisition of SCK

6

—

6

Balance at September 30, 2006

$
21

$
10

$
31

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

Cabot does not have any indefinite-lived intangible assets. At September 30, 2006 and 2005, Cabot had $5 million and $6 million of finite-lived intangible assets, respectively. These intangible assets at September 30, 2006 are comprised of $13 million for patents, $1 million for other intellectual property and less than $1 million of pension intangible assets related to minimum pension liabilities recorded in 2006, less accumulated amortization of $8 million for patents and $1 million for other intellectual property. These intangible assets at September 30, 2005 are comprised of $13 million for patents, $1 million for other intellectual property and $1 million of pension intangible assets related to minimum pension liabilities less related accumulated amortization of $8 million for patents and $1 million for other intellectual property.

In May 2006, Cabot entered into a cross license agreement with Aspen Aerogel, Inc. where each party granted certain patent rights to the other. In consideration for use of the patents granted by Cabot, the agreement calls for Cabot to receive $8 million of cash in ten equal semi-annual payments beginning on September 1, 2006 and the right to receive equity in Aspen. During the fourth quarter of 2006, the first installment payment was received and recorded in earnings. The remaining $7.2 million will be recognized when collection is reasonably assured. No amount has been recorded to date for the equity related consideration because of the contingent nature of the arrangement.

~~Note I. Accounts Payable, Accrued Liabilities and Other Liabilities~~

~~Accounts payable and accrued liabilities included in current liabilities consisted of the following:~~

September 30

2006

2005

(Dollars in millions)

Accounts payable

$
252

$
180

Accrued employee compensation

36

32

Accrued restructuring

9

5

Other accrued liabilities

87

104

Total

$
384

$
321

~~Other long-term liabilities consisted of the following:~~

September 30

2006

2005

(Dollars in millions)

Employee benefit plan liabilities

$
123

$
138

Non-current tax liabilities

45

73

Financial instrument liabilities

34

26

Other accrued liabilities

84

70

Total

$
286

$
307

~~Note J. Debt~~

~~Long-term debt is summarized below:~~

September 30

2006

2005

(Dollars in millions)

Variable Rate Debt:

$400 million Revolving Credit Facility, Yen drawdown, due 2010, 0.8%

$
79

$
82

Fixed Rate Debt:

Medium Term Notes (average stated rate):

Notes due 2012 – 2022, 8.3%

$
44

$
44

Notes due 2007 – 2011, 7.2%

75

75

Notes due 2027, 7.3%

8

8

Note due 2027, 6.6%

1

1

Notes due 2018, 7.4%

30

60

Total Medium Term Notes

158

188

Euro Bond due 2013, 5.25%, net of discount and fair value of swaps

173

174

Guarantee of ESOP Notes, due 2013, 8.3%

38

42

Japanese Yen Debt due 2008, 1.2%

1

13

Chinese Renminbi Notes due 2008 – 2011, 5.2% to 6.2%

41

8

Other, due 2014, 7.75%

1

1

Total fixed rate debt

412

426

Capital lease, due 2006 – 2021, 10%

2

2

493

510

Less current portion of long-term debt

(34
)

(47
)

Total long-term debt

$
459

$
463

~~$400 million Revolving Credit Facility~~—Cabot has a $400 million revolving credit facility that permits the Company to borrow funds on an unsecured basis in various currencies at floating interest rates. The credit facility expires on August 3, 2010. The Company has approximately $307 million remaining availability under the revolving credit facility as of September 30, 2006. The revolving credit facility agreement contains affirmative, negative and financial covenants, which the Company believes are customary for financings of this type, including financial covenants for certain maximum indebtedness and minimum cash flow requirements. The Company was in compliance with all debt covenants as of September 30, 2006 and 2005.

During fiscal 2005, Cabot repaid its then existing 9.3 billion yen debt by drawing down on the revolving credit facility. At September 30, 2006, the balance outstanding on the revolving credit facility remains at 9.3 billion yen ($ 79 million) which bears interest at yen-libor plus 30 basis points (.8% at September 30, 2006) and matures with the expiration of the revolving credit facility on August 3, 2010. The 9.3 billion yen debt has been designated as a net investment hedge. At September 30, 2006 and 2005, a credit of $3 million and zero, respectively, related to the revaluation of the debt from yen to U.S. dollar was included as a component of accumulated other comprehensive income (loss) with a corresponding amount in other long-term liabilities.

Cabot has entered into two variable-for-fixed rate swaps to hedge against the variability of cash flows caused by changes in interest rates related to this yen draw down. The swaps have an aggregate notional amount of 9.3 billion yen. Cabot will receive floating rate interest on the yen amount based on the six-month yen-LIBOR rate and pay a fixed rate yen based interest payment. During September 2005, in

conjunction with the refinancing of its yen debt, Cabot amended these swap agreements to match the maturity of the draw down under the revolving credit facility. In addition, due to the extension of the maturity date, the interest rates of 0.4% and 0.391% on the previously outstanding swaps of 5 billion yen and 4.3 billion yen, respectively, have changed to a fixed rate of 0.84% and 0.86%, respectively, for both swaps.

These two yen variable-for-fixed rate swaps have been designated as cash flow hedges and had a positive fair value (asset) of less than $1 million on September 30, 2006 and 2005, and are included in other assets. During fiscal 2006, changes in the value of the effective portion of the cash flow hedges were reported in accumulated other comprehensive income (loss). There was no charge to earnings due to ineffectiveness for either of the years ended September 30, 2006, or 2005 for the swaps. Within the next twelve months, Cabot does not expect to reclassify any gains from accumulated other comprehensive income ~~(loss)~~ to earnings, as it expects the swaps to be highly effective through their maturities.

~~Medium Term Notes~~—At September 30, 2006 and 2005, there were $158 million and $188 million, respectively, of medium term notes outstanding issued to numerous lenders with various fixed interest rates and maturity dates. In fiscal year 2006, Cabot repaid $30 million of these medium term notes as they matured. The weighted average maturity of the total outstanding medium term notes is 7 years with a weighted average interest rate of 7.5%.^(b)

At September 30, 2006 and 2005, Cabot had two fixed-to-variable interest rate swaps outstanding with an aggregate notional amount of $60 million. An interest rate swap with a notional value of $30 million and the related medium term note outstanding at September 30, 2005 matured in December 2005. In January 2006, a new fixed-to-variable interest rate swap for a notional amount of $30 million was entered into and is associated with a $30 million medium term note maturing in February 2009. The other remaining swap matures in February 2007 with the maturity of the note. These swaps have been designated as hedges under FAS 133 to offset changes in the fair value of the underlying debt. The negative fair values ~~(liabilities)~~ of the derivative instruments ~~were less than $1 million at September 30, 2006 and~~ have been recorded as other long-term liabilities in the consolidated balance ~~sheet~~sheets with a corresponding decrease to long-term debt. This compares with the positive fair values (assets) of the derivative instruments of less than $1 million at September 30, 2005, that were recorded in other assets in the consolidated balance sheet with a corresponding increase to long-term debt. The fair value interest rate swaps were determined to be highly effective and no amount of ineffectiveness was recorded in earnings for the years ended September 30, 2006 and 2005.

Foreign Currency Derivatives

Cabot’s international operations are subject to certain risks, including foreign currency fluctuations. The Company’s Treasury function, under the guidance of the Financial Risk Management Committee, continuously monitors foreign exchange exposures, so that Cabot can respond to changing economic and political environments. Exposures primarily relate to assets and liabilities denominated in foreign currencies as well as the risk that currency fluctuations could affect the dollar value of future cash flows generated in foreign currencies. Accordingly, Cabot uses cross currency swaps, foreign currency options and short-term forward contracts to minimize the exposure to foreign currency risk. The following is a summary of the derivative financial instruments that Cabot has entered into to manage certain of the Company’s foreign currency exposures.

Description

Borrowing

Notional
Amount

Receive

Pay

Fiscal
Year
Entered
Into

Maturity
(Fiscal
Year)

Fair Market Value
at September 30

FAS 133
Hedge
Designation

Earnings Impact of
Ineffectiveness Gain/
(Loss)

2007

2006

2007

2006

(USD in millions)

Cross

Currency

Swap

Eurobond (80% of $175 million)

USD 140

million swapped to EUR 124

million

USD - 5.25%
Fixed

EUR - 5.0% Fixed

2003

2013

$(40)

$(28)

Foreign Currency Cash Flow^(a)

—

Cross

Currency

Swap

Eurobond (20% of $175 million)

USD 35 million swapped to EUR 31 million

USD US-6
month
LIBOR

EUR-6 month LIBOR

2003

2013

$(9)

$(4)

No designation^(b)

N/A

Cross

Currency

Swap

N/A

USD 41 million swapped to

JPY 5.0 Billion

USD US-3
month
LIBOR

JPY-3 month LIBOR + 0.04%

2002

2009

$(3)

$(2)

Net investment hedge^(c)

—

Forward

Foreign

Currency

Contracts

N/A

^(d)

^(d

⁾

^(d)

2007

2008

—

No designation

N/A

Foreign

Currency

Call Options

N/A

AUD 67 million equivalent to

USD $50 million

AUD

USD

2006

Multiple
through
2009

Foreign Currency Cash Flow^(e)

—

Under a 1998 shelf registration, there are $400 million of debt securities still available for sale at September 30, 2006 and 2005, respectively. The Company has no current plans to offer additional securities under the registration statement.

~~Euro Bond~~^(a)—A Cabot subsidiary issued a $175 million bond with a fixed coupon rate of 5.25%. The bond is due September 1, 2013, with interest due on March 1 and September 1 of each year. A discount of approximately $1 million was recorded at inception of the issuance and is being amortized over the life of the bond. Amortization of the discount was immaterial for fiscal 2006 and 2005.

As part of the $175 million bond issuance, a Cabot subsidiary entered into a ten-year derivative contract with a notional amount of $140 million to swap U.S. dollars to Euros. This cross currency swap has been designated as a foreign currency cash flow hedge under FAS 133. The swap hedges the variability of the cash flows on $140 million (or 80%) of the debt issuance, for changes in the exchange rates over the life of the debt instrument. This swap effectively neutralizes the impact of U.S. dollar/Euro currency fluctuations on that subsidiary on $140 million of the bond. Changes in the value of the effective portion of the cash flow hedge are reported in accumulated other comprehensive income (loss) and a portion is subsequently reclassified to earnings to offset the revaluation foreign exchange gain (loss) on the underlying bond, while the ineffective portion would be reported directly to earnings. This swap had

negative fair value (liability) of $28 million and $21 million on September 30, 2006 and 2005, respectively, and is included in other long-term liabilities. There was no charge to earnings for the years ended September 30, 2006 and 2005 for ineffectiveness, and the Company does not expect to reclassify any material gains or losses from accumulated other comprehensive income (loss) to earnings within the next twelve months.

The Cabot subsidiary also holds two swaps on the remaining $35 million (or 20%) of the bond issuance. The first is a fixed to floating interest rate swap on the fixed rate coupon of 5.25% to a six-month U.S. LIBOR rate plus a spread of 62 basis points. The variable interest rate on the swap resets with the terms of the bond coupon payments. This swap has been designated as a fair value hedge under FAS 133. The swap had a negative fair value (liability) of $1 million which has been recorded as an other long term liability with a corresponding decrease to long term debt at September 30, 2006 compared to a nominal fair value on September 30, 2005. The interest rate swap was determined to be highly effective and, therefore, no ineffectiveness was recorded in earnings during the years ended September 30, 2006 and 2005. The second swap is a cross currency swap on $35 million of the bond issuance which converts U.S. dollars at variable interest rates to Euros at variable interest rates. ^(b)

This swap has not been designated as a hedge under FAS 133. ~~The cross currency swap had a negative fair value (liability) of $4 million and $2 million on September 30, 2006, and 2005, respectively, which is included in other long-term liabilities.~~ Changes in the value of the swap are recognized immediately in earnings, and are offset by the recognition in other income (charges) for the foreign exchange revaluation of the underlying foreign currency debt.

~~ESOP Deb~~^(c)t—In November 1988, Cabot’s Employee Stock Ownership Plan (“ESOP”) borrowed $75 million from an institutional lender in order to finance its purchase of 75,000 shares of Cabot’s Series B ESOP Convertible Preferred Stock. This debt bears interest at 8.3% per annum and is to be repaid in equal quarterly installments through December 31, 2013. Cabot, as guarantor, has reflected the outstanding balance of $38 million and $42 million as a liability in the consolidated balance sheet at September 30, 2006 and 2005, respectively. An equal amount, representing deferred employee benefits, has been recorded as a reduction to stockholders’ equity.

~~Japanese Yen Debt~~—A Cabot subsidiary repaid approximately $13 million of yen notes as they matured in fiscal 2006. Additionally, in connection with the acquisition of Cabot Japan on November 8, 2005, Cabot assumed the remaining 50% of SCK’s debt obligations of $13 million. Prior to the acquisition, SCK was accounted for as an equity affiliate and, therefore, was not consolidated. As a result of the acquisition and consolidation of Cabot Japan, Cabot had a total of $26 million of debt obligations as of the acquisition date. Subsequent to the closing of the acquisition Cabot has repaid $25 million of this debt with $1 million remaining outstanding as of September 30, 2006.

~~Chinese Renminbi Debt~~—Majority owned joint-ventures operating in China had unsecured debt facilities with numerous banks in China that allow for total long-term borrowings of 338 million Chinese Renminbi (RMB) ($42 million) with outstanding borrowings of 335 million RMB ($41 million) and 60 million RMB ($8 million) as of September 30, 2006 and 2005, respectively. The debt bears interest at rates ranging from 5.2% to 6.2% and has maturities ranging from 2007 to 2011. The financing has been used to fund capital expenditures at the Company’s newly constructed Carbon Black and Metal Oxides facilities located in Tianjin and Jiangxi Province.

~~Capital Lease Obligations~~—A majority owned joint venture has capital lease obligations for certain equipment with a net present value of $2 million. Cabot will make payments of a total of $3 million over the next fifteen years, including $1 million of imputed interest. Cabot has assets under capital leases of which the original costs at September 30, 2006 and 2005 were $2 million. The accumulated depreciation of assets under capital leases at September 30, 2006 and 2005 was $1 million for both years. The amortization related to those assets under capital lease is included in depreciation expense.

~~The aggregate principal amounts of long-term debt due in each of the five years from fiscal 2007 through 2011 and thereafter are as follows:~~

Fiscal Years Ended

(Dollars in millions)

2007

$
34

2008

12

2009

46

2010

90

2011

38

Thereafter

273

Total

$
493

~~At September 30, 2006, the Company had provided standby letters of credit totaling $30 million, which expire in fiscal 2007.~~

~~Short-term Notes Payable to Banks~~~~—The Company has notes payable to banks of $58 million and $34 million as of September 30, 2006 and 2005, respectively.~~

As of September 30, 2006 and 2005, the amount of notes outstanding to banks includes $8 million and $9 million, respectively, for book overdrafts and $8 million and zero, respectively, for notes issued by banks in China and Japan, which are both non-interest bearing balances. The weighted-average interest rate on short-term notes is 7.0% and 4.9% as of September 30, 2006 and 2005, respectively. The Company had an additional $2 million of outstanding borrowings against uncommitted facilities in certain foreign sites. The debt bears interest at rates ranging from 6.3% to 6.4% and has been renewed and will mature during the first quarter of fiscal 2008.

As of September 30, 2006 and 2005 Cabot had short-term debt agreements at its Argentina subsidiary for a total of $10 million and $11 million, respectively, to finance working capital and other requirements. The notes are expected to be refinanced as they mature at various dates throughout 2007. The debt bears interest at rates ranging from 6.6% to 12.3%.

During 2006, a Cabot subsidiary in India borrowed from uncommitted facilities from two local banks and had outstanding borrowings of $6 million and $4 million as of September 30, 2006 and 2005, respectively. The debt bears interest at rates ranging from 8.2% to 8.3%. The financing is being used for general working capital needs. These notes are expected to be refinanced as they mature at various dates throughout fiscal 2007.

The receipt and disbursement process in China is traditionally conducted using bank issued notes to satisfy certain company receivables and payables. As these notes typically mature in three to six months, a practice has developed whereby the notes received from customers for the satisfaction of amounts owed may be sold at a discounted rate to a bank. If the notes received are not discounted, they continue to be accounted for as a receivable from the bank and not the customer. These transactions are accounted for under the provisions of FAS 140. The Company entered into note discounting agreements in 2006 that would allow for up to 900 million RMB ($114 million) of bank notes to be discounted. As of September 30, 2006 notes in an aggregate amount of 292 million RMB ($37 million) have been sold under these discounting agreements.

Notes issued by a bank to a vendor on behalf of the Company are accounted for as satisfaction of the Company’s trade payable but are shown as notes payable until the note is settled with the bank. Both the issuing and discounting of notes by banks are typically applied against credit facilities established between the Company and the bank.

Majority owned joint-ventures operating in China had unsecured debt facilities with numerous banks in China that allow for total short-term borrowings in Chinese Renminbi of 562 million RMB ($71 million) with outstanding borrowings of 192 million RMB ($24 million) and 77 million RMB ($10 million) as of September 30, 2006 and 2005, respectively. The Company also has an existing U.S. dollar debt facility in China for $16 million. As of September 30, 2006, there were no outstanding borrowings against the US dollar

facility. All of these facilities are being used to fund overall working capital needs in China. The debt bears interest at rates ranging from 5.0% to 5.5%. These short-term borrowings are expected to be refinanced as they mature throughout the remainder of 2006 and 2007.

Additionally, during fiscal 2006, the Company issued notes from these facilities to satisfy certain vendor payments. These amounted to 57 million RMB ($7 million) and are included in the notes payable to banks in the Company’s consolidated balance sheet and reduce the availability under the facilities described above. As of September 30, 2006, 313 million RMB ($40 million) remains available for future drawdowns.

~~Note K. Financial Instruments~~

~~The following is a description of the derivative financial instruments that Cabot has entered into to manage certain of Cabot’s foreign currency exposures.~~

~~Japanese Yen Currency Swaps~~—Cabot uses both yen-based debt and cross currency swaps to hedge its net investment in Japanese subsidiaries against adverse movements in exchange rates. Cabot entered into two cross currency swap agreements in November 2002 to hedge a portion of its net investment in Japan. The hedge instruments swap U.S. dollar debt cash flows on a variable rate to yen debt cash flows on a variable rate. These swaps were originally maturing in October 2005 but were extended to October 31, 2006 and subsequent to year end were extended for another additional year to October 31, 2007. These derivative instruments, in total, swapped a notional value of $41 million at the three-month U.S. LIBOR interest rates for 5 billion yen at the three-month yen LIBOR interest rates. As of September 30, 2006 and 2005, and given rates in force at those dates, the cross currency swaps reduced Cabot’s interest rate by 4.93% and 3.78%, respectively, on the notional amount of $41 million.

~~These cross currency swaps had negative fair values (liabilities) of $2 million and $3 million at September 30, 2006 and 2005, respectively, and are included in other liabilities.~~ The change in the fair value of the cross currency swap ~~of $1 million for the twelve months ended September 30, 2006~~ has been recorded as a foreign currency translation loss in accumulated other comprehensive income, ~~(loss),~~ offsetting foreign currency translation gains of Cabot’s yen denominated net investments.

^(d)

Cabot’s forward foreign exchange contracts are denominated primarily in the Japanese yen, British pound sterling, Canadian dollar and Australian dollar. The ~~effectiveness~~duration of these forwards is generally 30 days. They are not formally designated as hedges ~~is based~~under FAS 133. Gains or losses on ~~changes~~these forwards

are intended to offset fluctuations in ~~the spot~~ foreign ~~exchange rates~~currency denominated receivables and ~~the balance~~payables. The total notional dollar value of ~~Cabot’s yen denominated net investments. The net amount recorded in earnings for the years-ended~~these forward contracts at September 30, 2007 was $13 million.
^(e)
During April 2006 ~~and 2005 related~~Cabot purchased a series of Australian dollar call option contracts to ~~the ineffectiveness of the hedges was immaterial.~~
~~Australian Dollar Currency Options~~~~—To~~ mitigate the foreign currency exposure associated with the future settlement of the Australian dollar denominated payables under a tantalum ore supply agreement, during April 2006 Cabot entered into option contracts with a total notional amount of 136 million Australian dollars ($97 million at inception). These contracts provide Cabot with the right, but not the obligation, to purchase Australian dollars at agreed strike prices monthly through January 2009. As of September 30, 2006, there was a notional amount of 116 million Australian dollars ($87 million) worth of options remaining outstanding.agreement. Certain of these call option contracts have been designated as foreign currency cash flow hedges under ~~FAS. 133, and related interpretations.~~FAS 133. Thus, the change in fair market value of the effective portion of the options are deferred as a component of accumulated other comprehensive income and recognized in cost of goods sold when the hedged item affects cost of goods sold. Based on prevailing exchange rates as of September 30, 2007, the Company expects to reclassify approximately $4 million into earnings over the next twelve months. The changes in fair value of the options contracts that have not been designated as a hedge under FAS 133 are recognized directly in earnings.

Net Investment Hedges

The Company has also designated the 9.3 billion yen debt described in Note J as a net investment hedge. At September 30, 2007 and 2006 a charge of $1 million and a credit of $1 million, respectively, related to the revaluation of the debt from yen to US dollars was included as a component of accumulated other comprehensive income (loss).

Note L. Fair Value of Financial Instruments

The carrying amounts and fair values of the Company’s financial instruments at September 30, 2007 and 2006 are as follows:


	2007				2006
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(Dollars in millions)
Assets:
Cash and available for sale marketable securities	$	158	$	158	$	193	$	193
Accounts receivable		563		563		534		534
Foreign currency cash flow hedge		8		8		2		2
Cash flow hedge interest rate swaps		1		1		1		1
Foreign exchange contracts		—		—		—		—

Liabilities:
Notes payable to banks—short-term		67		67		58		58
Accounts payable		427		427		384		384
Long-term debt—fixed rate		340		351		412		434
Long-term debt—floating rate		176		176		79		79
Fair value hedge interest rate swaps		1		1		1		1
Cross currency net investment hedges		3		3		2		2
Foreign currency fair value hedge		9		9		4		4
Foreign currency cash flow hedge		40		40		28		28

At September 30, 2007 and 2006, the fair values of cash, cash equivalents, accounts receivables, accounts payable and notes payable to banks approximated carrying values because of the short-term nature of these instruments. The estimated fair values of available for sale marketable securities, as described in Note F, are based on the market price at the respective year-ends. The estimated fair values of the derivative instruments as described in Note K are estimated based on the amount that Cabot would receive or pay to terminate the agreements at the respective year-ends. The fair value of Cabot’s fixed rate long-term debt is estimated based on quoted market prices at the end of each fiscal year. The carrying amounts of Cabot’s floating rate long-term debt approximates their fair value.

Note M. Employee Benefit Plans

Cabot provides both defined benefit and defined contribution plans for its employees. The defined benefit plans consist of the Cabot Cash Balance Plan (“CBP”) and several foreign pension plans. The defined contribution plans consist of the Cabot Retirement Savings Plan (“RSP”) and several foreign plans. Cabot also provides postretirement benefit plans, which include medical coverage and life insurance.

Defined Contribution Plans

Cabot recognized expenses related to U.S. and foreign defined contribution plans in the amounts of $10 million, $10 million and $9 million in 2007, 2006 and 2005, respectively.

Retirement Savings Plan

The RSP is a U.S. defined contribution plan, which encourages long-term systematic savings and provides funds for retirement or possible earlier needs. The RSP has two components, a 401(k) plan and an Employee Stock Ownership Plan (“ESOP”).

401(k)

The 401(k) component of the plan allows an eligible participant to contribute a percentage of his or her eligible compensation on a before-tax basis or an after-tax basis. For employees not subject to a collective bargaining agreement, Cabot makes a matching contribution of 75% of a participant’s before-tax or after-tax contribution on up to 7.5% of the participant’s eligible compensation, making the maximum matching contribution an amount equal to 5.625% of a participant’s eligible compensation. This matching contribution is in the form of Cabot common stock and is made on a quarterly basis.

Employee Stock Ownership Plan

Other than certain employees subject to collective bargaining agreements, all eligible employees of Cabot and its participating subsidiaries in the U.S. participate in the ESOP component of the plan. Under the ESOP, which is 100% Company funded, 108,696.645 shares of Cabot common stock will be allocated to participants’ accounts at the end of each quarter. These shares are allocated to participants’ accounts based on a pre-determined formula. Cabot has established a minimum and maximum contribution percentage of total eligible pay of 4% and 8%, respectively. The actual contribution percentage in any given quarter varies depending on Cabot’s stock price on the last day of the relevant quarter, the total eligible compensation and the amount of the dividends allocated to participants. If the calculated contribution allocation falls below 4%, Cabot makes an additional contribution in the form of common stock to bring the total contribution to 4% for the participant. If the calculated contribution allocation exceeds 8% of eligible compensation, the excess shares are used to fund the Company match on the 401(k) contributions. If there are still shares remaining after the Company match has been allocated, the remaining shares are allocated to all participants in the ESOP as additional contribution shares.

Supplemental Retirement Savings Plan

Cabot has a Supplemental Retirement Savings Plan (“SRSP”) to provide benefits to highly compensated employees in circumstances in which the maximum limits established under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code prevent them from receiving Company matching and ESOP contributions provided under the qualified RSP. This is the first of Cabot’s two Supplemental Executive Retirement Plans (“SERP”). The SRSP is non-qualified and unfunded. See Note N for further information on the SRSP.

Defined Benefit Plans

defined benefit pension liability at the beginning of the year. The CBP and certain foreign pension plans generally use the straight-line method of amortization over five years for the unrecognized net gains and losses. In fiscal 2007 and 2006, Cabot used a June 30 measurement date for all U.S. and foreign plan obligations and assets. Cabot is making all required contributions to the plans.

Cash Balance Plan

The CBP is a hybrid defined benefit pension plan, in which participants in the CBP accrue benefits in the form of account balances, with a guaranteed rate of return and defined notional contributions. The notional contributions take the form of pay-based credits, which are computed as a percentage of eligible pay and credited quarterly to participant accounts. Interest is credited quarterly based on the average one-year Treasury bill rate for the month of November in the preceding calendar year. As of September 30, 2007, 113 employees have “grandfathered” benefits under a traditional defined benefit formula, which, under certain circumstances, may entitle them to benefits in addition to those accrued under the CBP formula described above. Cabot contributes to the plan based on the fair value of plan assets and associated returns and Cabot’s obligations and their timing.

Supplemental Cash Balance Plan

Cabot has a Supplemental Cash Balance Plan (“SCBP”) to provide benefits to highly compensated employees in circumstances in which the maximum limits established under ERISA and the Internal Revenue Code prevent them from receiving some of the benefits provided under the qualified CBP. This is the second SERP. This plan is non-qualified and unfunded. The obligations in connection with SCBP plan were $6 million as of both September 30, 2007 and 2006, respectively, and have been recorded in other liabilities. Both the CBP and the SCBP qualify as defined benefit plans under FAS 87.

Cabot provides benefits under traditional defined benefit formulas to employees in certain non-U.S. locations through several foreign defined benefit plans.

Postretirement Benefit Plans

Cabot also has postretirement benefit plans that provide certain health care and life insurance benefits for retired employees. Typical of such plans, the Cabot postretirement benefit plans are unfunded. Cabot funds the plans as claims or insurance premiums come due. In 1992, Cabot established a per retiree cap on the amount the Company will pay for medical costs to limit the Company’s financial responsibility for the cost of providing medical coverage and mitigate the risk of a potential escalation in costs borne by Cabot for retiree medical coverage.

The Medicare Prescription Drug Improvement and Modernization Act of 2003 was passed by the United States Congress in March 2003. FASB Staff Position 106-2 (“FSP 106-2”) provides accounting guidance related to the Act. Cabot has determined that its U.S. postretirement health care plan provides a drug benefit that is actuarially equivalent to the Medicare Part D benefit. Under the plan’s cost sharing arrangement with retirees, the subsidy that Cabot will receive from Medicare will generally be used to offset a portion of the costs of providing retiree medical coverage.

Measurement of postretirement benefit expense is based on actuarial assumptions used to value the postretirement benefit liability at the beginning of the year. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. The fiscal 2007 weighted-average assumed health care cost trend rate is 9.0% for U.S. plans and 8.5% for foreign plans. The ultimate weighted-average health care cost trend rate has been designated as 5.0% for U.S. plans and 7.1% for foreign plans and is anticipated to be achieved during 2011 and 2013, respectively. A one-percentage point change in the 2007 assumed health care cost trend rate would have the following effects:


	1-Percentage-Point
	Increase				Decrease
	U.S.		Foreign		U.S.			Foreign
	(Dollars in millions)
Effect on total of service and interest cost components	$	—	$	—	$	—		$	—
Effect on postretirement benefit obligation	$	2	$	3	$	(2	)	$	(2	)

The following provides a reconciliation of benefit obligations, plan assets, the funded status and weighted-average assumptions of the defined benefit pension and postretirement benefit plans. These tables include the effect of adopting the balance sheet impact of FAS 158 for the fiscal 2007 amounts.


	Years Ended September 30
	2007						2006						2007						2006
	Pension Benefits												Postretirement Benefits
	U.S.			Foreign			U.S.			Foreign			U.S.			Foreign			U.S.			Foreign
	(Dollars in millions)
Change in Benefit Obligations:
Benefit obligation at beginning of year	$	131		$	233		$	138		$	231		$	86		$	17		$	117		$	17
Service cost		5			7			6			7			2			—			3			—
Interest cost		8			12			6			11			5			1			5			1
Plan participants’ contribution		—			1			—			1			—			—			—			—
Foreign currency exchange rate changes		—			22			—			12			—			2			—			1
(Gain)/loss from changes in actuarial assumptions		(3	)		(9	)		(8	)		(15	)		1			(4	)		(27	)		(2	)
Benefit obligations assumed in acquisition		—			—			—			9			—			—			—			—
Benefits paid⁽¹⁾		(14	)		(12	)		(10	)		(10	)		(6	)		(1	)		(8	)		—
Plan amendments		—			(3	)		—			—			—			—			—			—
Curtailment (gain) loss		—			(1	)		(1	)		—			—			—			(4	)		—
Settlement (gain) loss		—			—			—			(13	)		—			—			—			—
Other		(1	)		—			—			—			—			—			—			—
Termination (benefit) loss		—			—			—			—			—			—			—			—

Benefit obligations at end of year	$	126		$	250		$	131		$	233		$	88		$	15		$	86		$	17


Change in Plan Assets:
Fair value of plan assets at beginning of year	$	135		$	181		$	132		$	170		$	—		$	—		$	—		$	—
Actual return on plan assets		22			16			13			11			—			—			—			—
Employer contribution		1			15			—			12			6			1			8			—
Plan participants’ contribution		—			1			—			1			—			—			—			—
Foreign currency exchange rate changes		—			18			—			8			—			—			—			—
Other		—			—			—			—			—			—			—			—
Assets acquired		—			—			—			1			—			—			—			—
Benefits paid		(14	)		(12	)		(10	)		(9	)		(6	)		(1	)		(8	)		—
Settlement gain (loss)		—			—			—			(13	)		—			—			—			—

Fair value of plan assets at end of year	$	144		$	219		$	135		$	181		$	—		$	—		$	—		$	—

Funded status	$	18		$	(31	)	$	4		$	(52	)	$	(88	)	$	(15	)	$	(86	)	$	(17	)
Unrecognized transition amount		—			—			—			(1	)		—			—			—			—
Unrecognized prior service cost		—			—			3			1			—			—			(7	)		—
Unrecognized net (gain) loss		—			—			(13	)		47			—			—			6			6
Fourth quarter contributions		—			4			—			4			2			—			2			—

Recognized asset (liability)	$	18		$	(27	)	$	(6	)	$	(1	)	$	(86	)	$	(15	)	$	(85	)	$	(11	)

⁽¹⁾

In connection with the contracts designated as hedges, Cabot recorded less than $1 million of expense in earnings during the year ended September 30, 2006 related to the ineffective portion. The hedges had an initial value in April 2006 (upon entering into the contracts) of $1.8 million, which has decreased to $1.6 million as of September 30, 2006. At September 30, 2006, the Company expects to reclassify less than $1 million of losses on the option contracts from accumulated other comprehensive income over the next twelve months. For those options not designated as hedges, the Company recorded less than $1 million of expense during the year ended September 30, 2006.

Cabot recorded $2 million of assets and $34 million of liabilities to recognize the fair value of currency instruments at September 30, 2006 and September 30, 2005. A 10% appreciation in the U.S. dollar’s value relative to the hedged currencies would increase the derivative instruments’ fair value by $38 million and $41 million at September 30, 2006 and 2005, respectively. A 10% depreciation in the U.S. dollar’s value relative to the hedged currencies would decrease the derivative instruments’ fair value by $37 million and $38 million at September 30, 2006 and 2005, respectively. Any increase or decrease in the fair value of Cabot’s currency exchange rate sensitive derivative instruments would be substantially offset by a corresponding decrease or increase in the fair value of the hedged underlying asset, liability, or cash flow.

~~Note L. Fair Value of Financial Instruments~~

~~The carrying amounts and fair values of the Company’s financial instruments at September 30, 2006 and 2005 are as follows:~~

2006

2005

Carrying
Amount

Fair
Value

Carrying
Amount

Fair
Value

(Dollars in millions)

Assets:

Cash and available for sale marketable securities

$
193

$
193

$
217

$
217

Foreign currency cash flow hedge

2

2

—

—

Cash flow hedge interest rate swaps

1

1

—

—

Liabilities:

Notes payable to banks—short-term

58

58

34

34

Foreign exchange contracts

—

—

4

4

Long-term debt—fixed rate

412

434

426

456

Long-term debt—floating rate

79

79

82

82

Fair value hedge interest rate swaps

1

1

—

—

Cross currency net investment hedges

2

2

3

3

Foreign currency fair value hedge

4

4

2

2

Foreign currency cash flow hedge

28

28

21

21

At September 30, 2006 and 2005, the fair values of cash, cash equivalents, accounts receivables, accounts payable and notes payable to banks approximated carrying values because of the short-term nature of these instruments. The estimated fair values of available for sale marketable securities, as described in Note F, are based on the market price at the respective year-ends. The estimated fair values of the derivative instruments as described in Note J and K are estimated based on the amount that Cabot would receive or pay to terminate the agreements at the respective year-ends which represents the fair value. The fair value of Cabot’s fixed rate long-term debt is estimated based on quoted market prices at the end of each fiscal year. The carrying amounts of Cabot’s floating rate long-term debt approximates their fair value.

~~Note M. Employee Benefit Plans~~

~~Defined Contribution Plans~~

~~Cabot recognized expenses related to U.S. and foreign defined contribution plans in the amounts of $10 million, $9 million and $8 million in 2006, 2005 and 2004, respectively.~~

~~Retirement Savings Plan~~

~~401(k)~~

The 401(k) plan allows an eligible participant to contribute a percentage of his or her eligible compensation on a before-tax basis or an after-tax basis. For employees not subject to a collective bargaining agreement, Cabot makes a matching contribution of 75% of a participant’s eligible before-tax or after-tax contribution up to 7.5% of the participant’s eligible compensation. This matching contribution is in the form of Cabot stock and is made on a quarterly basis.

~~Employee Stock Ownership Plan~~

Other than certain employees subject to collective bargaining agreements, all eligible employees of Cabot and its participating subsidiaries in the U.S. participate in the ESOP. Under the ESOP, which is 100% Company funded, 742.6 shares of Series B ESOP convertible preferred stock are allocated to participants’ accounts at the end of each quarter. These shares are allocated to participants’ accounts based on a pre-determined formula. Cabot has established a minimum and maximum contribution percentage of total eligible pay of 4% and 8%, respectively. The actual contribution percentage in any given quarter varies depending on Cabot’s stock price on the last day of the relevant quarter, the total eligible compensation and the amount of the dividends allocated to participants. If the calculated contribution allocation falls below 4%, Cabot makes an additional contribution in the form of common stock to bring the total contribution to 4% for the participant. If the calculated contribution allocation exceeds 8% of eligible compensation, the excess shares are used to fund the Company match on the 401(k) contributions. If there are still shares remaining after the Company match has been allocated, the remaining shares are allocated to all participants in the ESOP as additional contribution shares.

~~Defined Benefit Plans~~

Defined benefit plans provide pre-determined benefits to employees to be distributed for future use upon retirement. Measurement of defined benefit pension expense is based on assumptions used to value the defined benefit pension liability at the beginning of the year. The CBP and certain foreign pension plans generally use the straight-line method of amortization over five years for the unrecognized net gains and losses. In fiscal 2006 and 2005, Cabot used a June 30 measurement date for all U.S. and foreign plan obligations and assets. Cabot is making all required contributions to the plans.

Cabot has assets of $13 million and $12 million at September 30, 2006 and 2005, respectively, that the Company has designated to fund pension obligations for one of its foreign plans. These pension plan assets are not included in the pension plan assets as of September 30, 2006 and 2005 as they do not qualify as plan assets under FAS No. 87, “Employers’ Accounting for Pensions”, because they are not specifically segregated or restricted for use to fund the defined benefit plan obligation, and accordingly, the assets are not shown in the funded status at September 30, 2006 and 2005. These assets are included in other assets in the consolidated balance sheets.

~~Cash Balance Plan~~

The CBP is a hybrid pension plan, in which participants in the CBP accrue benefits in the form of account balances, with a guaranteed rate of return and defined notional contributions. The notional contributions take the form of pay-based credits, which are computed as a percentage of eligible pay and credited quarterly to participant accounts. Interest is credited quarterly based on the average one-year Treasury bill rate for the month of November in the preceding calendar year. Approximately 125 employees have “grandfathered” benefits under a traditional defined benefit formula, which, under certain

circumstances, may entitle them to benefits in addition to those accrued under the CBP. Cabot’s benefit obligations with regard to such employees are accounted for as part of Cabot’s defined benefit obligations. Cabot contributes to the plan based on the fair value of plan assets and associated returns and Cabot’s obligations and their timing.

~~Cabot provides benefits under traditional defined benefit formulas to employees in certain non-U.S. locations through several foreign defined benefit plans.~~

~~Supplemental Executive Plans~~

Cabot has Supplemental Executive Retirement Plans (“SERP”) to provide benefits to certain executive officers, other officers and employees of the Company. These plans are non-qualified and unfunded. The Supplemental Retirement Savings Plan (“SRSP”) and the Supplemental Cash Balance Plan (“SCBP”), collectively the SERP’s, were established to provide benefits to highly compensated employees in circumstances in which the maximum limits established under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code prevent them from receiving some of the benefits provided under the qualified RSP and CBP.

The obligations in connection with the supplemental plans were $18 million as of September 30, 2006 and 2005, and have been recorded in other liabilities. Of this, $8 million are obligations under the SCBP and are included in benefit obligations in the reconciliation of benefit obligations below, and $10 million are obligations under the SRSP and are not included in the reconciliation of benefit obligations below.

~~Postretirement Benefit Plans~~

Cabot also has postretirement benefit plans that provide certain health care and life insurance benefits for retired employees. Typical of such plans, the Cabot postretirement benefit plans are unfunded. Cabot funds the plans as claims or insurance premiums come due, as plans are not required to have assets for this obligation. Cabot established a per retiree cap on the amount the Company will pay for medical costs to limit the Company’s financial responsibility for the cost of providing medical coverage and mitigate the risk of a potential escalation in costs borne by Cabot for retiree medical coverage.

The Medicare Prescription Drug Improvement and Modernization Act of 2003 was passed by the United States Congress in March 2003. FASB Staff Position 106-2 (“FSP 106-2”) provides accounting guidance related to the Act. Cabot has determined that its U.S. defined benefit postretirement health care plan provides a drug benefit that is actuarially equivalent to the Medicare Part D benefit. Under the plan’s cost sharing arrangement with retirees, the subsidy that Cabot will receive from Medicare will generally be used to offset the costs of providing retiree medical coverage.

Measurement of postretirement benefit expense is based on actuarial assumptions used to value the postretirement benefit liability at the beginning of the year. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. The health care cost trend rates are reducing gradually to the ultimate projected future rates and have been achieved for all but one U.S. plan and one foreign plan in 2006. The fiscal 2006 weighted-average assumed health care cost trend rate is 10.0% for U.S. plans and 8.6% for foreign plans. The ultimate weighted-average health care cost trend rate has been designated as 5.0% for U.S. plans and 7.3% for foreign plans and is anticipated to be achieved during 2011 and 2013, respectively. A one-percentage point change in the 2006 assumed health care cost trend rate would have the following effects:

1-Percentage-Point

Increase

Decrease

U.S.

Foreign

U.S.

Foreign

(Dollars in millions)

Effect on total of service and interest cost components

$
—

$
—

$
—

$
—

Effect on postretirement benefit obligation

$
3

$
3

$
—

$
(2
)

~~The following provides a reconciliation of benefit obligations, plan assets, the funded status and weighted-average assumptions of the defined benefit pension and postretirement benefit plans:~~

Years Ended September 30

2006

2005

2006

2005

Pension Benefits

Postretirement Benefits

U.S.

Foreign

U.S.

Foreign

U.S.

Foreign

U.S.

Foreign

(Dollars in millions)

Change in Benefit Obligations:

Benefit obligation at beginning of year

$
138

$
231

$
127

$
197

$
117

$
17

$
103

$
10

Service cost

6

7

5

6

3

—

2

—

Interest cost

6

11

7

10

5

1

6

1

Plan participants’ contribution

—

1

—

1

—

—

1

—

Foreign currency exchange rate changes

—

12

—

(1
)

—

1

—

—

(Gain)/loss from changes in actuarial assumptions

(8
)

(15
)

12

29

(27
)

(2
)

13

6

Benefit obligations assumed in acquisition

—

9

—

—

—

—

—

—

Benefits paid(1)

(10
)

(10
)

(13
)

(12
)

(8
)

—

(8
)

—

Curtailment (gain) loss

(1
)

—

—

—

(4
)

—

—

—

Settlement (gain) loss

(13
)

—

—

—

—

—

—

Termination (benefit) loss

—

—

—

1

—

—

—

—

Benefit obligations at end of year

$
131

$
233

$
138

$
231

$
86

$
17

$
117

$
17

Change in Plan Assets:

Fair value of plan assets at beginning of year

$
132

$
170

$
133

$
149

$
—

$
—

$
—

$
—

Actual return on plan assets

13

11

11

20

—

—

—

—

Employer contribution

—

12

1

11

8

—

7

—

Plan participants’ contribution

—

1

—

1

—

—

1

—

Foreign currency exchange rate changes

—

8

—

—

—

—

—

—

Assets acquired

—

1

—

—

—

—

—

—

Benefits paid

(10
)

(9
)

(13
)

(11
)

(8
)

—

(8
)

—

Settlement gain (loss)

—

(13
)

—

—

—

—

—

—

Fair value of plan assets at end of year

$
135

$
181

$
132

$
170

$
—

$
—

$
—

$
—

Funded status

$
4

$
(52
)

$
(6
)

$
(61
)

$
(86
)

$
(17
)

$
(117
)

$
(17
)

Unrecognized transition amount

—

(1
)

—

(1
)

—

—

—

—

Unrecognized prior service cost

3

1

4

1

(7
)

—

(8
)

—

Unrecognized net (gain) loss

(13
)

47

(1
)

61

6

6

39

8

Fourth quarter contributions

—

4

—

3

2

—

2

—

Recognized liability

$
(6
)

$
(1
)

$
(3
)

$
3

$
(85
)

$
(11
)

$
(84
)

$
(9
)

Amounts Recognized in the Consolidated Balance Sheets
Consist of:

Prepaid benefit cost

$
2

$
23

$
5

$
9

$
—

$
—

$
—

$
—

Accrued benefit liabilities

(8
)

(33
)

(8
)

(36
)

(85
)

(11
)

(84
)

(9
)

Intangible asset

—

—

—

1

—

—

—

—

Accumulated other comprehensive loss

—

9

—

29

—

—

—

—

Net amount recognized

$
(6
)

$
(1
)

$
(3
)

$
3

$
(85
)

$
(11
)

$
(84
)

$
(9
)

~~(1)~~Included in this amount is $1 million the Company paid directly to participants in its foreign defined ~~benefits plans in 2006 and 2005.~~

~~Pension Assumptions and Strategy~~

~~The following assumptions were used to determine the benefit obligations at September 30:~~

Assumptions as of September 30

2006

2005

2006

2005

Pension Benefits

Postretirement Benefits

U.S.

Foreign

U.S.

Foreign

U.S.

Foreign

U.S.

Foreign

Discount rate

6.0
%

5.0
%

4.8
%

4.6
%

6.0
%

5.3
%

4.8
%

5.0
%

Expected rate of return on plan assets

7.8
%

6.1
%

7.8
%

6.4
%

N/A

N/A

N/A

N/A

Assumed rate of increase in compensation

4.5
%

3.5
%

4.8
%

3.4
%

N/A

N/A

N/A

N/A

Assumed annual rate of increase in health care benefits

N/A

N/A

N/A

N/A

10.0
%

8.6
%

11.0
%

8.4
%

The discount rate that Cabot uses for determining future benefit obligations under the U.S. Defined Benefit Plans is based on Moody’s Aa index rate as of June 30, 2006 (the measurement date), less 25 basis points. The Moody’s Aa index rate was selected and continues to be an appropriate rate for Cabot, since it represents a long term high quality fixed income benchmark which approximates the long term nature of Cabot’s pension obligation (and related payout). Due to the nature of the CBP in the U.S., which typically pays quicker than an annuity as it allows for a lump sum payment to a participant upon retirement, Cabot’s policy is to reduce the Moody’s Aa index rate by 25 basis points. The reduction in the rate from the index provides for a better match of the intended maturity of the pension obligation.

~~As of the June 30, 2006 the discount rate under Moody’s Aa was 6.08%. Cabot used this as its benchmark to determine the discount rate for its future benefit obligations at the end of fiscal 2006.~~

~~Cabot’s investment strategy for each of its defined~~ benefit plans in ~~the U.S.~~2007 and abroad is generally based on a set of investment objectives and policies which cover time horizons and risk tolerance levels consistent with plan liabilities. Periodic studies are performed to determine the asset mix that will meet pension obligations at a reasonable cost to the Company. The assets of the worldwide defined benefit plans are comprised principally of investments in equity and high quality fixed income securities, which are broadly diversified across the capitalization and style spectrum and are managed using both active and passive strategies. The weighted average target allocation for U.S. plans is 60%-70% in equity and 30%-40% in fixed income. As of September 30, 2006, the weighted average target allocation for foreign plans was 45% in equity and 55% in fixed income.2006.

~~The Company’s defined benefit pension plans weighted-average asset allocations at September 30, 2006 and 2005, by asset category are as follows:~~

Pension Assets

September 30

2006

2005

U.S.

Foreign

U.S.

Foreign

Asset Category:

Equity securities

69
%

46
%

70
%

43
%

Debt securities

31
%

52
%

30
%

49
%

Cash securities and other

—

2
%

0
%

8
%

Total

100
%

100
%

100
%

100
%

To develop the expected long-term rate of return on plan assets assumption, the Company used a Capital Asset Pricing model. The model considers the current level of expected returns on risk-free investments comprised of government bonds, the historical level of the risk premium associated with the other asset classes in which the portfolio is invested, and the expectations for future returns of each asset

~~class. The expected return for each asset class was then weighted based on the target asset allocation to develop the expected long-term rate of return for each plan.~~

~~Net periodic defined benefit pension and other postretirement benefit costs include the following components:~~

Years Ended September 30

2006

2005

2004

2006

2005

2004

Pension Benefits

Postretirement Benefits

U.S.

Foreign

U.S.

Foreign

U.S.

Foreign

U.S.

Foreign

U.S.

Foreign

U.S.

Foreign

(Dollars in millions)

Service cost

$
6

$
7

$
5

$
6

$
6

$
6

$
3

—

$
2

$
—

$
3

$
—

Interest cost

6

11

7

10

7

10

5

1

6

1

6

—

Expected return on plan assets

(10
)

(11
)

(11
)

(10
)

(10
)

(9
)

—

—

—

—

—

—

Amortization of prior service cost

1

—

—

3

—

—

(1
)

—

(1
)

—

(1
)

—

Unrecognized losses (gains)

—

4

—

—

(1
)

4

2

1

1

—

2

—

Settlements or termination benefits

—

(1
)

—

2

—

—

—

—

—

—

1

—

~~Net periodic benefit cost (benefit)~~

—

The termination benefits are accounted for under FAS No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits”. In connection with the Altona plant closure, the Company recorded a charge of $2 million in the first quarter of fiscal 2005 for special termination benefits related to the severance and employee benefits program offered to employees. This has been included as a component of the Altona restructuring charges.

   Years Ended September 30
   2007 2006 2007 2006
   Pension Benefits Postretirement Benefits
   U.S. Foreign U.S. Foreign U.S. Foreign U.S. Foreign
   (Dollars in millions)
Net Amounts Recognized in the Consolidated Balance Sheet at September 30, 2007

Noncurrent assets
   $ 24 $ 6 $ 2 $ 23 $ — $ — $ — $ —
Current liabilities
   (1 ) (1 ) — (33 ) (7 ) (1 ) — —
Noncurrent liabilities
   (5 ) (32 ) (8 ) — (79 ) (14 ) (85 ) (11 )
Accumulated other comprehensive (income) loss
   (26 ) 31 — 9 1 2 — —

Net amount recognized in consolidated balance sheet
   $ (8 ) $ 4 $ (6 ) $ (1 ) $ (85 ) $ (13 ) $ (85 ) $ (11 )

Amounts recognized in Accumulated Other Comprehensive Income at September 30, 2007 were as follows:


	Pension Benefits						Postretirement Benefits
	U.S.			Foreign			U.S.			Foreign
	(Dollars in millions)
Net actuarial (gain)/loss	$	(29	)	$	34		$	6		$	2
Net prior service cost/(credit)		3			(2	)		(5	)		—
Net transition obligation/(asset)		—			(1	)		—			—
Translation (gain)/loss		—			—			—			—

Balance in accumulated other comprehensive income at end of the year-pretax	$	(26	)	$	31		$	1		$	2

Impact of the Adoption of FAS 158

The incremental effect of adopting FAS 158 on individual captions in the consolidated balance sheet at September 30, 2007 is shown below:


	Before Application of FAS 158			FAS 158 Adjustments			After Application of FAS 158
Current deferred income taxes	$	3		$	—		$	3
Other assets	$	35		$	(5	)	$	30
Non-current deferred income taxes	$	29			(2	)		27

Total assets	$	67		$	(7	)	$	60

Accounts payable and accrued liabilities	$	—			(10	)	$	(10	)
Other liabilities	$	(137	)	$	7		$	(130	)
Non-current deferred income taxes		1			3			4

Total liabilities	$	(136	)	$	—		$	(136	)

Accumulated other comprehensive income	$	—		$	7		$	7

Total stockholders’ equity	$	—		$	7		$	7

The Company is continuing to evaluate the impact of the adoption of the change in measurement date related to the second part of FAS 158 on its consolidated financial statements. The Company uses a June 30 measurement date for all its plans, which will change to September 30 on or before September 30, 2009.

In 2008, an estimated net loss of $2 million and a prior service credit of less than $1 million for the defined benefit pension plans will be amortized from accumulated other comprehensive income to net periodic benefit cost. In 2008, an estimated net loss of less than $1 million and prior service credit of $1 million for other postretirement benefit plans will be amortized from accumulated other comprehensive income to net periodic benefit cost.

Pension Assumptions and Strategy

The following assumptions were used to determine the benefit obligations at September 30:


	Assumptions as of September 30
	2007				2006				2005
	Pension Benefits
	U.S.		Foreign		U.S.		Foreign		U.S.		Foreign
Actuarial assumptions as of the year-end measurement date:
Discount rate	6.0	%	5.3	%	6.0	%	5.0	%	4.8	%	4.6	%
Assumed rate of increase in compensation	4.5	%	3.6	%	4.5	%	3.5	%	4.8	%	3.4	%
Actuarial assumptions used to determine net cost during the year:
Discount rate	6.0	%	5.0	%	4.8	%	4.6	%	5.8	%	5.5	%
Expected rate of return on plan assets	7.8	%	6.3	%	7.8	%	6.1	%	7.8	%	6.4	%
Assumed rate of increase in compensation	4.5	%	3.5	%	4.8	%	3.4	%	4.8	%	3.6	%

	Assumptions as of September 30
	2007				2006				2005
	Postretirement Benefits
	U.S.		Foreign		U.S.		Foreign		U.S.		Foreign
Actuarial assumptions as of the year-end measurement date:
Discount rate	6.0	%	5.6	%	6.0	%	5.3	%	4.8	%	5.0	%
Assumed annual rate of increase in health care benefits	9.0	%	8.5	%	10.0	%	8.6	%	11.0	%	8.4	%
Actuarial assumptions used to determine net cost during the year:
Discount rate	6.0	%	5.3	%	4.8	%	5.0	%	5.8	%	5.9	%
Assumed annual rate of increase in health care benefits	10.0	%	8.6	%	11.0	%	8.4	%	10.0	%	8.1	%

Cabot uses discount rates as of June 30^th, the plans’ measurement date, to determine future benefit obligations under its U.S. and Foreign defined benefit plans. The discount rates for the defined benefit plans in the U.S. and Canada are based on Moody’s Aa index rates, less 25 basis points and the CIBC World Market AA bond index, respectively. For the European defined benefit plans the discount rates are based on either the Euro or Sterling iBoxx AA corporate bond index, depending on the local currency of the entity and the duration of the plans. In Japan and Indonesia the discount rates are based on the local Government Bond Index that best reflects the long-term duration of the plans.

The rates utilized are selected because they represent long-term high quality fixed income benchmarks that approximate the long-term nature of Cabot’s pension obligations and related payouts. Due to the nature of the CBP in the U.S., which typically pays more quickly than an annuity as it allows for a lump sum payment to a participant upon retirement, Cabot’s policy is to reduce the Moody’s Aa index rate by 25 basis points. The reduction in the rate from the index provides for a better match of the intended maturity of the pension obligation.

Cabot’s investment strategy for each of its defined benefit plans in the U.S. and abroad is generally based on a set of investment objectives and policies that cover time horizons and risk tolerance levels consistent with plan liabilities. Periodic studies are performed to determine the asset mix that will meet pension obligations at a reasonable cost to the Company. The assets of the worldwide defined benefit plans are comprised principally of investments in equity and high quality fixed income securities, which are

broadly diversified across the capitalization and style spectrum and are managed using both active and passive strategies. The weighted average target asset allocation for U.S. plans is 65% in equity and 35% in fixed income. As of September 30, 2007, the weighted average target asset allocation for foreign plans was 47% in equity and 53% in fixed income.

The Company’s defined benefit pension plans weighted-average asset allocations at September 30, 2007 and 2006, by asset category are as follows:


	Pension Assets
	September 30
	2007				2006
	U.S.		Foreign		U.S.		Foreign
Asset Category:
Equity securities	72	%	48	%	69	%	46	%
Debt securities	28	%	50	%	31	%	52	%
Cash securities and other	—		2	%	—		2	%

Total	100	%	100	%	100	%	100	%

Net periodic defined benefit pension and other postretirement benefit costs include the following components:


	Years Ended September 30
	2007						2006						2005						2007					2006					2005
	Pension Benefits																		Postretirement Benefits
	U.S.			Foreign			U.S.			Foreign			U.S.			Foreign			U.S.			Foreign		U.S.			Foreign		U.S.			Foreign
	(Dollars in millions)
Service cost	$	5		$	6		$	6		$	7		$	5		$	6		$	2			—	$	3			—	$	2		$	—
Interest cost		8			12			6			11			7			10			5			1		5			1		6			1
Expected return on plan assets		(10	)		(12	)		(10	)		(11	)		(11	)		(10	)		—			—		—			—		—			—
Amortization of prior service cost		—			—			1			—			—			3			(1	)		—		(1	)		—		(1	)		—
Net losses (gains)		—			4			—			4			—			—			—			—		2			1		1			—
Settlements or termination benefits		—			—			—			(1	)		—			2			—			—		—			—		—			—

Net periodic benefit cost (benefit)	$	3		$	10		$	3		$	10		$	1		$	11		$	6		$	1	$	9		$	2	$	8		$	1

For those plans where the accumulated benefit obligation exceeded the related fair value of plan assets, the accumulated benefit obligation and fair value of plan assets for Cabot’s pension benefits are as follows:


	2007				2006
	U.S.⁽¹⁾		Foreign		U.S.⁽¹⁾		Foreign
	(Dollars in millions)
Accumulated benefit obligation	$	6	$	31	$	6	$	69
Fair value of plan assets	$	—	$	4	$	—	$	38

⁽¹⁾

Represents the value of the accumulated benefit obligation ~~exceeded~~under the ~~related fair value of plan assets, the accumulated benefit obligation and fair value of plan assets for Cabot’s pension benefits are as follows:~~SCBP, which is unfunded.

2006

2005

U.S.

Foreign

U.S.

Foreign

(Dollars in millions)

Accumulated benefit obligation

$
6

$
69

$
6

$
126

Fair value of plan assets

$
—

$
38

$
—

$
92

For those plans where the projected benefit obligation exceeded the related fair value of plan assets, the projected benefit obligation and fair value of plan assets for Cabot’s pension benefits are as follows:


	2007				2006
	U.S.⁽¹⁾		Foreign		U.S.⁽¹⁾		Foreign
	(Dollars in millions)
Projected benefit obligation	$	6	$	142	$	6	$	233
Fair value of plan assets	$	—	$	107	$	—	$	181

⁽¹⁾

Represents the value of the projected benefit obligation ~~exceeded the related fair value of plan assets, the projected benefit obligation and fair value of plan assets for Cabot’s pension benefits are as follows:~~

2006

2005

U.S.

Foreign

U.S.

Foreign

(Dollars in millions)

Projected benefit obligation

$
6

$
233

$
8

$
223

Fair value of plan assets

$
—

$
181

$
—

$
161

The accumulated benefit obligation was $123 million for the U.S. plans and $203 million for the foreign plans as of September 30, 2006 and $128 million for the U.S. plans and $198 million for the foreign plans at September 30, 2005.

~~Contributions~~

The Company does not expect to contribute to its U.S. pension plan in 2007 as the plans are fully funded. However, the Company expects to contribute approximately $12 million to its foreign plans in fiscal 2007.

~~Estimated Future Benefit Payments~~

~~The Company expects that the following benefit payments will be made to plan participants:~~

Pension
Benefits

Postretirement
Benefits

U.S.

Foreign

U.S.

Foreign

(Dollars in millions)

Years Ended:

2007

$12

$11

$ 8

$1

2008

11

12

8

1

2009

11

14

8

1

2010

10

14

8

1

2011

11

16

8

1

2012-2016

56

87

38

5

~~Note N. Stock-Based Compensation~~

Cabot established the 2006 Long-Term Incentive Plan (the “2006 Plan”) in order to provide equity-based compensation to the Company’s key employees, advisors and consultants. The 2006 Plan was approved by Cabot’s stockholders on March 9, 2006 and replaces the 1996 Equity Incentive Plan and the 1999 Equity Incentive Plan. Although the 2006 Plan allows Cabot to issue various forms of equity, Cabot expects to use the 2006 Plan primarily to issue shares of restricted stock and stock options under its long-term incentive compensation program. The terms of awards made under this program are generally determined by the Compensation Committee of the Board of Directors. As the program has been administered since 1992, participants are granted a specific number of shares of common stock (the “Grant Number”) that the participant may then elect either (i) to purchase as shares of restricted stock at a percentage of the market price of such stock on the date of grant (which in the last six years has been 30%) or (ii) to receive as non-qualified stock options for a number of shares of common stock equal to two times the Grant Number, exercisable at 100% of the market price of such stock on the date of grant. Both the purchased restricted stock and the stock options granted under the ~~program are subject to a three-year vesting period. Stock options granted under the program expire five years from the date of grant. Certain of the terms under~~SCBP, which stock options and restricted stock are issued to international employees are modified slightly from the terms of awards made to employees in the U.S. to account for tax or securities laws issues applicable to such international employees. Approximately 1.1 million stock awards have been granted under the 2006 Plan and there are approximately 3.4 million shares available for future grants at September 30, 2006. No new awards may be granted under either the 1996 Equity Incentive Plan or the 1999 Equity Incentive Plan, but there remain outstanding awards previously granted under these plans.

The accumulated benefit obligation was $120 million for the U.S. defined benefit plans and $218 million for the foreign plans as of September 30, 2007 and $123 million for the U.S. defined benefit plans and $203 million for the foreign plans at September 30, 2006.

Contributions

The Company does not expect to contribute to its U.S. pension plan in 2008. However, the Company expects to contribute approximately $13 million to its foreign plans in fiscal 2008.

Estimated Future Benefit Payments

The Company expects that the following benefit payments will be made to plan participants:


	Pension Benefits				Postretirement Benefits
	U.S.		Foreign		U.S.		Foreign
	(Dollars in millions)
Years Ended:
2008	$	18	$	14	$	8	$	1
2009		10		17		8		1
2010		9		16		8		1
2011		10		16		7		1
2012		10		19		7		1
2013-2017		51		72		34		5

Note N. Stock-Based Compensation

Cabot established the 2006 Long-Term Incentive Plan (the “2006 Plan”) in order to provide equity-based compensation to the Company’s key employees, advisors and consultants. The 2006 Plan was approved by Cabot’s stockholders on March 9, 2006 and replaces the 1996 Equity Incentive Plan and the 1999 Equity Incentive Plan. Although the 2006 Plan allows Cabot to issue various forms of equity, Cabot expects to use the 2006 Plan primarily to issue shares of restricted stock and stock options under its long-term equity incentive program. The terms of awards made under this program are generally determined by the Compensation Committee of the Board of Directors. Participants are granted a specific number of shares of common stock (the “Grant Number”) that the participant may then elect either (i) to purchase as shares of restricted stock at a percentage of the market price of such stock on the date of grant (which in the last six years has been 30%) or (ii) to receive as non-qualified stock options for a number of shares of common stock equal to two times the Grant Number, exercisable at 100% of the market price of such stock on the date of grant. Both the purchase restricted stock and the stock options granted under the program are subject to a three-year vesting period. Stock options granted under the program expire five years from the date of grant. Certain of the terms under which stock options and restricted stock are issued to international employees are modified slightly from the terms of awards made to employees in the U.S. to account for tax or securities laws issues applicable to such international employees. Approximately 1.9 million stock awards have been granted under the 2006 Plan and there are approximately 2.6 million shares available for future grants at September 30, 2007. No new awards may be granted under either the 1996 Equity Incentive Plan or the 1999 Equity Incentive Plan, but there remain outstanding awards previously granted under these plans.

Through fiscal year 2005, Cabot followed Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations, which resulted in the accounting for grants of awards to employees at their intrinsic value in the consolidated financial statements. On October 1, 2005, Cabot adopted FAS No. 123(R), using the modified prospective method, which permits the provisions of FAS 123(R) to be applied to the consolidated financial statements on a going-forward basis. Prior periods have not been adjusted. FAS 123(R) requires companies to recognize share-based payments to employees as compensation expense on a fair value method. Under the fair value recognition provisions of FAS 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the service period, which generally represents the vesting period. The fair value of stock options is calculated using the Black-Scholes option-pricing model and the fair value of restricted stock is based on the intrinsic value of the stock on the date of grant. The expense recognized over the service period is required to include an estimate of the awards that will be forfeited. Previously, as permitted under APB 25, Cabot recorded the impact of forfeitures as incurred. In connection with the adoption of FAS 123(R), during the first quarter of fiscal year 2006, Cabot recorded a $2 million gain (after-tax) from the cumulative effect of the change from recording forfeitures as they occur to estimating forfeitures during the service period. In addition, the previously recorded unearned compensation balance of $41 million, as of the date of adoption, which was included as a component of stockholders’ equity, was reclassified to additional paid-in capital and retained earnings.

Stock-based Compensation

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


	Year Ended September 30, 2005
	(in millions, except for per share amounts)
Net loss, as reported	$	(48	)
Add: Stock-based compensation expense included in reported net loss, net of related tax effects		21
Deduct: Stock-based compensation using fair value method for all awards, net of related tax effects		(23	)

Pro forma net loss	$	(50	)
Net loss per common share:
Basic, pro forma	$	(0.87	)
Basic, as reported	$	(0.84	)
Diluted, pro forma	$	(0.87	)
Diluted, as reported	$	(0.84	)

Stock-based employee compensation expense was $15 million after tax for the years ended September 30, 2007 and 2006. The Company recognized the full impact of its stock-based employee compensation in the consolidated statements of operations for the years ended September 30, 2007 and 2006 under FAS 123(R) and did not capitalize any such costs on the consolidated balance sheets because those that qualified for capitalization were not material. The following table presents stock-based compensation expenses included in the Company’s consolidated statement of operations:


	September 30
	2007			2006
	(Dollars in millions)
Cost of sales	$	7		$	9
Selling and administrative		14			12
Research and technical		2			2

Stock-based compensation expense before tax		23			23

Income tax benefit		(8	)		(8	)

Net stock-based compensation expense	$	15		$	15

Stock OptionsAs of September 30, 2007, Cabot has $1 million of total unrecognized compensation cost related to non-vested options granted under the Company’s equity incentive plans. That cost is expected to be recognized over a weighted-average period of 1.2 years.

Restricted StockAs of September 30, 2007, Cabot has $42 million of total unrecognized compensation cost related to non-vested restricted stock granted under the Company’s equity incentive plans. That cost is expected to be recognized over a weighted-average period of 1.6 years. The estimated weighted average grant date fair values of restricted stock granted during fiscal years 2007, 2006 and 2005 were $29.62, $20.52 and $18.15, respectively.

In many instances, the Company provides loans to employees, other than executive officers, to purchase restricted stock under its long-term equity incentive program. These loans, secured by the purchased shares, are full recourse and have a term of approximately three years. The loans accrue interest at market rates. As of September 30, 2007 and 2006, the outstanding loan balances were $19 and $20 million, respectively, and are classified as notes receivable for restricted stock on the statement of stockholders’ equity.

Equity Incentive Plan Activity

The following table summarizes the total stock option and the restricted stock activity in the equity incentive plans for the year ended September 30, 2007:


	September 30, 2007
	Stock Options						Restricted Stock
	Total Options		Weighted Average Exercise Price		Weighted Average Grant Date Fair Value		Restricted Shares		Weighted Average Grant Date Fair Value
	(Shares in thousands)
Outstanding at September 30, 2006	663		$	29.92	$	9.45	2,953		$	21.38
Granted	42			46.03		11.87	806			29.62
Exercised/Vested	(321	)		27.87		9.91	(1,072	)		24.77
Cancelled/Forfeited	(16	)		39.10		10.32	(119	)		18.98

Outstanding at September 30, 2007	368			33.18		9.67	2,568			22.65

Exercisable at September 30, 2007	110			33.40

Stock Options

The following table summarizes information related to the outstanding and vested options on September 30, 2007:

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the Company’s closing common stock price of $35.53 on September 30, 2007, which would have been received by the option holders had all option holders exercised their options on that date.

The following table summarizes information related to the total intrinsic value of options exercised during the year ended September 30, 2007:


	September 30, 2007
	(Dollars in millions)
Intrinsic Value	$	5
Cash Received		9
Tax Benefit		2

The Company settles employee stock option exercises with newly issued common shares. The total fair value of the options vested during the year ended September 30, 2007 was $5 million. The Company uses the Black-Scholes option-pricing model to estimate the fair value of the options at the grant date. The estimated weighted average grant date fair values of options granted during fiscal 2007, 2006 and 2005 were $11.87, $8.40 and $8.86 per option, respectively. The fair values on the grant date were calculated using the following weighted-average assumptions:


	Years Ended September 30
	2007			2006			2005
Expected stock price volatility		26	%		31	%		42	%
Risk free interest rate		4.8	%		4.9	%		3.9	%
Expected life of options (years)		4			4			4
Expected annual dividends per share	$	0.72		$	0.64		$	0.64

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

Supplemental Retirement Savings Plan

Cabot’s SRSP provides benefits to highly compensated employees in circumstances in which the maximum limits established under ERISA and the Internal Revenue Code prevent them from receiving all of the Company matching and ESOP contributions that would otherwise be provided under the qualified RSP. The SRSP is non-qualified and unfunded. Contributions under the SRSP are treated as if invested in Cabot common stock. The majority of the distributions made under the SRSP are required to be paid from shares of Cabot common stock held in treasury. The remaining distributions, which relate to certain grandfathered accounts, will be paid in cash based on the market price of Cabot common stock at the time of distribution. The aggregate value of the accounts that will be paid out in stock, which is equivalent to approximately 200,000 shares of Cabot common stock as of September 30, 2007, is reflected at historic cost in stockholders’ equity, and the aggregate value of the accounts that will be paid in cash, which is approximately $3 million as of September 30, 2007, is reflected in other long-term liabilities and marked-to-market quarterly.

Note O. Restructurings

Closure of Waverly, West Virginia Carbon Black Facility

In June 2007, Cabot announced that it would close its carbon black manufacturing facility in Waverly, West Virginia. The decision to close the facility was driven by changes in the North American tire market. Site operations are expected to cease by the middle of calender year 2008. The total charges related to closing the plant are expected to be approximately $22 million, which includes an anticipated net gain on the sale of land where the facility is located. This gain is expected to be less than $1 million. The $22 million includes approximately $2 million for severence and employee benefits, $17 million for accelerated depreciation of the facility assets and $3 million for demolition of the facility. All the charges associated with closing the plant are related to the rubber blacks and performance products product lines. Through September 30, 2007, Cabot has recorded $8 million of these charges, which includes approximately $7 million for accelerated depreciation of the facility assets and approximately $1 million for severance and related benefits. The Company anticipates that the remaining $14 million of charges will be recorded over the next two fiscal years in connection with the closure, demolition and site remediation. As of September 30, 2007, the Company had $1 million of reserves recorded related to severance and related benefits. The Company expects to make cash payments of $3 million and $2 million in fiscal 2008 and 2009, respectively.

Cost Reduction Initiatives

In September 2006, Cabot announced a global restructuring plan principally aimed at reducing the fundamental cost structure of its rubber blacks and performance products product lines. These initiatives included streamlining the Company’s sales, manufacturing, technical service and certain functional groups through a workforce reduction. Implementation began in September 2006 and has been substantially completed. The total number of employees impacted by the cost reductions was approximately 130, with the majority having left the Company by September 30, 2006. Included in this restructuring plan was the closure of the Company’s technical facility in Leiden, Netherlands. The building was sold during the fourth quarter of fiscal 2007 resulting in a gain of approximately $2 million, which was recorded during fiscal 2007. Proceeds from the sale were received during the first quarter of fiscal 2008.

During fiscal 2007, due partly to ongoing weakness in the Supermetals Business, the decision was made to terminate the employment of eight employees in that business. This resulted in a charge of less than $1 million for severance and related benefits during fiscal 2007.

All charges associated with these actions have been recorded in accordance with FAS No. 112, “Employers’ Accounting for Postemployment Benefits” or FAS No. 146, “Accounting for the Costs Associated with Exit or Disposal Activities”, as appropriate. Cabot expects to make cash payments related to these charges of approximately $2 million during fiscal 2008.

The following summarizes the charge recorded for the workforce reductions at September 30, 2007:


	Severance And Employee Benefits
	(Dollars in millions)
Reserve at September 30, 2005	$	—
Charges for the twelve months ended September 30, 2006		10
Cash paid		(1	)
Reserve at September 30, 2006	$	9
Charges for the twelve months ended September 30, 2007		5
Cash paid		(12	)

Reserve at September 30, 2007	$	2

Closure of Altona, Australia Carbon Black Facility

In October 2004, Cabot initiated a plan to shut down its Altona, Australia carbon black manufacturing facility due to an indication by Cabot’s raw materials supplier that it would cease supply in September 2005, as well as the decline of the carbon black business in Australia. Production at this facility ceased on October 3, 2005. Through September 30, 2007, Cabot has recorded charges associated with this restructuring of approximately $28 million, which is expected to be partly offset by gains on the sale of the land where the facility was located. All charges associated with this restructuring are related to the rubber blacks and performance products product lines and have been recorded in the consolidated statements of operations since October 2004. No further material charges are expected related to this restructuring. The Company has $1 million of reserves remaining which is expected to be paid during fiscal 2008 in connection with severance and related benefits and completion of site remediation and restoration.

During the first quarter of fiscal 2008, the Company completed the sale of the land. The gain on the sale of the land is approximately $13 million, after tax, net of settlement costs. The gain will be recorded and the proceeds are expected to be received during the first quarter of fiscal 2008.

Total Restructuring

As of September 30, 2007, the reserve balances for the Waverly, West Virginia plant closure, the cost reduction initiatives and the Altona, Australia plant closure are included in accrued expenses in the accompanying consolidated balance sheets.

Restructuring costs were recorded in the consolidated statements of operations for the years ended September 30, 2007, 2006 and 2005 as follows:


	Years Ended September 30
	2007		2006			2005
	(Dollars in millions)
Net sales and other operating revenue	$	—	$	(1	)	$	—
Cost of sales		12		6			14
Selling and administrative expense		—		8			2

Total	$	12	$	13		$	16

Note P. Stockholders’ Equity

In May 2007, the Board of Directors authorized Cabot to repurchase up to five million shares of Cabot’s common stock in the open market or in privately negotiated transactions. On September 14, 2007, the Board increased this share repurchase authorization to 10 million shares. This authority does not have a set expiration date. During fiscal 2007 approximately 4.6 million shares were repurchased under the May 2007 authorization and a prior authorization, and as of September 30, 2007, approximately 5.5 million shares remain available for repurchase under the current authorization. Approximately 1.1 million and 1.6 million shares were repurchased under a prior share repurchase authorization during the fiscal years ended September 30, 2006 and 2005, respectively.

On July 20, 2007, there were 32,095 shares of Series B ESOP Convertible Preferred Stock outstanding, which were converted into approximately 4.7 million shares of the Company’s common stock. This conversion did not change the Company’s diluted earnings per share (“EPS”) as all preferred shares had been considered converted for purposes of the diluted EPS calculation. However, the increase in the number

of outstanding shares of common stock decreased the Company’s basic EPS for the year ended September 30, 2007 by $0.03 per share.

Cabot is the guarantor of the outstanding debt held by the ESOP as described in Note J. Cabot contributed $4 million during each of fiscal 2007, 2006 and 2005 to the ESOP to service the debt. Dividends on ESOP shares used for debt service were $3 million in both fiscal 2007 and 2006 and $4 million in fiscal 2005. In addition, interest incurred on the ESOP debt was $3 million in both fiscal 2007 and 2006 and $4 million in 2005.

During fiscal 2007, 2006 and 2005, Cabot paid cash dividends of $58.13, $77.50 and $77.50 respectively, per share of Series B ESOP Convertible Preferred Stock and $0.72, 0.64 and $0.64, respectively, per share of common stock.

Accumulated Other Comprehensive Income

The balance of related after-tax components comprising accumulated other comprehensive income are summarized below:


	September 30
	2007			2006
	(Dollars in millions)
Foreign currency translation adjustments	$	72		$	21
Unrealized holding gain on marketable securities		1			1
Unrealized holding loss on derivative instruments		2			(6	)
Minimum pension liability adjustment		—			(6	)
Effect of the adoption of FAS 158		(7	)		—

Accumulated other comprehensive income	$	68		$	10

Note Q. Earnings Per Share

Basic and diluted earnings per share (“EPS”) were calculated as follows:


	Years Ended September 30
	2007			2006			2005
	(In millions, except per share amounts)
Basic EPS:
Income (loss) available to common shares (numerator)	$	128		$	86		$	(51	)

Weighted-average common shares outstanding		65			63			63
Less: contingently issuable shares⁽¹⁾		(3	)		(3	)		(3	)

Adjusted weighted-average shares (denominator)		62			60			60

Basic EPS	$	2.03		$	1.42		$	(0.84	)

Income per share from discontinued businesses		0.03			0.03			—
Loss per share from cumulative effect of changes in accounting principles		—			(0.03	)		—

Net income (loss) per share—basic	$	2.06		$	1.42		$	(0.84	)

Diluted EPS:
Income (loss) available to common shares	$	128		$	86		$	(51	)
Dividends on preferred stock⁽²⁾		1			2			—

Income (loss) available to common shares plus assumed conversions (numerator)	$	129		$	88		$	(51	)

Weighted-average common shares outstanding		62			60			60
Effect of dilutive securities:
Assumed conversion of preferred stock		4			6			—
Common shares issuable⁽³⁾⁽⁴⁾		2			2			—

Adjusted weighted-average shares (denominator)		68			68			60

Diluted EPS	$	1.87		$	1.28		$	(0.84	)

Income per share from discontinued businesses		0.03			0.03			—
Income per share from cumulative effect of changes in accounting principles		—			(0.03	)		—

Net income (loss) per share—diluted	$	1.90		$	1.28		$	(0.84	)

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

~~Stock-based Compensation~~⁽¹⁾

Prior to the adoption of FAS 123(R), Cabot included in its consolidated financial statements the stock-based compensation disclosure requirements of FAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”. The following table illustrates the effect the fair value recognition provisions of FAS No. 123 “Accounting for Stock Based Compensation” would have had on net income (loss) and earnings per share for the years ended September 30, 2005 and 2004.

Years Ended
September 30

2005

2004

(in millions, except for per share amounts)

Net income (loss), as reported

$            (48
)

$             124

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

21

19

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

(23
)

(21
)

Pro forma net income (loss)

$            (50
)

$             122

Net income (loss) per common share:

Basic, pro forma

$         (0.87
)

$            2.04

Basic, as reported

$         (0.84
)

$            2.07

Diluted, pro forma

$         (0.87
)

$            1.79

Diluted, as reported

$         (0.84
)

$            1.82

Stock-based employee compensation expense was $15 million after tax for the year ended September 30, 2006. The Company recognized the full impact of its stock-based employee compensation in the consolidated statements of operations for the year ended September 30, 2006 under FAS 123(R) and did not capitalize any such costs on the consolidated balance sheets because those that qualified for capitalization were not material. The following table presents stock-based compensation expenses included in the Company’s consolidated statement of operations:

	~~Year Ended~~ ~~September 30, 2006~~
	~~(Dollars in millions)~~
~~Cost of sales~~		~~$ 9~~
~~Selling and administrative~~		12
~~Research and technical~~		2
~~Stock-based compensation expense before tax~~		23
~~Income tax benefit~~		(8	)
~~Net stock-based compensation expense~~		~~$15~~

~~Stock Options~~As of September 30, 2006, Cabot has $1 million of total unrecognized compensation cost related to non-vested options granted under the Company’s equity incentive plans. That cost is expected to be recognized over a weighted-average period of 1.5 years.

~~Restricted Stock~~As of September 30, 2006, Cabot has $37 million of total unrecognized compensation cost related to non-vested restricted stock granted under the Company’s equity incentive plans. That cost is expected to be recognized over a weighted-average period of 1.58 years.

~~Equity Incentive Plan Activity~~

~~The following table summarizes the total stock option and the restricted stock activity in the equity incentive plans for the year ended September 30, 2006:~~

September 30, 2006

(Shares in thousands)

Stock Options

Restricted Stock

Total
Options

Weighted
Average
Exercise
Price

Non-Vested
Options

Weighted
Average
Exercise
Price

Restricted
Shares

Weighted
Average
Grant Date
Fair Value

Outstanding at September 30, 2005

866

$29.42

450

$29.79

3,092

$30.29

Granted

93

35.23

93

35.23

972

35.23

Exercised/Vested

(270
)

29.98

(161
)

28.00

(886
)

28.22

Cancelled/Forfeited

(26
)

31.50

(20
)

20.36

(225
)

30.85

Outstanding at September 30, 2006

663

29.92

362

31.94

2,953

32.49

Exercisable at September 30, 2006

301

27.50

~~Stock Options~~

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

Options
Outstanding

Vested
Options

Aggregate Intrinsic Value (dollars in millions)

$5

$3

Weighted Average Remaining Contractual Term (in years)

2

1

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the Company’s closing common stock price of $37.20 on September 30, 2006, which would have been received by the option holders had all option holders exercised their options on that date.

~~The following table summarizes information related to the total intrinsic value of options exercised during the year ended September 30, 2006:~~

	~~September 30, 2006~~
	~~(Dollars in millions)~~
~~Intrinsic Value~~		$2
~~Cash Received~~		8
~~Tax Benefit~~		1

~~The Company settles employee stock option exercises with newly issued common shares. The total fair value of the options vested during the year ended September 30, 2006 was $6 million.~~

The Company uses the Black-Scholes option-pricing model to estimate the fair value of the options at the grant date. The estimated weighted average fair values of options granted during fiscal 2006, 2005 and

~~2004 were $8.40, $8.86 and $11.00 per option, respectively. The fair values on the grant date were calculated using the following weighted-average assumptions:~~

Years Ended September 30

2006

2005

2004

Expected stock price volatility

31
%
42
%
44
%
Risk free interest rate

4.9
%
3.8
%
3.7
%
Expected life of options (years)

4

4

4

Expected annual dividends per share

$0.64

$0.64

$0.60

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

~~Note O. Restructuring~~

~~Cost Reduction Initiatives~~

In September, 2006, Cabot announced a restructuring plan principally to reduce the fundamental cost structure of the carbon black product lines and strengthen the Company’s financial health. These initiatives include streamlining the Company’s sales, manufacturing, technical service and certain functional groups through a workforce reduction. Implementation has begun and is expected to conclude during the course of fiscal year 2007. The total number of employees impacted by the cost reductions is expected to be approximately 130 people, with the majority having left the Company by September 30, 2006. Termination and related benefits costs associated with this restructuring have been and will be recorded in accordance with FAS 112, “Employers’ Accounting for Postemployment Benefits (“FAS 112”) or FAS 146, “Accounting for the Costs Associated with Exit or Disposal Activities” (“FAS 146”), as appropriate. The total charge related to these initiatives was $10 million as of September 30, 2006. The Company expects to record an additional $3 million related to the restructuring and make cash payments of $12 million during fiscal 2007.

In addition to the benefits accrued as part current and prior restructuring plans, the Company offers other post-employment benefits, as defined by FAS 112, to its employees. These benefits have not been accrued as of September 30, 2006 or 2005 as the amount of the Company’s obligation cannot be reasonably estimated.

~~The following summarizes the charge recorded for the workforce reductions at September 30, 2006:~~

	~~Severance~~ ~~And~~ ~~Employee~~ ~~Benefits~~
	~~(Dollars in millions)~~
~~Charges for the twelve months ended September 30, 2006~~		~~$10~~
~~Cash paid~~		(1	)
~~Reserve at September 30, 2006~~		~~$ 9~~

~~Altona Restructuring~~

In October 2004, Cabot initiated a plan to shut down its Altona, Australia carbon black manufacturing facility due to an indication by Cabot’s raw materials supplier that it would cease supply in September 2005, as well as the decline of the carbon black business in Australia. Production at this facility ceased on October 3, 2005. As of September 30, 2006, Cabot has recorded charges associated with this restructuring of approximately $28 million, which is expected to be partly offset by gains on the sale of the land on which the facility was located. These gains are estimated to be between approximately $7 million and $10 million (net of transaction costs) and the sale of the land is expected to occur during fiscal 2007. No further charges are expected related to this restructuring. The $28 million of charges includes

approximately $9 million for severance and employee benefits, $7 million for accelerated depreciation of the facility assets, $2 million for the demolition of the facility, $2 million for asset retirement obligations related to site remediation and restoration and $8 million for the realization of foreign currency translation adjustments. As of September 30, 2006, substantial liquidation of the Company’s operating subsidiary in Australia has been completed and therefore, an $8 million non-cash charge for the foreign currency translation adjustment has been recorded. All charges associated with this restructuring initiative are related to the Carbon Black Business. Cabot has recorded all of these charges in the consolidated statements of operations since October 2004 and has $2 million of reserves recorded as of September 30, 2006. It is anticipated that the remaining $2 million of reserves will be paid during fiscal 2007 in connection with the remediation and restoration of the property.

~~Details of the Altona restructuring activity and changes in the reserve during the years ended September 30, 2005 and 2006 are as follows:~~

Severance
And
Employee
Benefits

Asset
Retirement
Obligation

Accelerated
Depreciation

Total

(Dollars in millions)

Charges for the year ended September 30, 2005

$ 7

$—

$ 7

$14

Costs charged against assets

(2
)

—

(7
)

(9
)

Recognition of asset retirement obligation

—

2

—

2

Cash paid

(1
)

—

—

(1
)

Reserve at September 30, 2005

$ 4

$ 2

$—

$ 6

Charges for the year ended September 30, 2006

2

2

4

Costs charged against assets

1

—

—

1

Recognition of asset retirement obligation

—

—

—

Cash paid

(6
)

(3
)

—

(9
)

Reserve at September 30, 2006

$ 1

$ 1

$—

$ 2

~~The charges related to the Altona restructuring for the year ended September 30, 2006 are exclusive of $1 million of gains on the sale of fixed assets.~~

~~European and Zierbena Restructuring~~

As of September 30, 2006, the Company had less than $1 million of restructuring reserves for severance and employee benefits related to the Company’s fiscal 2003 European restructuring plan and closure of its carbon black manufacturing facility in Zierbena, Spain and less than $1 million of asset retirement obligations related to site remediation and restoration of the Zierbena facility. During fiscal 2006, $4 million of payments were made related to these restructurings. Cabot expects the remaining accruals to be paid out during fiscal 2007 in connection with the completion of the site remediation and restoration.

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

~~Restructuring costs were recorded in the consolidated statements of operations for the years ended September 30, 2006, 2005 and 2004 as follows:~~

Years Ended September 30

2006

2005

2004

(Dollars in millions)

Net sales and other operating revenue

$(1
)

$—

$—

Cost of sales

6

14

5

Selling and administrative expense

8

2

1

Total

$13

$16

$ 6

~~Note P. Stockholders’ Equity~~

In May 2004, the Board of Directors authorized Cabot to purchase up to 5 million shares of Cabot common stock. Approximately 1.1 million, 1.6 million and 1.7 million shares have been repurchased during the fiscal years ended September 30, 2006, 2005 and 2004, respectively. Approximately 1.6 million shares remain available for repurchase under the current authorization.

In November 1995, Cabot declared a dividend of one Preferred Stock Purchase Right (“Right”) for each outstanding share of Cabot’s common stock. Each Right entitled the holder, upon the occurrence of certain specified events, to purchase from Cabot one one-hundredth of a share of Series A Junior Participating Preferred Stock at a purchase price of $200 per share. The Rights expired on November 10, 2005.

In November 1988, Cabot sold 75,336 shares of its Series B ESOP Convertible Preferred Stock to the ESOP for cash at a price of $1,000 per share. Each share of the Series B ESOP Convertible Preferred Stock is convertible into 146.4 shares of Cabot’s common stock, subject to certain events and anti-dilution adjustment provisions, and carries voting rights on an “as converted” basis. The trustee of the ESOP has the right to convert the shares of Series B ESOP Convertible Preferred Stock to common stock. In addition, the trustee for the ESOP has the right to cause Cabot to redeem shares sufficient to provide for periodic distributions to plan participants. Cabot has the option to redeem the shares for $1,000 per share, convert the shares to common stock, or a combination thereof.

The issued shares of Series B ESOP Convertible Preferred Stock receive preferential and cumulative quarterly dividends and are ranked as to dividends and liquidation prior to Cabot’s common stock. For purposes of calculating diluted earnings per share, the Series B ESOP Convertible Preferred Stock is assumed to be converted to common stock based on the 146.4 conversion rate. At September 30, 2006, 6 million shares of Cabot’s common stock were reserved for issuance upon conversion of the Series B ESOP Convertible Preferred Stock.

Cabot is the guarantor for the outstanding debt held by the ESOP as described in Note J. Cabot contributed $4 million in 2006 and 2005 and $3 million in 2004 to the ESOP to service the debt. Dividends on ESOP shares used for debt services were $3 million in 2006 and $4 million in 2005 and 2004. In addition, actual interest incurred on debt associated with the ESOP was $3 million in 2006 and $4 million in 2005 and 2004.

~~During 2006, 2005 and 2004, Cabot paid cash dividends of $77.50 per share of Series B ESOP Convertible Preferred Stock and $0.64, $0.64 and $0.60, respectively, per share of common stock.~~

~~Comprehensive Income~~

~~The pre-tax, tax and after-tax effects of the components of other comprehensive income (loss) are shown below:~~

Years Ended September 30

Pre-tax

Tax

After-tax

(Dollars in millions)

2004

Foreign currency translation adjustments

$
27

$
—

$
27

Unrealized holding loss arising during the period on marketable securities(1)

(12
)

5

(7
)

Unrealized holding loss arising during the period on derivative instruments

(7
)

2

(5
)

Minimum pension liability adjustment

20

(6
)

14

Other comprehensive income

$
28

$
1

$
29

2005

Foreign currency translation adjustments

$
22

$
—

$
22

Unrealized holding loss arising during the period on derivative instruments

(9
)

3

(6
)

Minimum pension liability adjustment

(8
)

3

(5
)

Other comprehensive income

$
5

$
6

$
11

2006

Foreign currency translation adjustments

$
34

$
(5
)

$
29

Unrealized holding gain arising during the period on derivative instruments

9

(3
)

6

Minimum pension liability adjustment

20

(6
)

14

Other comprehensive income

$
63

$
(14
)

$
49

~~(1)~~ During the fourth quarter of fiscal 2004, Cabot recorded a pre-tax impairment charge of $12 million in other charges related to the value of its investment in the Sons of Gwalia stock due to a significant decline in its fair market value. The Sons of Gwalia stock was suspended from trading after the Company appointed voluntary administrators under the Australian Corporation Act, which is similar to U.S. bankruptcy. The loss was recognized and the book value of this investment was reduced to zero.

~~The balance of related after-tax components comprising accumulated other comprehensive income (loss) are summarized below:~~

September 30

2006

2005

(Dollars in millions)

Foreign currency translation adjustments

$
21

$
(8
)

Unrealized holding gain on marketable securities

1

1

Unrealized holding loss on derivative instruments

(6
)

(12
)

Minimum pension liability adjustment

(6
)

(20
)

Accumulated other comprehensive income (loss)

$
10

$
(39
)

~~Note Q. Earnings Per Share~~

~~Basic and diluted earnings per share (“EPS”) were calculated as follows:~~

Years Ended September 30

2006

2005

2004

(In millions, except
per share amounts)

Basic EPS:

Income (loss) available to common shares (numerator)

$
86

$
(51
)
$
121

Weighted-average common shares outstanding

63

63

62

Less: contingently issuable shares(1)

(3
)
(3
)
(3
)
Adjusted weighted-average shares (denominator)

60

60

59

Basic EPS

$
1.42

$
(0.84
)
$
2.04

Income per share from discontinued businesses

0.03

—

0.03

Loss per share from cumulative effect of changes in accounting principles

(0.03
)
—

—

Net income (loss) per share—basic

$
1.42

$
(0.84
)
$
2.07

Diluted EPS:

Income (loss) available to common shares

$
86

$
(51
)
$
121

Dividends on preferred stock(2)

2

—

3

Income (loss) available to common shares plus assumed conversions (numerator)

$
88

$
(51
)
$
124

Weighted-average common shares outstanding

60

60

59

Effect of dilutive securities:(3)

Assumed conversion of preferred stock

6

—

7

Common shares issuable(4)(5)

2

—

2

Adjusted weighted-average shares (denominator)

68

60

68

Diluted EPS

$
1.28

$
(0.84
)
$
1.79

Income per share from discontinued businesses

0.03

—

0.03

Income per share from cumulative effect of changes in accounting principles

(0.03
)
—

—

Net income (loss) per share—diluted

$
1.28

$
(0.84
)
$
1.82

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

⁽²⁾

Represents dividends paid on preferred stock, prior to the conversion to common stock during the fourth quarter of fiscal 2007, which would not be paid on common stock issued upon conversion of preferred stock. Due to the Company’s net loss position dividends on preferred stock were not added back to income (loss) available to common shares for the year ended September 30, 2005 when calculating diluted EPS.

⁽³⁾ Commencing in fiscal 2004, Cabot has adjusted its calculation of diluted shares outstanding to reflect the number of shares the Company could repurchase with the assumed proceeds from restricted stock awards under the Company’s Long Term Incentive Program.

~~(4)~~Represents incremental shares from the (i) assumed ~~conversion~~exercise of stock ~~options~~options; and (ii) outstanding unvested restricted stock issued under Cabot Equity Incentive Plans.

~~(5)~~⁽⁴⁾

At September 30, 2007 and 2006, ~~100,000 of~~outstanding options to purchase 34,000 and 100,000 shares of common stock, ~~outstanding~~respectively, were not included in the calculation of diluted earnings per share because those options’ exercise prices were greater than the average market price of Cabot common ~~stock.~~stock for that period. For the year ended September 30, 2005, approximately 7 million common shares, based on assumed conversion of preferred stock, and 1 million of common shares, representing restricted stock and stock options issued under Cabot’s Equity Incentive Plans, were excluded from the calculation of diluted earnings per share, as those shares would have been anti-dilutive due to the Company’s net loss position. At September 30, 2004, 100,000 of options to purchase shares of common stock outstanding were not included in the calculation of diluted earnings per share because those options’ exercise prices were greater than the average market price of Cabot common stock.

~~Note R. Income Taxes~~

~~Income (loss) before income taxes was as follows:~~

Years Ended September 30

   2006

   2005

   2004

(Dollars in millions)

Income (loss) from continuing operations:

Domestic

$
(31
)

$
(89
)

$
43

Foreign

128

(4
)

121

$
97

$
(93
)

$
164

Note R. Income Taxes

Income (loss) before income taxes was as follows:


	Years Ended September 30
	2007			2006			2005
	(Dollars in millions)
Income (loss) from continuing operations:
Domestic	$	(30	)	$	(31	)	$	(89	)
Foreign		198			128			(4	)

	$	168		$	97		$	(93	)

Taxes on income consisted of the following:


	Years Ended September 30
	2007			2006			2005
	(Dollars in millions)
U.S. federal and state:
Current	$	3		$	(27	)	$	(18	)
Deferred		(33	)		(2	)		(48	)

Total		(30	)		(29	)		(66	)

Foreign:
Current		62			34			38
Deferred		6			4			(17	)

Total		68			38			21

Total U.S. and foreign	$	38		$	9		$	(45	)

The provision for income taxes at Cabot’s tax rate differed from the provision for income taxes at the statutory rate as follows:


	Years Ended September 30
	2007			2006			2005
	(Dollars in millions)
Continuing Operations:
Computed tax expense at the federal statutory rate	$	59		$	34		$	(32	)
Foreign income:
Impact of taxation at different rates, repatriation and other		(22	)		(19	)		(20	)
Impact of foreign losses for which a current tax benefit is not available		6			9			5
State taxes, net of federal effect		—			1			(1	)
Recognition of currency translation loss		—			2			—
Supermetals Business goodwill impairment charge		—			—			31
Extraterritorial income exclusion/qualified production activity income		(1	)		(2	)		(4	)
U.S. and state benefits from research and experimentation activities		(4	)		—			(3	)

Tax audit settlements		(3	)		(18	)		(23	)

Other, net		3			2			2

Total Continuing Operations	$	38		$	9		$	(45	)

Significant components of deferred income taxes were as follows:


	September 30
	2007			2006
	(Dollars in millions)
Deferred tax assets:
Depreciation and amortization	$	17		$	11
Pension and other benefits		77			80
Environmental liabilities		4			6
Inventory		13			18
Deferred expenses		18			26
Net operating loss and other tax carryforwards		103			78
Other		25			25

Subtotal		257			244
Valuation allowances		(53	)		(45	)

Total deferred tax assets	$	204		$	199


	2007			2006
	(Dollars in millions)
Deferred tax liabilities:
Depreciation and amortization		28		$	42
Pension and other benefits		14			10
Unremitted earnings of non-U.S. subsidiaries		14			17
Inventory		2			2
Deferred revenue		—			3
Other		9			10

Total deferred tax liabilities		67		$	84

In 2007, Cabot recorded $3 million of tax benefits in net income from continuing operations related to tax settlements in various jurisdictions. In addition, Cabot recorded $3 million in tax benefit in discontinued operations related to legal and tax settlements.

In 2006, Cabot recorded $18 million of tax benefits in net income from continuing operations, related to a $12 million settlement of an Internal Revenue Service audit of the years 2000 to 2002 and $6 million related to tax settlements in other jurisdictions. In addition, Cabot recorded a $2 million tax benefit in discontinued operations from the settlement of an Internal Revenue Service audit of the years 2000 to 2002.

In 2005, Cabot recorded a $23 million tax benefit for the settlement of an Internal Revenue Service audit of the years 1997 to 1999 and refund claims for credits generated in those years.

Cabot has filed its tax returns in accordance with the tax laws in each jurisdiction and maintains tax reserves for differences between tax obligations as reflected in its tax filings and potential final tax obligations for exposures that can be reasonably estimated. As of September 30, 2007, the Company has recorded $59 million for these exposures. In the event that actual results are significantly different from these estimates, Cabot’s provision for income taxes could be significantly impacted.

Approximately $243 million of net operating loss carryforwards and $41 million of other tax credit carryforwards remain at September 30, 2007. The benefits of these carryforwards are dependent upon taxable income during the carryforward period in the jurisdictions where they arose. Accordingly, a valuation allowance has been provided where management has determined that it is more likely than not that the carryforwards will not be utilized. The following table provides detail surrounding the expiration dates of these carryforwards.

   NOLs    Credits
   (Dollars in millions)
Expiration periods

2008 to 2014
   $ 87    —
2015 and thereafter
   23    32
Indefinite carryforward
   133    9

Total
   243    41

Provisions have not been made for U.S. income taxes or non-U.S. withholding taxes on approximately $433 million of undistributed earnings of non-U.S. subsidiaries, as these earnings are considered indefinitely reinvested. These earnings could become subject to U.S. income taxes and non-U.S. withholding taxes if they were remitted as dividends, were loaned to Cabot Corporation or a U.S. subsidiary, or if Cabot should sell its stock in the subsidiaries.

Cabot has net deferred tax assets of $137 million, $114 million of which is in the U.S. The Company believes that the U.S. net deferred tax assets are more likely than not recoverable through expected future taxable operating income in the U.S. However, recovery is dependent on achieving the forecast of future taxable operating income over an extended period of time. As of September 30, 2007, the Company would need to generate approximately $325 million in cumulative future U.S. taxable operating income at various times over approximately 20 years to realize all of our net U.S. deferred tax assets. The Company also believes that it is more likely than not that the Cabot will recover the $23 million non-U.S. net deferred tax asset which will require approximately $65 million of future taxable operating income to be generated by various non-U.S. subsidiaries. The Company reviews its forecast in relation to actual results and expected trends on a quarterly basis. Failure to achieve operating income targets may change the Company’s assessment regarding the recoverability of Cabot’s net deferred tax assets and such change could result in a valuation allowance being recorded against some or all of the Company’s net deferred tax assets. Any increase in a valuation allowance would result in additional income tax expense, lower stockholders’ equity and could have a significant impact on Cabot’s earnings in future periods.

The valuation allowance at September 30, 2007 and 2006 represents management’s best estimate of the non-realizable portion of the net deferred tax assets. The valuation allowance increased in certain tax jurisdictions by $8 million in 2007 due to the uncertainty of the ultimate realization of certain future tax benefits and net operating losses reflected as deferred tax assets.

The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires the Company to make estimates and assumptions that affect the reported amount of tax-related assets and liabilities and income tax provisions. Cabot assesses the recoverability of its deferred tax assets on an ongoing basis. In making this assessment, Cabot is required to consider all available positive and negative evidence to determine whether, based on such evidence, it is more likely than not that some portion or all of its net deferred assets will be realized in future periods. This assessment requires significant judgment. In addition, the Company has made significant estimates involving current and deferred income taxes. Cabot does not recognize current and future tax benefits until it is deemed probable that certain tax positions will be sustained.

Note S. Commitments and Contingencies

Operating Lease Commitments

Cabot leases certain transportation vehicles, warehouse facilities, office space, machinery and equipment under operating cancelable and non-cancelable leases, most of which expire within ten years and may be renewed by Cabot. Rent expense under such arrangements for 2007, 2006 and 2005 totaled $25 million, $20 million and $10 million, respectively. Future minimum rental commitments under non-cancelable leases are as follows:


	(Dollars in millions)
2008	$	25
2009		20
2010		13
2011		12
2012		8
2013 and thereafter		39

Total future minimum rental commitments	$	117

Other Long-Term Commitments

Cabot has entered into long-term purchase agreements for various key raw materials in the Carbon Black, Supermetals and Metal Oxides businesses. Raw materials purchased under these agreements by business for fiscal years 2007, 2006 and 2005 are as follows:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Business
Carbon Black	$	193	$	146	$	63
Supermetals		46		37		76
Metal Oxides		15		8		12

Total	$	254	$	191	$	151

The purchase commitments for the Carbon Black, Supermetals and Metal Oxides businesses covered by these agreements are with various suppliers and purchases are expected to take place as follows:


	Payments Due by Fiscal Year
	2008		2009		2010		2011		2012		Thereafter		Total
	(Dollars in millions)
Business
Carbon Black	$	204	$	147	$	103	$	95	$	72	$	587	$	1,208
Supermetals		66		29		11		2		—		—		108
Metal Oxides		15		14		14		14		26		144		227

Total	$	285	$	190	$	128	$	111	$	98	$	731	$	1,543

Guarantee Agreements

contingencies and routine warranties. Cabot is unable to estimate the maximum potential liability for these types of indemnities as a maximum obligation is not explicitly stated in most cases and the amounts, if any, are dependent upon the outcome of future contingent events, the nature and likelihood of which cannot be reasonably estimated. The duration of the indemnities vary, and in many cases are indefinite. Cabot has not recorded any liability for these indemnities in the consolidated financial statements, except as otherwise disclosed.

Contingencies

Cabot is a defendant, or potentially responsible party, in various lawsuits and environmental proceedings wherein substantial amounts are claimed or at issue.

Environmental Matters

As of September 30, 2007 and 2006, Cabot had $11 million and $13 million, respectively, reserved for environmental matters primarily related to divested businesses. In 2007 and 2006, there was $5 million and $4 million in accrued expenses and $6 million and $9 million, respectively, in other liabilities on the consolidated balance sheets for environmental matters. These amounts represent Cabot’s best estimates of its share of costs likely to be incurred at those sites where costs are reasonably estimable based on its analysis of the extent of clean up required, alternative clean up methods available, abilities of other responsible parties to contribute and its interpretation of laws and regulations applicable to each site. Cabot reviews the adequacy of this reserve as circumstances change at individual sites. Charges for environmental expense were $4 million and $2 million in 2007 and 2006, respectively. Cash payments were $6 million and $5 million during fiscal 2007 and 2006, respectively, related to these environmental matters.

At September 30, 2007, the operational and maintenance component of the $11 million reserve for environmental matters includes $4 million on a net present value basis which approximates $5 million on an undiscounted basis. Cabot expects to make payments of $2 million in each of fiscal 2008 through 2012 and a total of $3 million thereafter. A weighted average risk free rate of 4.51% is used for the environmental liability at September 30, 2007. The book value of the liabilities will be accreted up to the undiscounted liability value through interest expense over the expected cash flow period. The accreted interest expense was less than $1 million during both fiscal 2007 and 2006.

Respirator Liabilities

Cabot has exposure in connection with a safety respiratory products business that a subsidiary acquired from American Optical Corporation (“AO”) in an April 1990 asset purchase transaction. The subsidiary manufactured respirators under the AO brand and disposed of that business in July 1995. In connection with its acquisition of the business, the subsidiary agreed, in certain circumstances, to assume a portion of AO’s liabilities, including costs of legal fees together with amounts paid in settlements and judgments, allocable to AO respiratory products used prior to the 1990 purchase by the Cabot subsidiary. In exchange for the subsidiary’s assumption of certain of AO’s respirator liabilities, AO agreed to provide to the subsidiary the benefits of: (1) AO’s insurance coverage for the period prior to the 1990 acquisition and (2) a former owner’s indemnity of AO holding it harmless from any liability allocable to AO respiratory products used prior to May 1982.

Generally, these respirator liabilities involve claims for personal injury, including asbestosis, silicosis and, more recently, coal worker’s pneumoconiosis, allegedly resulting from the use of respirators that are claimed to have been negligently designed or labeled. Neither Cabot, nor its past or present subsidiaries, at any time manufactured asbestos or asbestos-containing products. Moreover, not every person with exposure to asbestos 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, AO’s insurers, and another former owner and its insurers (collectively, the “Payor Group”), are responsible for significant portions of the costs of these liabilities, leaving Cabot’s subsidiary with a portion of the liability in only some of the pending cases.

The subsidiary disposed of the business in July 1995 by transferring it to a newly-formed joint venture called Aearo Corporation (“Aearo”) and retained an equity interest in Aearo. Cabot agreed to have the subsidiary retain certain liabilities allocable to respirators used prior to the 1995 transaction so long as Aearo pays 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. Cabot has no liability in connection with any products manufactured by Aearo after 1995. Between July 1995 and September 30, 2001, the Company’s total costs and payments in connection with these respirator liabilities did not exceed the total amounts received from Aearo. Since September 30, 2001, the Company’s total costs and payments in connection with these liabilities have exceeded the amount Cabot has received from Aearo because of the significant increase in claims filed against AO beginning in calendar year 2001. In August 2003, Cabot and its subsidiary sold all of the subsidiary’s equity interest in Aearo for approximately $35 million. This sale did not alter the arrangements described above.

As of December 31, 2002, there were approximately 50,000 claimants in pending cases asserting claims against AO in connection with respiratory products. As of September 30, 2003, 2004, 2005, 2006 and 2007 there were approximately 87,000, 91,000, 92,000, 63,000 and 55,000 claimants, respectively. A large portion of the claims asserted during 2003 were filed in Mississippi and appear to have been prompted by changes in Mississippi’s state procedural laws, which caused claimants to file their claims prior to the effective date of these changes. In 2005, a federal judge ruled that many of the “diagnoses” presented in a broad silicosis class action were unreliable. As a consequence of this ruling, silica and non-malignant asbestos claims filed throughout the country have dropped significantly for AO and for defendants in general in non-malignant asbestos and silica cases. In addition, many claims filed against AO have been dismissed without payment. It appears that this reduction in silica and non-malignant asbestos claims has stabilized, although the total number of dismissals still outnumbered the new cases filed in calendar year 2007, through September 30, 2007.

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. Cabot engaged through counsel the assistance of Hamilton, Rabinovitz & Alschuler, Inc. (“HR&A”), a leading consulting firm in the field of tort liability valuation, to quantify Cabot’s estimated share of the liability for pending and future respirator claims. The methodology developed by HR&A addresses the complexities surrounding Cabot’s 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 Cabot’s period of direct manufacture and Cabot’s contractual obligations assuming that all other members of the Payor Group meet their obligations. Based on these estimates, Cabot has a reserve for these matters of $18 million on a net present value basis ($26 million on an undiscounted basis) at September 30, 2007.

It is important to note that in estimating Cabot’s share of liability for these matters, the Company has excluded settlement data from the 2002 settlement of a large number of claims in Mississippi in estimating future claims values. This settlement data was excluded because the procedure by which claims values were established in that settlement was not in conformity with past practice. In this settlement, generally, the values paid for claims were established before the claims were actually asserted. As a result, payments made did not reflect substantial differences between the severity of claims. Including this data, therefore, would result in an unsupported increase in the projected settlement values for future cases involving non-malignant injury, which represent a significant majority of the pending and estimated future claims.

cost of resolving claims, (iv) significant changes in the legal costs of defending these claims, (v) changes in the nature of claims received, (vi) changes in the law and procedure applicable to these claims, (vii) the financial viability of members of the Payor Group, (viii) a change in the availability of AO’s insurance coverage, and (ix) a determination that the Company’s interpretation of the contractual obligations on which it has estimated its share of liability is inaccurate. Cabot cannot determine the impact of these potential developments on its current estimate of its share of liability for existing and future claims. Accordingly, the actual amount of these liabilities for existing and future claims could be different than the reserved amount.

The $18 million liability for respirator claims is recognized on a discounted basis using a discount rate of 6.00% which represents management’s best estimate of the risk free rate to the cash flow payments of the liability that are projected through 2052. The total expected aggregate undiscounted amount is $26 million. Cabot estimates payments of approximately $3 million, $2 million, $2 million, $1 million, $1 million in 2008, 2009, 2010, 2011 and 2012, respectively, and a total of $17 million in 2013 through 2052. The book value of the liabilities will be accreted up to the undiscounted liability value through interest expense over the expected cash flow period, which was less than $1 million in fiscal 2007. Cash payments were $1 million during both fiscal 2007 and 2006 related to this liability. If the timing of Cabot’s actual payments made for respirator claims differs significantly from the Company’s estimated payment schedule, and the Company could no longer reasonably predict the timing of such payments, Cabot then could be required to record the reserve amount on an undiscounted basis on its consolidated balance sheets, causing an immediate impact to its consolidated statements of operations.

Carbon Black Antitrust Litigation

Cabot, Phelps Dodge Corporation, Columbian Chemicals Co., Degussa Engineered Carbons, LP, Degussa AG, and Degussa Corporation (referred to collectively as the “Defendants”), were named defendants in class action lawsuits filed in several U.S. federal district courts in 2003 and consolidated in U.S. Federal District Court for the District of Massachusetts in 2003. The plaintiffs in these cases alleged that the Defendants conspired to fix, raise, maintain or stabilize prices for carbon black sold in the United States during a specified period. Cabot denies any wrongdoing of any kind in these cases and strongly believes that it has good defenses to these claims. Nonetheless, in fiscal year 2007, Cabot settled this action to avoid further expense, inconvenience, risk and the distraction of burdensome and protracted litigation.

During fiscal years 2003 and 2004, the Company and the above Defendants were named in nine actions filed in Superior Court of the State of California on behalf of a purported class of indirect purchasers of carbon black in the state of California from as early as November 1998 to the present. During fiscal years 2004 and 2005, the Company and the Defendants were named in actions filed in state courts in the states of Florida, Kansas, Tennessee, South Dakota, North Carolina and New Jersey on behalf of all indirect purchasers of carbon black in these states. Each of these complaints asserts violations under the applicable state laws for conduct that is similar to what is alleged in the federal cases described above (the “state actions”). The plaintiffs in the state actions also seek treble damages in an unspecified amount and attorneys’ fees. In October 2007, the Defendants settled the California state actions which were accrued for as of September 30, 2007. Court approval of this settlement is pending. Cabot believes that it has valid defenses to all of the remaining state action claims, and will continue to assert them vigorously. While the outcome of litigation is uncertain, the Company does not believe that the ultimate disposition of these matters will have a material adverse effect on the Company’s financial position.

As stated above, Cabot denies any wrongdoing of any kind in these carbon black antitrust actions and strongly believes it has good defenses to these claims. In light of its strong defenses, the Company did not view its liability for these claims to be probable and, therefore, did not record a reserve for potential liabilities in these matters as of September 30, 2006. The settlement of the federal actions in 2007 and the California state actions in October 2007 gave rise to a change in the Company’s estimates for contingent liabilities of approximately $11 million in fiscal year 2007, which has been recorded in the Company’s consolidated financial statements. Approximately $1 million remains in accruals in the Company’s consolidated balance sheet at September 30, 2007.

Beryllium Claims

Cabot is a party to several pending actions in connection with its discontinued beryllium operations. Cabot entered the beryllium industry through an acquisition in 1978. The Company 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.

During the last several years, several individuals who have resided or worked for many years in the immediate vicinity of the Company’s former beryllium facility located in Reading, Pennsylvania have brought suits against Cabot and NGK for personal injury allegedly caused by beryllium particle emissions produced at that facility. Eight personal injury claims against Cabot are pending in state court in Pennsylvania. In addition, since October 2003, approximately 50 individuals in separate cases have asserted claims for medical monitoring now pending in numerous Pennsylvania state court actions. The 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. In 2005, summary judgment was granted in Cabot’s favor by the Pennsylvania state trial court in three of the medical monitoring cases and the plaintiffs appealed. In October 2007, the Pennsylvania Superior Court upheld the grant of summary judgment. Discovery is ongoing in the remaining personal injury and medical monitoring cases.

There are also four beryllium product liability cases pending in California state courts. All of these cases are stayed by court order pending the testing of the plaintiffs for beryllium exposure.

In September 2006, Cabot was one of several named defendants inAnthony v. Small Tube Manufacturing Corp. et al., a class action complaint that was filed in the Pennsylvania Court of Common Pleas of Philadelphia County on behalf of certain present and former employees of the U.S. Gauge Inc. facility in Sellersville, Pennsylvania. Cabot removed the case to the United States District Court for the Eastern District of Pennsylvania. U.S. Gauge is a company alleged to have purchased beryllium-containing products from Cabot. The class action alleges that the present and former employees were exposed to beryllium dust and fumes during the machining of beryllium-containing products purchased from Cabot and that they are therefore entitled to receive medical monitoring. There are three other companies named as defendants in the case. Cabot has asserted claims against the other defendants and another party. Discovery in the case has not yet begun.

In December 2006, Cabot was one of several named defendants inSheridan et al. v. NGK North America, Inc., et al., a class action complaint filed in the Pennsylvania Court of Common Pleas of Philadelphia County on behalf of persons who resided within a one mile radius of the Reading facility for a period of at least six months between 1950 and 2000. Cabot removed the case to the United States District Court for the Eastern District of Pennsylvania. The class action alleges that these persons were exposed to emissions of beryllium from the Reading plant and are, therefore, entitled to receive medical monitoring. Discovery regarding class certification began in October 2007.

Cabot believes it has 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. While the outcome of litigation is uncertain, the Company does not believe that the ultimate disposition of these matters will have a material adverse effect on the Company’s financial position.

AVX

On March 8, 2004, AVX Corporation (“AVX”) filed an action against the Company in the United States District Court for the District of Massachusetts. This complaint alleged that Cabot violated the federal antitrust laws in connection with the tantalum supply agreement between Cabot and AVX by tying the purchase of one type of tantalum product by AVX to the purchase of other types. Discovery is proceeding in this matter.

On September 6, 2005, AVX filed a lawsuit in the Superior Court of Massachusetts for Suffolk County alleging that Cabot improperly administered a tantalum supply agreement with AVX. In particular, AVX claims that Cabot has not provided all of the price relief due to AVX pursuant to “most favored nation” (“MFN”) pricing provisions in the agreement. AVX is seeking a declaration of the rights of the parties to the agreement, an accounting of monies paid, due or owing under the MFN provisions, and an award of any sums not paid that should have been. Cabot has filed an answer and a counterclaim against AVX asserting that AVX has underpaid for product in accordance with a proper construction of the MFN provisions. This action was moved to the Business Litigation Section of the Superior Court of Massachusetts in November 2005. Discovery in this case is ongoing, but to date AVX has claimed that it is owed an additional $28 million in MFN credit. In early April 2007, Cabot and AVX filed cross-motions for summary judgment on two key disputed issues in the litigation. A hearing on the motions took place on May 1, 2007. No decision has been issued. Cabot believes that it has valid defenses to all of AVX’s claims against the Company and will continue to assert them vigorously. While the outcome of litigation is uncertain, the Company does not believe that the ultimate disposition of these matters will have a material adverse effect on the Company’s financial position.

Other

In 2001, Cabot entered into agreements (the “Project Agreements”) with Private Power LLC (“Private Power”) relating to co-generation projects at Cabot’s Ville Platte and Franklin (Canal) plants in Louisiana. Shortly after the Project Agreements were entered into, disputes arose regarding the scope of the projects and each party’s respective rights under the Project Agreements. In December 2002, Cabot filed a suit in the Massachusetts state court seeking a declaration that Cabot had not terminated the Project Agreements. Private Power filed counterclaims, which were eventually amended to include claims for breach of contract and allegations of bad faith. In May 2007, Cabot’s motion to dismiss Private Power’s claims was denied. In August 2007, Cabot amended its complaint to add breach of contract and bad faith claims. Discovery is ongoing in the case. The Company believes it has valid defenses to all of Private Power’s claims and will continue to assert them vigorously. While the outcome of litigation is uncertain, the Company does not believe that the ultimate disposition of this matter will have a material adverse effect on the Company’s financial position.

The Company has various other lawsuits, claims and contingent liabilities arising in the ordinary course of its business and in respect of the Company’s divested businesses. In the opinion of the Company, although final disposition of some or all of these other suits and claims may impact the Company’s financial statements in a particular period, they should not, in the aggregate, have a material adverse effect on the Company’s financial position.

Note T. Concentration of Credit Risk

Credit risk represents the loss that would be recognized if counterparties failed to completely perform as contracted. Financial instruments that subject Cabot to credit risk consist principally of cash and cash equivalent, investments, trade receivables and derivatives. Cabot maintains cash and cash equivalents, investments and derivatives with major banks and financial institutions and the Company has not experienced any material credit losses related to these instruments held at these financial institutions. Furthermore, concentrations of credit risk exist for groups of customers when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.

During fiscal years 2007, 2006 and 2005, The Goodyear Tire and Rubber Company accounted for approximately 12%, 14% and 12%, respectively, of Cabot’s annual consolidated net sales. No other customer individually represented more than 10% of net sales for any period presented. Cabot’s loss of this or other customers that may account for a significant portion of the Company’s sales, or any decrease in sales to any of these customers, could have a material adverse effect on Cabot’s business, financial condition or results of operations.

Tire manufacturers in the Carbon Black Business and capacitor manufacturers in the Supermetals Business comprise significant portions of Cabot’s trade receivable balance. The accounts receivable balance for these significant customers are as follows:

Cabot has not experienced significant losses in the past from these customers. Cabot monitors its exposure to customers to minimize potential credit losses.

Note U. Financial Information by Segment & Geographic Area

Segment Information

Cabot is organized into four reportable segments: the Carbon Black Business, the Metal Oxides Business, the Supermetals Business, and the Specialty Fluids Business.

The Carbon Black Business is primarily comprised of the rubber blacks, performance products and inkjet colorants product lines as well as the business development activities of Cabot Superior MicroPowders (“CSMP”). The revenues from each of these product lines are as follows:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Rubber blacks	$	1,416	$	1,378	$	976
Performance products		541		488		469
Inkjet colorants		46		47		39
CSMP		2		4		6

Total Carbon Black Sales	$	2,005	$	1,917	$	1,490

Cabot’s 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. Performance products are specialized grades of carbon black that are used to enhance conductivity and static charge control, to provide UV protection, to enhance mechanical properties, to provide chemical flexibility through surface treatment and as pigments. These products are used in a wide variety of industries such as inks, coatings, cables, pipes, toners and electronics. Cabot’s performance products include black and white thermoplastic concentrates and specialty compounds that are marketed to the plastics industry. Cabot’s inkjet colorants are high-quality pigment-based black and other colorant dispersions the Company manufactures by surface treating special grades of carbon black and other pigments. Cabot’s inkjet colorant products are produced for various inkjet printing markets, including small office and home office, high speed, wide format, and commercial and industrial printing applications.

The Metal Oxides Business is comprised of the fumed metal oxides (including fumed silica and fumed alumina and dispersions thereof) and aerogel product lines. The revenues from each of these product lines are as follows:


	Years Ended September 30
	2007		2006		2005
	(Dollars in millions)
Fumed metal oxides	$	270	$	253	$	231
Aerogel		1		1		—

Total Metal Oxides Sales	$	271	$	254	$	231

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, polishing slurries, lighting, coatings and cosmetics. Cabot’s aerogels are nano-structured high surface area hydrophobic silica particles with potential uses in a variety of thermal and acoustic insulation applications. This product has been incorporated into the skylight, window and wall system products of several manufacturers of panels for use in the daylighting segment of the construction industry. The product line continues to focus on application and market development activities for use of aerogels in the daylighting and other commercial areas, including oil and gas pipeline insulation applications.

The Supermetals Business produces tantalum, niobium (columbium) and their alloys. Tantalum, which accounts for substantially all of this Business’s sales, is produced in various forms. Electronics is the largest market 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. In addition, the Company sells the starting metals used to manufacture finished tantalum sputtering targets used in thin film applications, including semiconductors, inkjet heads, magnetics and flat panel displays.

The Specialty Fluids Business produces and markets cesium formate as a drilling and completion fluid for use primarily in high pressure and high temperature oil and gas well operations. Cesium formate products are solids-free, high-density fluids that have a low viscosity, permitting them to flow readily in oil and gas wells. The fluid is resistant to high temperatures, minimizes damage to producing reservoirs and is readily biodegradable. In a majority of applications, cesium formate is blended with other formates or products.

The accounting policies of the segments are the same as those described in the summary of “Significant Accounting Policies.” Exceptions are noted as follows and are incorporated in the tables below. Revenues from external customers for certain product lines within the Carbon Black Business include 100% of sales from one equity affiliate. Segment profit is a measure used by Cabot’s operating decision-makers to measure consolidated operating results and assess segment performance. Cabot evaluates the performance of its segments and allocates resources based on segment profit or loss before taxes (“PBT”). Segment PBT includes equity in net income of affiliated companies, royalties paid by equity affiliates, minority interest and allocated corporate costs and excludes interest expense, foreign currency transaction gains and losses, interest income, dividend income, as well as certain items that have not been allocated to a segment as they are significant and unusual or infrequent. Cash, short-term investments, cost investments, income taxes receivable, deferred taxes and headquarters’ assets are included in unallocated and other. Expenditures for additions to long-lived assets include total equity and other investments (including available-for-sale securities), property, plant and equipment, intangible assets and assets held for rent.

Financial information by segment is as follows:


	Carbon Black		Metal Oxides		Supermetals⁽¹⁾		Specialty Fluids		Segment Total		Unallocated and Other⁽²⁾			Consolidated Total
	(Dollars in millions)
Years Ended September 30,
2007
Revenues from external customers⁽³⁾	$	2,005	$	271	$	233	$	58	$	2,567	$	49		$	2,616
Depreciation and amortization		112		25		5		4		146		3			149
Equity in net income of affiliated companies		11		1		—		—		12		—			12
Income (loss) from continuing operations before taxes⁽⁴⁾		156		36		15		25		232		(64	)		168
Assets⁽⁵⁾		1,657		257		266		85		2,265		371			2,636
Investment in equity-basis affiliates		61		4		—		—		65		—			65
Total expenditures for additions to long-lived assets⁽⁶⁾		114		16		13		1		144		100			244
2006
Revenues from external customers⁽³⁾	$	1,917	$	254	$	292	$	44	$	2,507	$	36		$	2,543
Depreciation and amortization		96		23		5		4		128		3			131
Equity in net income of affiliated companies		11		1		—		—		12		—			12
Income (loss) from continuing operations before taxes⁽⁴⁾⁽⁷⁾		101		22		41		16		180		(83	)		97
Assets⁽⁵⁾		1,552		245		284		71		2,152		382			2,534
Investment in equity-basis affiliates		55		4		—		—		59		—			59
Total expenditures for additions to long-lived assets⁽⁶⁾		154		23		10		4		191		27			218
2005
Revenues from external customers⁽³⁾	$	1,490	$	231	$	346	$	40	$	2,107	$	18		$	2,125
Depreciation and amortization		91		22		22		4		139		3			142
Equity in net income of affiliated companies		11		1		—		—		12		—			12
Income (loss) from continuing operations before taxes⁽⁴⁾		94		16		52		17		179		(272	)		(93	)
Assets⁽⁵⁾		1,287		234		351		74		1,946		428			2,374
Investment in equity-basis affiliates		60		3		—		—		63		—			63
Total expenditures for additions to long-lived assets⁽⁶⁾		136		26		21		6		189		97			286

~~Taxes on income consisted of the following:~~

Years Ended September 30

   2006

   2005

   2004

(Dollars in millions)

U.S. federal and state:

Current

$
(27
)

$
(18
)

$
(3
)

Deferred

(2
)

(48
)

6

Total

(29
)

(66
)

3

Foreign:

Current

34

38

41

Deferred

4

(17
)

(5
)

Total

38

21

36

Total U.S. and foreign

$
9

$
(45
)

$
39

~~The provision for income taxes at Cabot’s effective tax rate differed from the provision for income taxes at the statutory rate as follows:~~

Years Ended September 30

   2006

   2005

   2004

(Dollars in millions)

Continuing Operations:

Computed tax expense at the federal statutory rate

$
34

$
(32
)

$
57

Foreign income:

Impact of taxation at different rates, repatriation and other

(19
)

(20
)

(17
)
Impact of foreign losses for which a current tax benefit is not available

9

5

4

State taxes, net of federal effect

1

(1
)

—

Recognition of currency translation loss

2

—

—

Supermetals Business goodwill impairment charge

—

31

—

Extraterritorial income exclusion/foreign sales corporation

(2
)

(4
)

(6
)
U.S. and state benefits from research and experimentation activities

—

(3
)

(1
)
Competent authority relief

—

—

(7
)
Tax audit settlements

(18
)

(23
)

—

Valuation allowance on Sons of Gwalia investment loss

—

—

8

Other, net

2

2

1

Total Continuing Operations

$
9

$
(45
)

$
39

~~Significant components of deferred income taxes were as follows:~~

September 30

2006

2005

(Dollars in millions)

Deferred tax assets:

Depreciation and amortization

$
11

$
42

Pension and other benefits

80

72

Environmental liabilities

6

8

Investments

3

—

Inventory

18

15

Deferred expenses

26

15

Net operating loss and other tax carryforwards

78

51

Other

22

25

Subtotal

244

228

Valuation allowances

(45
)

(42
)

Total deferred tax assets

$
199

$
186

2006

2005

(Dollars in millions)

Deferred tax liabilities:

Depreciation and amortization

$
42

$
34

Pension and other benefits

10

9

Investments

3

State and local taxes

—

Inventory

2

1

Deferred revenue

3

3

Other

27

17

Total deferred tax liabilities

$
84

$
67

In 2006, Cabot recorded $18 million of tax benefits in net income from continuing operations, $12 million from the settlement of an Internal Revenue Service audit of the years 2000 to 2002 and $6 million related to tax settlements in other jurisdictions. In addition, Cabot recorded a $2 million tax benefit in discontinued operations from the settlement of an Internal Revenue Service audit of the years 2000 to 2002.

~~In 2005, Cabot recorded a $23 million tax benefit for the settlement of an Internal Revenue Service audit of the years 1997 to 1999 and refund claims for credits generated in those years.~~

~~In 2004, Cabot recorded a $7 million tax benefit for a tax audit filing resolved in the same year.~~

Cabot has filed its tax returns in accordance with the tax laws in each jurisdiction and maintains tax reserves for differences between tax expense as finally determined and income tax expense for exposures that can be reasonably estimated. In the event that actual results are significantly different from these estimates, Cabot’s provision for income taxes could be significantly impacted.

Approximately $214 million of net operating loss carryforwards and $19 million of other tax credit carryforwards remain at September 30, 2006. Of the net operating loss carryforwards, $90 million will expire in the years 2007 through 2013, $26 million will expire in years after 2013, and $98 million can be carried forward indefinitely. Of the tax credit carryforwards, $18 million will expire in years after 2013 and $1 million can be carried forward indefinitely. The benefits of these carryforwards are dependent upon taxable income during the carryforward period in the jurisdictions where they arose. Accordingly, a

~~valuation allowance has been provided where management has determined that it is more likely than not that the carryforwards will not be utilized.~~

Provisions have not been made for U.S. income taxes or non-U.S. withholding taxes on approximately $371 million of undistributed earnings of non-U.S. subsidiaries, as these earnings are considered indefinitely reinvested. These earnings could become subject to U.S. income taxes and non-U.S. withholding taxes if they were remitted as dividends, were loaned to Cabot or a U.S. subsidiary, or if Cabot should sell its stock in the subsidiaries.

Cabot has net U.S. deferred tax assets of $99 million that it believes are more likely than not recoverable through future taxable income. However, recovery is dependent on achieving the Company’s forecast of future operating income over an extended period of time. As of September 30, 2006, the Company would require approximately $285 million in cumulative future U.S. operating income, adjusted for permanent differences (book/tax differences that will not reverse), to be generated at various times over approximately 20 years to realize its net U.S. deferred tax assets. The Company will review its forecast in relation to actual results and expected trends on an ongoing basis. Failure to achieve the Company’s operating income targets may change its assessment regarding the recoverability of its net deferred tax assets and such change could result in a valuation allowance being recorded against some or all of its U.S. deferred tax assets. Any increase in a valuation allowance would result in additional income tax expense, lower stockholders’ equity and could have a significant impact on the Company’s earnings in future periods.

The valuation allowance at September 30, 2006 and 2005 represents management’s best estimate of the non-realizable portion of the net deferred tax assets. The valuation allowance increased in certain tax jurisdictions by $3 million in 2006 due to the uncertainty of the ultimate realization of certain future tax benefits and net operating losses reflected as deferred tax assets.

~~Note S. Commitments and Contingencies~~

~~Operating Lease Commitments~~

Cabot leases certain transportation vehicles, warehouse facilities, office space, machinery and equipment under operating cancelable and non-cancelable leases, most of which expire within ten years and may be renewed by Cabot. Rent expense under such arrangements for 2006, 2005 and 2004 totaled $20 million, $10 million and $9 million, respectively. Future minimum rental commitments under non-cancelable leases are as follows:

(Dollars in millions)

2007

$
20

2008

12

2009

10

2010

10

2011

7

2012 and thereafter

36

Total future minimum rental commitments

$
95

~~Other Long-Term Commitments~~

Cabot has entered into long-term purchase agreements for various key raw materials in the Carbon Black, Metal Oxides and Supermetals Businesses. The purchase commitments for the Supermetals Business covered by these agreements are with suppliers and are estimated to aggregate approximately $112 million for the periods 2007 through 2011 and thereafter. Purchases under these agreements are expected to be approximately $46 million, $45 million, $15 million, $2 million, $2 million and $2 million for 2007, 2008, 2009, 2010 and 2011 and thereafter, respectively. Raw materials purchased under these agreements were $37 million in 2006 and $76 million in 2005 and 2004, respectively.

On February 8, 2006, the Company and the Sons of Gwalia settled their dispute over the price to be paid by Cabot for tantalum ore under an existing supply agreement. As part of the settlement, the companies terminated their existing agreement and entered into a new three-year tantalum ore supply agreement that incorporates a significantly reduced annual volume commitment. Cabot made a lump sum payment of $27 million to terminate the then existing supply agreement and other related agreements. Under the new agreement, which is denominated in Australian dollars, Cabot will pay higher prices for ore than under the prior agreement. The $27 million lump sum payment has been recorded as an expense during fiscal 2006 and has been included as a component of cost of goods sold in the accompanying Consolidated Statements of Operations. The purchase commitments under the new contract have been included in the amounts discussed above for the Company’s Supermetals Business.

The purchase commitments for the Carbon Black Business covered by these agreements are with various suppliers and are estimated to aggregate approximately $1.3 billion for the periods 2007 through 2011 and thereafter. Purchases under these agreements are expected to be approximately $172 million, $188 million, $115 million, $91 million, $89 million and $623 million for 2007, 2008, 2009, 2010 and 2011 and thereafter, respectively. Raw materials purchased under these agreements were $146 million, $63 million and $26 million in 2006, 2005 and 2004, respectively. The increase in purchase commitments for the Carbon Black Business is a result of raw material supply agreements the Company secured for its newly constructed Carbon Black facility located in Tianjin, China.

The purchase commitments for the Metal Oxides Business covered by these agreements are with various suppliers and are estimated to aggregate approximately $94 million for the periods 2007 through 2011 and thereafter. Purchases under these agreements are expected to be $9 million, $2 million, $2 million, $3 million, $3 million and $75 million for 2007, 2008, 2009, 2010 and 2011 and thereafter,

~~respectively. Raw materials purchased under these agreements were $8 million, $12 million and $109 million in 2006, 2005 and 2004, respectively.~~

~~Guarantee Agreements~~

Cabot has provided certain indemnities pursuant to which it may be required to make payments to an indemnified party in connection with certain transactions and agreements. In connection with certain acquisitions and divestitures, Cabot has provided routine indemnities with respect to such matters as environmental, tax, insurance, product and employee liabilities. In connection with various other agreements, including service and supply agreements, Cabot may provide routine indemnities for certain contingencies and routine warranties. In most cases, a maximum obligation is not explicitly stated, thus the potential amount of future maximum payments cannot be reasonably estimated. The duration of the indemnities varies, and in many cases is indefinite. Cabot has not recorded any liability for these indemnities in the consolidated financial statements, except as otherwise disclosed.

~~Contingencies~~

~~Cabot is a defendant, or potentially responsible party, in various lawsuits and environmental proceedings wherein substantial amounts are claimed or at issue.~~

As of September 30, 2006 and 2005, Cabot had $13 million and $17 million, respectively, reserved for environmental matters primarily related to divested businesses. In 2006 and 2005, there was $4 million in accrued expenses and $9 million and $13 million, respectively, in other liabilities on the consolidated balance sheets for environmental matters. These amounts represent Cabot’s best estimates of its share of costs likely to be incurred at those sites where costs are reasonably estimable based on its analysis of the extent of clean up required, alternative clean up methods available, abilities of other responsible parties to contribute and its interpretation of laws and regulations applicable to each site. Cabot reviews the adequacy of this reserve as circumstances change at individual sites. Charges for environmental expense of $1 million and $1 million in 2006 and 2005 were included in other income (charges) on the consolidated statements of operations. Cash payments were $5 million and $4 million during fiscal 2006 and 2005, respectively, related to these environmental matters.

At September 30, 2006, the operational and maintenance component of the $13 million reserve for environmental matters includes $4 million on a net present value basis which approximates $6 million on an undiscounted basis. Cabot expects to make payments of $3 million from fiscal 2007 through 2011 and a total of $3 million thereafter. A discount rate of 4.93% is used for the environmental liability at September 30, 2006. The book value of the liabilities will be accreted up to the undiscounted liability value through interest expense over the expected cash flow period, which was less than $1 million during both fiscal 2006 and 2005.

~~Respirator Liabilities~~

Cabot has exposure in connection with a safety respiratory products business that a subsidiary acquired from American Optical Corporation (“AO”) in an April 1990 asset purchase transaction. The subsidiary manufactured respirators under the AO brand and disposed of that business in July 1995. In connection with its acquisition of the business, the subsidiary agreed, in certain circumstances, to assume a portion of AO’s liabilities, including costs of legal fees together with amounts paid in settlements and judgments, allocable to AO respiratory products used prior to the 1990 purchase by the Cabot subsidiary. In exchange for the subsidiary’s assumption of certain of AO’s respirator liabilities, AO agreed to provide to the subsidiary the benefits of: (1) AO’s insurance coverage for the period prior to the 1990 acquisition, and (2) a former owner’s indemnity of AO holding it harmless from any liability allocable to AO respiratory products used prior to May 1982. Generally, these respirator liabilities involve claims for personal injury, including asbestosis and silicosis, allegedly resulting from the use of respirators that are claimed to have been negligently designed or labeled.

~~101~~

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, AO’s insurers, and another former owner and its insurers (collectively, the “Payor Group”), are responsible for significant portions of the costs of these liabilities, leaving Cabot’s subsidiary with a portion of the liability in only some of the pending cases.

The subsidiary disposed of the business in July 1995 by transferring it to a newly-formed joint venture called Aearo Corporation (“Aearo”) and retained an equity interest in Aearo. Cabot agreed to have the subsidiary retain liabilities allocable to respirators used prior to the 1995 transaction so long as Aearo pays 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. Cabot has no liability in connection with any products manufactured by Aearo after 1995. Between July 1995 and September 30, 2001, the Company’s total costs and payments in connection with these respirator liabilities did not exceed the total amounts received from Aearo. Since September 30, 2001, the Company’s total costs and payments in connection with these liabilities have exceeded the amount Cabot has received from Aearo because of the significant increase in claims filed against AO beginning in calendar year 2001. In August 2003, Cabot and its subsidiary sold all of the subsidiary’s equity interest in Aearo for approximately $35 million. This sale did not alter the arrangements described above.

As of December 31, 2002, there were approximately 50,000 claimants in pending cases asserting claims against AO in connection with respiratory products. As of September 30, 2003, 2004, 2005 and 2006 there were approximately 87,000, 91,000, 92,000 and 63,000 claimants, respectively. A large portion of the claims asserted during 2003 were filed in Mississippi and appear to have been prompted by changes in Mississippi’s state procedural laws, which caused claimants to file their claims prior to the effective date of these changes. In 2005, a federal judge ruled that many of the “diagnoses” presented in a broad silicosis class action were unreliable. As a consequence of this ruling, silica and non-malignant asbestos claims filed throughout the country have dropped significantly for AO and for defendants in general in non-malignant asbestos and silica cases. In addition, many of the claims filed against AO during 2003, 2004 and 2005, which were pending as of September 30, 2005, have been dismissed without payment. It is not clear at this time whether this reduction in silica and non-malignant asbestos claims will continue or stabilize or whether the number of these claims will rebound.

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. Cabot engaged through counsel the assistance of Hamilton, Rabinovitz & Alschuler, Inc. (“HR&A”), a leading consulting firm in the field of tort liability valuation, to quantify Cabot’s estimated share of the liability for pending and future respirator claims. The methodology developed by HR&A addresses the complexities surrounding Cabot’s 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 Cabot’s period of direct manufacture and Cabot’s contractual obligations assuming that all other members of the Payor Group meet their obligations. Based on these estimates, Cabot has a reserve for these matters of $18 million on a net present value basis ($28 million on an undiscounted basis) at September 30, 2006.

established in that settlement was not in conformity with past practice. In this settlement, generally, the values paid for claims were established before the claims were actually asserted. As a result, payments made did not reflect substantial differences between the severity of claims. Including this data, therefore, would result in an unsupported increase in the projected settlement values for future cases involving non-malignant injury, which represent a significant majority of the pending and estimated future claims.

Cabot’s current estimate of the cost of its 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) a continuation in the recent trend of dismissals without payment of pending silica and non-malignant asbestos claims that began this year, (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 and (viii) a determination that the Company’s interpretation of the contractual obligations on which it has estimated its share of liability is inaccurate. Cabot cannot determine the impact of these potential developments on its current estimate of its 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.

~~Carbon Black Antitrust Litigation~~

During fiscal year 2003, the Company, Phelps Dodge Corporation, Columbian Chemicals Co., Degussa Engineered Carbons, LP, Degussa AG, and Degussa Corporation (referred to collectively as the “Defendants”), were named in fifteen antitrust lawsuits filed in several federal district courts, one of which was dismissed. The complaints were filed by the plaintiffs on their own behalf and on behalf of all individuals or entities who purchased carbon black in the United States directly from the Defendants from approximately 1999 until the present (the “Period”) and allege that the Defendants conspired to fix, raise, maintain or stabilize prices for carbon black sold in the United States during the Period. In the complaint, the plaintiffs seek treble damages in an unspecified amount and attorneys’ fees. Liability for damages in antitrust cases is joint and several among the defendants. In August 2003, the pending federal cases were consolidated by a multi-jurisdictional panel and transferred to the federal court for the District of Massachusetts. In the second quarter of fiscal 2005, the Defendants were named in an antitrust lawsuit filed in federal district court in New York. This action was consolidated with the other pending federal cases. In June 2006, the Defendants filed a motion for summary judgment. Arguments on the motion were heard in October 2006. In November 2006, the plaintiffs filed a pleading seeking the court’s approval of a $4 million settlement with the Degussa defendants. In the pleading, the plaintiffs estimated their total damages (subject to trebling) to be approximately $100 million.

behalf of all indirect purchasers of carbon black in these respective states. Each of these complaints asserts violations under the applicable state laws for conduct that is similar to what is alleged in the federal cases described above. The plaintiffs in the state actions also seek treble damages in an unspecified amount and attorneys’ fees. All nine pending California actions have been consolidated in the Superior Court in the State of California (City and County of San Francisco).

The Company believes it has valid defenses to all of these federal and state antitrust claims and will continue to assert them vigorously. While the outcome of litigation is uncertain, the Company does not believe that the ultimate disposition of these matters will have a material adverse effect on the Company’s financial position.

~~Beryllium Claims~~

Cabot is a party to several pending actions in connection with its discontinued beryllium operations. Cabot 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. During the last several years, several individuals who have resided or worked for many years in the immediate vicinity of our former beryllium facility located in Reading, Pennsylvania have brought suits against Cabot and NGK for personal injury allegedly caused by beryllium particle emissions produced at that facility. Nine personal injury claims against Cabot are pending in state court in Pennsylvania. One of the claims was filed during the fourth quarter of fiscal 2006. Discovery is ongoing in these cases.

Since October 2003, approximately 50 individuals have asserted claims for medical monitoring now pending in numerous Pennsylvania state court actions. The 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. In June 2006, summary judgment was granted to Cabot in connection with the medical monitoring claims of three of these individuals. The plaintiffs filed an appeal in July 2006.

There are also six beryllium product liability cases pending in state courts, five of which are pending in California and one of which is pending in Washington. Four California cases are stayed by court order pending the testing of the plaintiffs for beryllium exposure, and discovery is underway in the fifth California case. The Washington case is not active at this time. In August 2006, a case pending in Florida was voluntarily dismissed with prejudice by the plaintiffs.

~~In September 2006, Cabot was one of several named defendants in~~ ~~Anthony v. Small Tube Manufacturing Corp. et al.~~, a class action complaint filed in the United States District Court for the Eastern District of Pennsylvania on behalf of certain present and former employees of the U.S. Gauge Inc. facility in Sellersville, Pennsylvania. U.S. Gauge is a company alleged to have purchased the beryllium-containing products from Cabot. The class action alleges that the present and former employees were exposed to beryllium dust and fumes during the machining of beryllium-containing products purchased from Cabot and that they are therefore entitled to receive medical monitoring. There are three other companies named as defendants in the case. Cabot has filed an answer, cross-claims and third-party counterclaims. Discovery in the case has not yet begun.⁽¹⁾

~~In December 2006, Cabot was one of several named defendants in~~ ~~Sheridan et al. v. NGK North America, Inc., et al.~~, a class action complaint filed in the Pennsylvania Court of Common Pleas of Philadelphia County on behalf of persons who resided within a one mile radius of the Reading facility for a period of at least six months between 1950 and 2000. The class action alleges that these persons were exposed to emissions of beryllium from the Reading plant and are, therefore, entitled to receive medical monitoring. Cabot has not yet responded to the complaint, and discovery in the case has not yet begun.

~~Other~~

The Company has various other lawsuits, claims and contingent liabilities arising in the ordinary course of its business. In the opinion of the Company, although final disposition of some or all of these other suits and claims may impact the Company’s financial statements in a particular period, they should not, in the aggregate, have a material adverse effect on the Company’s financial position.

~~Note T. Risk Management~~

~~Market Risk~~

Cabot’s principal financial risk management objective is to identify and monitor our exposure to changes in interest rates and foreign currency rates, in order to assess the impact that changes in each could have on future cash flow and earnings. Cabot manages these risks through normal operating and financial activities and, when deemed appropriate, through the use of derivative financial instruments as well as foreign currency debt.

Cabot’s financial risk management policy prohibits entering into financial instruments for speculative purposes. All instruments entered into by Cabot are reviewed and approved by Cabot’s Financial Risk Management Committee, an internal management committee responsible for overseeing Cabot’s financial risk management policy.

By using derivative instruments, Cabot is subject to credit and market risk. If a counterparty fails to fulfill its performance obligations under a derivative contract, our credit risk 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 repayment risk for Cabot. We minimize the credit (or repayment) risk in derivative instruments by entering into transactions with highly rated counterparties that are reviewed periodically by us.

~~Interest Rates~~

Cabot’s main objective in managing its exposure to interest rate changes is to reduce the total funding cost and thereby limit the impact of interest rate changes on earnings and cash flows. Cabot uses interest rate swaps, foreign currency borrowings and foreign currency swaps to accomplish this objective. Cabot’s primary exposure is to the U.S. dollar yield curve. For further details see Note K.

~~Foreign Currency~~

Cabot’s international operations are subject to certain risks, including currency fluctuations and government actions. The Company’s Treasury function, under the guidance of the Financial Risk Management Committee, continuously monitors foreign exchange exposures, so that Cabot can respond to changing economic and political environments. Exposures primarily relate to assets and liabilities denominated in foreign currencies as well as the risk that currency fluctuations could affect the dollar value of future cash flows generated in foreign currencies. Accordingly, Cabot uses short-term forward contracts and foreign currency options to minimize the exposure to foreign currency risk. In 2006 and 2005, none of Cabot’s forward contracts and some of the foreign currency options were designated as hedging instruments under FAS 133. Cabot’s forward foreign exchange contracts are denominated primarily in the

~~Euro, Japanese yen, British pound sterling, Canadian dollar, Australian dollar and Indonesian rupiah. The foreign currency options are denominated in Australian dollar.~~

At September 30, 2006 and 2005, Cabot had $161 million and $139 million respectively in foreign currency forward contracts outstanding. The company also had foreign currency options with a notional value of $87 million and zero outstanding at September 30, 2006 and 2005 respectively. For 2006, 2005 and 2004, the net realized gains associated with the forward contracts were $3 million, $5 million and $4 million respectively. The net unrealized losses as of September 30, 2006, 2005 and 2004, respectively, were less than $1 million, $4 million and zero respectively, based on the fair value of the instruments. Gains and losses associated with foreign exchange contracts were not material to each respective period and are recorded in other income (charges) on the consolidated statement of operations.

Cabot also uses non-U.S. dollar denominated derivatives and non-derivatives (foreign currency debt) financial instruments to hedge its foreign currency risk related to the Japanese yen and the Euro. For further details see Note K.

~~Political Risk~~

Cabot is exposed to political or country risks inherent in doing business in some countries. These risks may include actions of governments, importing and exporting issues, contract loss and asset abandonment. The Company considers these risks carefully in connection with its investment and operating activities.

~~Share Repurchases~~

Cabot repurchases its shares in order to offset dilution caused by issuing shares under the Company’s various employee stock plans. In addition, the Company may repurchase its shares as one method of returning excess cash to shareholders.

~~Concentration of Credit~~

Credit risk represents the loss that would be recognized if counterparties failed to completely perform as contracted. Financial instruments that subject Cabot to credit risk consist principally of trade receivables. Furthermore, concentrations of credit risk exist for groups of customers when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.

During fiscal years 2006, 2005 and 2004, Goodyear Tire and Rubber Company accounted for approximately 14%, 12% and 11%, respectively, of Cabot’s annual consolidated net sales. No other customer individually represented more than 10% of net sales for any period presented. Cabot’s loss of this or other customers that may account for a significant portion of the Company’s sales, or any decrease in sales to any of these customers, could have a material adverse effect on Cabot’s business, financial condition or results of operations.

Tire manufacturers in the Carbon Black Business and customers of the Supermetals Business comprise significant portions of Cabot’s trade receivable balance. The accounts receivable balance for these significant customers are as follows:

September 30

2006

2005

(Dollars in millions)

Tire manufacturers

$
168

$
173

Supermetals customers

$
50

$
63

~~Cabot has not experienced significant losses in the past from these customers. Cabot monitors its exposure to customers to minimize potential credit losses.~~

~~Employee Benefits~~

Cabot provides defined benefit, defined contribution, and postretirement plans for its employees. Cabot is exposed to risk related to the defined benefit plan in the U.S. and several foreign defined benefit plans. Cabot is obligated to pay certain future benefits to employees under these plans. Cabot contributes to the plan assets each quarter based on the estimated future obligation. If the fair value of plan assets held for the defined benefit plans decreases due to market conditions, the expense to Cabot for providing these benefits could increase in future years.

Cabot funds the postretirement plans as claims or insurance premiums come due. The expense to Cabot for providing these benefits could increase in future years. At September 30, 2006, the accumulated postretirement benefit obligation is $86 million in U.S. plans and $17 million in foreign plans, of which $85 million in U.S. plans and $11 million in foreign plans is reserved for this liability. For further details see Note M.

~~Other Market Risks~~

Cabot is partially self-insured for certain third party liability, workers’ compensation and employee health benefits in the United States and Canada. 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. Cabot has accrued amounts equal to the actuarially determined liabilities. The actuarial valuations are 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.

~~Note U. Financial Information by Segment & Geographic Area~~

~~Segment Information~~

During the last quarter of fiscal 2005, management changed its segment reporting structure to better reflect the way the Company manages and thinks about the businesses. Under the new reporting structure, Cabot is organized into four reportable segments: the Carbon Black Business, the Metal Oxides Business, the Supermetals Business (“CSM”), and the Specialty Fluids Business (“CSF”). Prior year segment information, which included the disclosure of reportable segments, has been conformed to reflect this change.

~~107~~

Carbon black is a form of elemental carbon, which 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. Carbon black is widely used to enhance the physical, electrical and optical properties of the systems and applications in which it is incorporated. Carbon black is manufactured to match customer needs and performance requirements and is sold to diverse markets, including the automotive, building materials, agricultural, coatings, toners, plastics, inkjet printing and electronics markets. The 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. Performance products are specialized grades of carbon black that are used to enhance conductivity and static charge control, to provide UV protection, to enhance mechanical properties, to provide chemical flexibility through surface treatment and as pigments. These products are used in a wide variety of industries such as inks, coatings, cables, pipes, toners and electronics. Cabot’s performance products include black and white thermoplastic concentrates and specialty compounds that are marketed to the plastics industry. Cabot’s inkjet colorants are high-quality pigment-based black and other colorant dispersions the Company manufactures by surface treating special grades of carbon black and other pigments. Cabot’s inkjet colorant products are produced for various inkjet printing markets, including small office home office, high speed, wide format, and commercial and industrial printing applications.

The Metal Oxides Business is primarily comprised of the fumed metal oxides (including fumed silica and fumed alumina and dispersions thereof) and aerogel product lines. The revenues from each of these product lines are as follows:

Years Ended September 30

    2006

    2005

    2004

(Dollars in millions)

Fumed metal oxides

$
253

$
231

$
221

Aerogel

1

—

—

Total Metal Oxides Sales

$
254

$
231

$
221

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 and cosmetics. Cabot’s aerogels are nano-structured high surface area hydrophobic silica particles with potential uses in a variety of thermal and acoustic insulation applications. This product has been incorporated into the skylight, window and wall system products of several manufacturers of panels for use in the daylighting segment of the construction industry. The product line continues to focus on application and market development activities for use of aerogels in other commercial areas, and in fiscal 2006, began working with several potential customers to qualify our aerogels products for oil and gas pipeline insulation applications.

The Supermetals Business produces tantalum, niobium (columbium) and their alloys. Tantalum, which accounts for substantially all of this Business’s sales, is produced in various forms. Electronics is the largest market for tantalum powder and wire, which are 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 other applications such as the production of superalloys and chemical process equipment, and for various other industrial and aerospace applications.

In addition, the Company sells tantalum products for the manufacture of tantalum sputtering targets used in thin film applications, including semiconductors, inkjet heads, magnetics and flat panel displays.

The Specialty Fluids Business produces and markets cesium formate as a drilling and completion fluid for use in high pressure and high temperature oil and gas well operations. Cesium formate products are solids-free, high-density fluids that have a low viscosity, permitting them to flow readily in oil and gas wells. The fluid is resistant to high temperatures, minimizes damage to producing reservoirs and is readily biodegradable. Cesium formate is blended and sold with other formates or products in a majority of applications.

The accounting policies of the segments are the same as those described in the summary of “Significant Accounting Policies.” Exceptions are noted as follows and are incorporated in the tables below. Revenues from external customers for certain product lines within the Carbon Black Business include 100% of sales from one equity affiliate. Segment profit is a measure used by Cabot’s operating decision-makers to measure consolidated operating results and assess segment performance. Cabot evaluates the performance of its segments and allocates resources based on segment profit or loss before taxes (“PBT”). Segment PBT includes equity in net income of affiliated companies, royalties paid by equity affiliates and minority interest and excludes corporate governance costs, interest expense, foreign currency transaction gains and losses, interest income, dividend income, non-allocated corporate overhead as well as certain items that have not been allocated to a segment as they are significant and unusual or infrequent. Cash, short-term investments, cost investments, income taxes receivable, deferred taxes and headquarters’ assets are included in unallocated and other. Expenditures for additions to long-lived assets include total equity and other investments (including available-for-sale securities), property, plant and equipment, intangible assets and assets held for rent.

~~109~~

~~Financial information by segment is as follows:~~

Years Ended September 30,

Carbon
Black

Metal
Oxides

Supermetals(1)

Specialty
Fluids

Segment
Total

Unallocated
and Other(2)

Consolidated
Total

(Dollars in millions)

2006

Revenues from external customers(3)

$
1,917

$
254

$
292

$
44

$
2,507

$
36

$
2,543

Depreciation and amortization

96

23

5

4

128

12

131

Equity in net income of affiliated companies

11

1

—

—

12

—

12

Income (loss) from continuing operations before taxes(4)

105

18

41

16

180

(83
)

97

Assets(5)

1,552

245

284

71

2,152

382

2,534

Investment in equity-basis affiliates

55

4

—

—

59

—

59

Total expenditures for additions to long-lived assets(6)

154

23

10

4

191

27

218

2005

Revenues from external customers(3)

$
1,490

$
231

$
346

$
40

$
2,107

$
18

$
2,125

Depreciation and amortization

91

22

22

4

139

3

142

Equity in net income of affiliated companies

11

1

—

—

12

—

12

Income (loss) from continuing operations before taxes(4)

94

16

52

17

179

(272
)

(93
)

Assets(5)

1,287

234

351

74

1,946

428

2,374

Investment in equity-basis affiliates

60

3

—

—

63

—

63

Total expenditures for additions to long-lived assets(6)

136

26

21

6

189

97

286

2004

Revenues from external customers(3)

$
1,325

$
221

$
338

$
27

$
1,911

$
23

$
1,934

Depreciation and amortization

86

22

20

3

131

3

134

Equity in net income of affiliated companies

5

1

—

—

6

—

6

Income (loss) from continuing operations before taxes(4)

114

18

77

6

215

(51
)

164

Assets(5)

1,181

205

572

72

2,030

396

2,426

Investment in equity- basis affiliates

53

3

—

—

56

—

56

Total expenditures for additions to long-lived assets(6)

83

14

21

6

124

111

235

~~(1)~~Income before taxes related to the Supermetals Business for the year ended September 30, 2005 is exclusive of goodwill impairment charges of $90 million, $121 million of long-lived asset impairment charges and $15 of charges related to cost reduction initiatives, which are included in unallocated and other charges.

⁽²⁾	~~(2)~~Unallocated and other includes certain corporate items and eliminations that are not allocated to the operating segments.

⁽³⁾

~~(3)~~Revenues from external customers for the Carbon Black Business includes 100% of sales from one equity affiliate and at market-based prices. Unallocated and Other revenues from external customers reflects an adjustment for the equity affiliate sales and includes royalties paid by equity affiliates offset by external shipping and handling fees:


	Years Ended September 30
	2007			2006			2005
	(Dollars in millions)
Equity affiliate sales	$	(40	)	$	(39	)	$	(36	)
Royalties paid by equity affiliates and other operating revenues		14			10			12
Shipping and handling fees		75			65			42

Total	$	49		$	36		$	18

⁽⁴⁾

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Equity affiliate sales

$
(39
)

$
(36
)

$
(36
)

Royalties paid by equity affiliates and other operating revenues

10

12

8

Shipping and handling fees

65

42

51

Total

$
36

$
18

$
23

~~(4)~~Income (loss) from continuing operations before taxes for Unallocated and Other includes:


	Years Ended September 30
	2007			2006			2005
	(Dollars in millions)
Interest expense	$	(34	)	$	(27	)	$	(29	)
Certain items^(a)		(34	)		(51	)		(242	)
Reversal of equity in net income of affiliated companies		(12	)		(12	)		(12	)
Foreign currency transaction gains (losses)^(b)		8			(2	)		2
Other unallocated income^(c)		8			9			9

Total	$	(64	)	$	(83	)	$	(272	)

^(a)

Years Ended September 30

  2006

  2005

  2004

(Dollars in millions)

Interest expense

$
(27
)

$
(29
)

$
(30
)

Certain items(a)

(51
)

(242
)

(18
)

Reversal of equity in net income of affiliated companies

(12
)

(12
)

(6
)

Foreign currency transaction gains (losses)(b)

(2
)

2

(2
)

Other unallocated income(c)

9

9

5

Total

$
(83
)

$
(272
)

$
(51
)

~~(a)~~Certain items ~~includes investment income,~~for fiscal 2007 include charges of $12 million for legal reserves, $8 million and ~~certain other items that are not included~~$1 million for the closure of the Company’s carbon black facilities in ~~segment PBT. These certain~~Waverly, West Virginia and Altona, Australia, respectively, $3 million for the global restructuring initiatives, $6 million for environmental reserves and settlement and $4 million related to the acquisition of substantially all of the assets of AP Materials, Inc. Certain items for fiscal 2006 include a $10 million for charge for global restructuring initiatives, $11 million for charges related to the closure of the Company’s Altona facility, $3 million for cost reduction initiatives and $27 million for the Sons of Gwalia settlement payment. These certain items for fiscal 2005 include $16 million for restructuring charges, $90 million of goodwill asset impairment charges as discussed in Note D, $121 million of long-lived asset impairment charges as discussed in Note D and $15 million of charges related to cost reduction initiatives in the Supermetals Business. These certain items for fiscal 2004 include $6 million for restructuring charges, a $12 million charge for the impairment of an investment, income of $2 million related to respirator reserve recoveries and $2 million of charges related to other non-operating items.

^(b)

~~(b)~~Net of other foreign currency risk management activity.

^(c)

~~(c)~~Other unallocated income includes investment income and other items that are not included in segment PBT.

⁽⁵⁾	~~(5)~~Unallocated and Other assets includes cash, short-term investments, investments other than equity basis, income taxes receivable, deferred taxes and headquarters’ assets.

⁽⁶⁾	~~(6)~~Expenditures for additions to long-lived assets include total equity and other investments (including available-for-sale securities), property, plant and equipment, intangible assets and assets held for rent.

⁽⁷⁾

~~111~~

~~Geographic Information~~

~~Sales are attributed~~Amounts include a reclassification of $4 million of profit from the Carbon Black segment to the ~~United States and~~Metal Oxides segment. This reclassification was deemed to ~~all foreign countries based on~~be immaterial for purposes of the ~~location from which~~annual segment reporting in the ~~sale originated. Revenues and long-lived assets from external customers attributable to an individual country, other than the United States and Japan, did not meet the threshold for disclosure.~~September 30, 2006 consolidated financial statements.

~~Revenues from external customers and long-lived asset information by geographic area are summarized as follows:~~

United
States

Japan

Other Foreign
Countries

Consolidated
Total

(Dollars in millions)

Years Ended September 30,

2006

Revenues from external customers

$
790

$
351

$
1,402

$
2,543

Long-lived assets(1)

$
383

$
16

$
704

$
1,103

2005

Revenues from external customers

$
609

$
219

$
1,297

$
2,125

Long-lived assets(1)

$
332

$
22

$
615

$
969

2004

Revenues from external customers

$
614

$
183

$
1,137

$
1,934

Long-lived assets(1)

$
472

$
141

$
549

$
1,162

Geographic Information

Sales are attributed to the United States and to all foreign countries based on the location from which the sale originated. Revenues from external customers and long-lived assets attributable to an individual country, other than the United States, Japan and China, did not meet the threshold for disclosure.

Revenues from external customers and long-lived asset information by geographic area are summarized as follows:


	United States		Japan		China		Other Foreign Countries		Consolidated Total
	(Dollars in millions)
Years Ended September 30,
2007
Revenues from external customers	$	717	$	345	$	267	$	1,287	$	2,616
Long-lived assets⁽¹⁾	$	387	$	67	$	145	$	566	$	1,165
2006
Revenues from external customers	$	790	$	351	$	206	$	1,196	$	2,543
Long-lived assets⁽¹⁾	$	383	$	16	$	130	$	574	$	1,103
2005
Revenues from external customers	$	609	$	219	$	124	$	1,173	$	2,125
Long-lived assets⁽¹⁾	$	332	$	22	$	68	$	547	$	969

⁽¹⁾	Long-lived assets include total equity and other investments, (including available-for-sale marketable securities), net property, plant and equipment, net intangible assets and assets held for rent.

Note V. Unaudited Quarterly Financial Information

Unaudited financial results by quarter for the fiscal years ended September 30, 2007 and 2006 are summarized below.


	Quarter Ended
	December			March			June			September			Year
	(Dollars in millions, except per share amounts)
Fiscal 2007
Net sales	$	655		$	637		$	649		$	675		$	2,616
Gross profit		149			138			106			111			505
Income from continuing operations		54	⁽¹⁾		31	⁽²⁾		21	⁽³⁾		21	⁽⁴⁾		127
Income (loss) from discontinued operations		—			—			(1	)⁽⁵⁾		3	⁽⁶⁾		2

Net income	$	54		$	31		$	20		$	24		$	129
Dividends on preferred stock, net of tax benefit		—			(1	)		—			—			(1	)

Income available to common shares	$	54		$	30		$	20		$	24		$	128

Income from continuing operations per common share (diluted)	$	0.79		$	0.45		$	0.31		$	0.32		$	1.87
Income per common share (diluted)	$	0.79		$	0.45		$	0.30		$	0.36		$	1.90

Fiscal 2006
Net sales	$	587		$	627		$	666		$	663		$	2,543
Gross profit		106			85			115			113			419
Income from continuing operations		22	⁽⁷⁾		12	⁽⁸⁾		25	⁽⁹⁾		29	⁽¹⁰⁾		88
Discontinued Operations, net of tax		—			—			—			2	⁽¹¹⁾		2
Cumulative effect of accounting changes, net of tax		2	⁽¹²⁾		—			—			(4	)⁽¹²⁾		(2	)

Net income	$	24		$	12		$	25		$	27		$	88
Dividends on preferred stock, net of tax benefit		(1	)		—			(1	)		—			(2	)

Income available to common shares	$	23		$	12		$	24		$	27		$	86

Income from continuing operations per common share (diluted)	$	0.31		$	0.17		$	0.37		$	0.43		$	1.28
Income (loss) from cumulative effect of change in accounting principle per common share (diluted)		0.04			—			—			(0.07	)		(0.03	)
Income from discontinued operations per common share (diluted)		—			—			—			0.03			0.03

Income per common share (diluted)	$	0.35		$	0.17		$	0.37		$	0.39		$	1.28

⁽¹⁾	Includes charges of $2 million for global restructuring initiatives and $1 million related to closure of the Company’s Altona, Australia facility.

⁽²⁾	Includes charges of $5 million for environmental reserves and a legal settlement, $2 million for global restructuring initiatives, as well as a $10 million reserve related to the carbon black antitrust litigation.

⁽³⁾	Includes charges of $3 million related to the closure of the Company’s Waverly, West Virginia carbon black facility and $1 million for environmental reserves.

⁽⁴⁾

Includes charges of $2 million for legal reserves, $5 million related to the closure of the Company’s Waverly, West Virginia carbon black facilitiy, $4 million for the ~~fiscal years ended September 30,~~acquisition of flamed synthesis technology and a $1 million benefit in connection with the 2006 ~~and 2005 are summarized below and should be read~~global restructuring initiatives, which primarily relates to the sale of the Company’s Leiden, Netherlands facility.

⁽⁵⁾

Amount relates to a legal reserve in ~~conjunction~~connection with ~~Management’s Discussion and Analysis of Financial Condition and Results of Operations.~~the Company’s discontinued operations.

Quarter Ended

December

March

June

September

Year

(Dollars in millions, except per share amounts)

Fiscal 2006

Net sales

$
587

$
627

$
666

$
663

$
2,543

Gross profit

106

85

115

113

419

Income from continuing operations

22
(1)

12
(2)
25
(3)

29
(4)

88

Discontinued Operations, net of tax

—

—

—

2
(6)

2

Cumulative effect of accounting changes, net of tax

2
(5)

—

—

(4
)(5)

(2
)
Net income

$
24

$
12

$
25

$
27

$
88

Dividends on preferred stock, net of tax benefit

(1
)

—

(1
)

—

(2
)
Income available to common shares

$
23

$
12

$
24

$
27

$
86

Income from continuing operations per common share (diluted)

$
0.31

$
0.17

$
0.37

$
0.43

$
1.28

Income (loss) from cumulative effect of change in accounting principle per common share (diluted)

0.04

—

—

(0.07
)

(0.03
)
Income from discontinued operations per common share (diluted)

—

—

—

0.03

0.03

Income per common share (diluted)

$
0.35

$
0.17

$
0.37

$
0.39

$
1.28

Fiscal 2005

Net sales

$
495

$
527

$
545

$
558

$
2,125

Gross profit

117

130

118

68

433

Income (loss) from continuing operations

35
(7)

(50
)(8)
26
(9)

(59
)(10)

(48
)
Net income (loss)

$
35

$
(50
)
$
26

$
(59
)

$
(48
)
Dividends on preferred stock, net of tax benefit

(1
)

—

(1
)

(1
)

(3
)
Income (loss) available to common shares

$
34

$
(50
)
$
25

$
(60
)

$
(51
)
Income (loss) from continuing operations per common share (diluted)

$
0.51

$
(0.84
)
$
0.39

$
(1.02
)

$
(0.84
)
Income (loss) per common share (diluted)

$
0.51

$
(0.84
)
$
0.39

$
(1.02
)

$
(0.84
)

~~(1)~~⁽⁶⁾

Amount relates to a favorable tax settlement recognized during the period related to our discontinued liquified natural gas business.

⁽⁷⁾	Includes $1 million charge for restructuring initiatives and $1 million charge for cost reduction initiatives.

~~(2)~~⁽⁸⁾

Includes $2 million charge for restructuring initiatives, $2 million charge for cost reduction initiatives and $27 million charge for the Sons of Gwalia settlement payment.

~~(3)~~⁽⁹⁾

Includes $1 million charge for restructuring initiatives and $1 million charge for cost reduction initiatives.

~~(4)~~⁽¹⁰⁾

Includes $10 million charge for global restructuring initiatives and $7 million charge related to the closure of our Altona facility.

~~(5)~~⁽¹¹⁾

Amount relates to a favorable tax settlement recognized during the period related to our discontinued liquified natural gas business.

⁽¹²⁾	Amounts related to the cumulative benefit resulting from the adoption of FAS 123(R) in the first quarter of fiscal 2006, net of tax, and amounts related to the cumulative expense resulting from the adoption of FIN 47 in the fourth quarter of 2006, net of tax.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Cabot Corporation

Boston, Massachusetts

We have audited the accompanying consolidated balance sheet of Cabot Corporation and subsidiaries (the “Company”) as of September 30, 2007, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2007, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note M to the consolidated financial statements, the Company adopted the funded status and the disclosure requirements of Statement of Financial Accounting Standard No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)” as of September 30, 2007.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of September 30, 2007, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 29, 2007 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ Deloitte & Touche LLP

Boston, Massachusetts

November 29, 2007

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Cabot Corporation:

In our opinion, the consolidated balance sheet as of September 30, 2006 and the related consolidated statements of income, changes in stockholders’ equity and cash flows for each of two years in the period ended September 30, 2006 present fairly, in all material respects, the financial position of Cabot Corporation and its subsidiaries at September 30, 2006, and the results of their operations and their cash flows for each of the two years in the period ended September 30, 2006, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Boston, Massachusetts

December 14, 2006

~~(6)~~     ~~Amount relates to a favorable tax settlement recognized during the period related to our discontinued liquified natural gas business.~~
~~(7)~~     ~~Includes $4 million charge for restructuring initiatives and $3 million of tax benefit related to the closure of the Altona facility.~~
~~(8)~~     ~~Includes charges of $4 million for restructuring initiatives and $90 million for goodwill asset impairment.~~
~~(9)~~     ~~Includes $4 million charge for restructuring initiatives.~~
~~(10)~~    ~~Includes charges of $3 million for restructuring initiatives, $15 million for cost reduction initiatives and $121 million for long-lived asset impairment.~~
~~114~~

~~Report of Independent Registered Public Accounting Firm~~
~~To the Board of Directors and Shareholders of Cabot Corporation:~~
We have completed integrated audits of Cabot Corporation’s 2006 and 2005 consolidated financial statements and of its internal control over financial reporting as of September 30, 2006, and an audit of its 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
~~Consolidated financial statements~~
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Cabot Corporation and its subsidiaries at September 30, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note N to the consolidated financial statements, the Company changed its method of accounting for share-based payments on October 1, 2005. As discussed in Note A to the consolidated financial statements, the Company changed its method of accounting for asset retirement obligations as of September 30, 2006.
~~Internal control over financial reporting~~
Also, in our opinion, management’s assessment, included in Management’s Annual Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of September 30, 2006 based on criteria established in ~~Internal Control - Integrated Framework~~ issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2006, based on criteria established in ~~Internal Control - Integrated Framework~~ issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for

external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As described in Management’s Annual Report on Internal Control over Financial Reporting, management has excluded Cabot Japan K.K. from its assessment of internal control over financial reporting as of September 30, 2006 because an additional 50% interest was acquired by the Company in a purchase business combination during fiscal year 2006. We have also excluded Cabot Japan K.K. from our audit of internal control over financial reporting. Cabot Japan K.K. is a wholly owned subsidiary whose total assets and total revenues represent $126 million and $127 million, respectively, of the related consolidated financial statement amounts as of and for the year ended September 30, 2006.
~~/s/ PricewaterhouseCoopers LLP~~
~~Boston, Massachusetts~~
~~December 14, 2006~~
~~116~~

Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

~~None.~~

Item 9A.

Controls and Procedures

Disclosure Controls and Procedures

Cabot carried out an evaluation, under the supervision and with the participation of its 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-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of September 30, 2007. Based on that evaluation, Cabot’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 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 and such information is accumulated and communicated to management to allow timely decisions regarding required disclosure.

Management’s Annual Report on Internal Control Over Financial Reporting

Cabot’s management is responsible for establishing and maintaining adequate internal control over financial reporting for Cabot. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers, and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.

Cabot’s management assessed the effectiveness of Cabot’s internal control over financial reporting as of September 30, 2007 based on the framework established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, Cabot’s management concluded that Cabot’s internal control over financial reporting was effective as of September 30, 2007.

Cabot’s internal control over financial reporting as of September 30, 2007 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report below.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ending September 30, 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Cabot Corporation

Boston, Massachusetts

We have audited the internal control over financial reporting of Cabot Corporation and subsidiaries (the “Company”) as of September 30, 2007, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the consolidated financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2007, based on the criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended September 30, 2007 of the Company and our report dated November 29, 2007 expressed an unqualified opinion on those financial statements and included an explanatory paragraph relating to the Company’s adoption of Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)”.

/s/ Deloitte & Touche LLP

Boston, Massachusetts

November 29, 2007

~~Disclosure Controls and Procedures~~
Cabot carried out an evaluation, under the supervision and with the participation of its 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-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of September 30, 2006. Based on that evaluation, Cabot’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 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 and such information is accumulated and communicated to management to allow timely decisions regarding required disclosure.
~~Management’s Annual Report on Internal Control Over Financial Reporting~~
Cabot’s management is responsible for establishing and maintaining adequate internal control over financial reporting for Cabot. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers, and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
·       ~~Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;~~
·       Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
·       Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.
~~Cabot’s management assessed the effectiveness of Cabot’s internal control over financial reporting as of September 30, 2006 based on the framework established in~~ ~~Internal Control—Integrated Framework~~ issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, Cabot’s management concluded that Cabot’s internal control over financial reporting was effective as of September 30, 2006. During fiscal year 2006, Cabot purchased the 50% equity interest it did not already own in Showa Cabot K.K. from our joint venture partner and renamed the entity Cabot Japan K.K. Management has excluded Cabot Japan K.K. from its assessment of internal control over financial

reporting as of September 30, 2006. Cabot Japan K.K. had total assets of $126 million and total revenue of $127 million included in Cabot’s consolidated financial statements as of and for the year ended September 30, 2006.
Management’s assessment of the effectiveness of Cabot’s internal control over financial reporting as of September 30, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report that appears under Item 8.
~~Changes in Internal Control Over Financial Reporting~~
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ending September 30, 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company is in the process of reviewing the internal control of Cabot Japan K.K. and will make appropriate changes as we incorporate our controls and procedures at Cabot Japan K.K. We intend to disclose any changes in our internal control over financial reporting resulting from the acquisition of Cabot Japan K.K. that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting, within or prior to our first annual assessment of internal control over financial reporting that is required to include Cabot Japan K.K., which is the end of fiscal year 2007.
Item 9B.
Other Information

None.

PART III

~~None.~~

~~PART III~~

Item 10.

Directors, ~~and~~ Executive Officers ~~of the Registrant~~
~~Certain information regarding our executive officers is included at the end of Part I of this Annual Report under the heading “Executive Officers of the Registrant.”~~

~~Cabot has adopted Global Ethics~~ and Corporate Governance

Certain information regarding our executive officers is included at the end of Part I of this annual report under the heading “Executive Officers of the Registrant.”

Cabot has adopted Global Ethics and Compliance Standards, a code of ethics that applies to all of the Company’s employees and directors, including the Chief Executive Officer, the Chief Financial Officer, the Controller and other senior financial officers. The Global Ethics and Compliance Standards are posted on our website, www.cabot-corp.com (under the “Corporate Governance” caption). We intend to satisfy the disclosure requirement regarding any amendment to, or waiver of, a provision of the Global Ethics and Compliance Standards applicable to the Chief Executive Officer, the Chief Financial Officer, the Controller or other senior financial officers by posting such information on our website.

The other information required by this item will be included in our Proxy Statement for the 2008 Annual Meeting of Stockholders (“Proxy Statement”) and is herein incorporated by reference.

~~The other information required by this item will be included in our Proxy Statement for the 2007 Annual Meeting of Stockholders (“Proxy Statement”) and is herein incorporated by reference.~~

Item 11. Executive Compensation

The information required by this item will be included in our Proxy Statement and is incorporated herein by reference.

~~The information required by this item will be included in our Proxy Statement and is incorporated herein by reference.~~

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table provides information as of September 30, 2006 regarding the number of shares of common stock that may be issued under Cabot’s equity compensation plans. All of our equity compensation plans have been approved by our stockholders.
Plan category

Number of
securities to be
issued upon exercise
of outstanding
options, warrants
and rights
(a)

Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)

Number of securities
remaining available for future
issuance under equity
compensation plans
(excluding securities reflected
in column (a))
(c)(2)

Equity compensation plans approved by security holders(1)

662,400

$
29.92

3,447,600

Equity compensation plans not approved by security holders

N/A

N/A

N/A

The following table provides information as of September 30, 2007 regarding the number of shares of common stock that may be issued under Cabot’s equity compensation plans. All of our equity compensation plans have been approved by our stockholders.


Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)	Weighted-average exercise price of outstanding options, warrants and rights (b)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)(2)
Equity compensation plans approved by security holders⁽¹⁾	368,100	$	33.18	2,955,500
Equity compensation plans not approved by security holders	N/A		N/A	N/A

⁽¹⁾	Included in this category are the following equity plans that have been approved by Cabot’s stockholders: 2006 Long-Term Incentive Plan, 1999 Equity Incentive Plan, ~~and~~ 1996 Equity Incentive Plan and Non-Employee Directors’ Stock Compensation Plan.

⁽²⁾

The number in this column of the table represents the securities remaining available for future issuance under the 2006 Long-Term Incentive Plan and Non-Employee Directors’ Stock Compensation Plan. No new awards may be made under either the 1996 Equity Incentive Plan or the 1999 Equity Incentive Plan although there remain outstanding awards previously granted under these plans.

The other information required by this item will be included in our Proxy Statement and is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this item will be included in our Proxy Statement and is incorporated herein by reference.

~~The information required by this item will be included in our Proxy Statement and is incorporated herein by reference.~~

Item 14.

Principal Accounting Fees and Services

The information required by this item will be included in our Proxy Statement and is incorporated herein by reference.

PART IV

~~The information required by this item will be included in our Proxy Statement and is incorporated herein by reference.~~

~~PART IV~~

Item 15.

Exhibits, ~~and~~ Financial Statement Schedules

(a) ~~(a)~~Financial Statements. See “Index to Financial Statements” under Item 8 on page 5753 of this Form 10-K.

(b) ~~(b)~~Exhibits. (Certain exhibits not included in copies of the Form 10-K sent to stockholders.)
~~120~~

The exhibit numbers in the following list correspond to the numbers assigned to such exhibits in the Exhibit Table of Item 601 of Regulation S-K. Cabot will furnish to any stockholder, upon written request, any exhibit listed below, upon payment by such stockholder of the Company’s reasonable expenses in furnishing such exhibit.


Exhibit Number		Description
3(a)	—	Certificate of Incorporation of Cabot Corporation restated effective October 24, 1983, as amended (incorporated herein by reference to Exhibit 3.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2005, file reference 1-5667, filed with the SEC on February 9, 2006).

3(b)	—	The By-laws of Cabot Corporation as amended January 12, 2007 (incorporated herein by reference to Exhibit 3.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2006, file reference 1-5667, filed with the SEC on February 9, 2007).

4(a)(i)	—	Indenture, dated as of December 1, 1987, between Cabot Corporation and The First National Bank of Boston, Trustee (the “Indenture”) (incorporated herein by reference to Exhibit 4 of Amendment No. 1 to Cabot’s Registration Statement on Form S-3, Registration No. 33-18883, filed with the SEC on December 10, 1987).

4(a)(ii)	—	First Supplemental Indenture dated as of June 17, 1992, to the ~~numbers assigned~~Indenture (incorporated by reference to ~~such exhibits in~~Exhibit 4.3 of Cabot’s Registration Statement on Form S-3, Registration Statement No. 33-48686, filed with the SEC on June 18, 1992).

4(a)(iii)	—	Second Supplemental Indenture, dated as of January 31, 1997, between Cabot Corporation and State Street Bank and Trust Company, Trustee (incorporated herein by reference to Exhibit ~~Table~~4 of ~~Item 601~~Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1996, file reference 1-5667, filed with the SEC on February 14, 1997).

4(a)(iv)	—	Third Supplemental Indenture, dated as of ~~Regulation S-K.~~November 20, 1998, between Cabot ~~will furnish~~Corporation and State Street Bank and Trust Company, Trustee (incorporated herein by reference to ~~any stockholder, upon written request, any exhibit listed below, upon payment~~Exhibit 4.1 of Cabot’s Current Report on Form 8-K, dated November 20, 1998, file reference 1-5667, filed with the SEC on November 20, 1998).

10(a)	—	Credit Agreement dated August 3, 2005 among Cabot Corporation, Bank of America, N.A., as Administrative Agent, Swing Line Lender, and L/C Issuer, Citibank, N.A., as Syndication Agent, and the other lenders party thereto (incorporated herein by ~~such stockholder~~reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005, file reference 1-5667, filed with the SEC on August 9, 2005).

10(b)(i)*	—	1996 Equity Incentive Plan (incorporated herein by reference to Exhibit 28 of Cabot’s Registration Statement on Form S-8, Registration No. 333-03683, filed with the SEC on May 14, 1996).

10(b)(ii)*	—	1999 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999, file reference 1-5667, filed with the SEC on May 17, 1999).

10(b)(iii)*	—	Amendments to Cabot Corporation 1996 and 1999 Equity Incentive Plans, dated May 12, 2000 (incorporated herein by reference to Exhibit 10 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000, file reference 1-5667, filed with the SEC on May 15, 2000).

Exhibit
Number
Description
10(b)(iv)* — Amendment to 1999 Equity Incentive Plan dated March 7, 2002 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002, file reference 1-5667, filed with the SEC on May 15, 2002).
10(b)(v)* — 2006 Long-Term Incentive Plan (incorporated herein by reference to Appendix B of Cabot’s Proxy Statement on Schedule 14A relating to the 2006 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 30, 2006).
10(b)(vi)* — Non-Employee Directors’ Stock Compensation Plan (incorporated herein by reference to Appendix B of Cabot’s Proxy Statement on Schedule 14A relating to the 2006 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 30, 2006).
10(b)(vii)* — Cabot Corporation Short-Term Incentive Compensation Plan (incorporated herein by reference to Appendix C of Cabot’s Proxy Statement on Schedule 14A relating to the 2007 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 29, 2007).
10(c) — Note Purchase Agreement between John Hancock Mutual Life Insurance Company, State Street Bank and Trust Company, as trustee for the Cabot Corporation Employee Stock Ownership Plan, and Cabot Corporation, dated as of November 15, 1988 (incorporated by reference to Exhibit 10(c) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1988, file reference 1-5667, filed with the SEC on December 29, 1988).
10(d)(i)* — Supplemental Cash Balance Plan (incorporated herein by reference to Exhibit 10(e)(i) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(ii)* — Supplemental Cash Balance Plan, as amended and restated effective January 1, 2002 (incorporated herein by reference to Exhibit 10(d)(ii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
10(d)(iii)* — Supplemental Employee Stock Ownership Plan (incorporated herein by reference to Exhibit 10(e)(ii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(iv)* — Supplemental Retirement Incentive Savings Plan (incorporated herein by reference to Exhibit 10(e)(iii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(v)* — Supplemental Retirement Savings Plan, as amended and restated effective December 31, 2000 (incorporated herein by reference to Exhibit 10(d)(v) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
10(d)(vi)* — Cabot Corporation Deferred Compensation Plan dated January 1, 1995 (incorporated herein by reference to Exhibit 10(e)(v) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1995, file reference 1-5667, filed with the SEC on December 29, 1995).
10(d)(vii)* — Amendment 1997-I to Cabot Corporation Deferred Compensation Plan dated June 30, 1997 (incorporated herein by reference to Exhibit 10(d)(vi) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1997, file reference 1-5667, filed with the SEC on December 24, 1997).
10(d)(viii)*† — Cabot Corporation Amended and Restated Deferred Compensation Plan dated July 13, 2007.

Exhibit
Number
Description
10(d)(ix)* — Non-Employee Directors’ Stock Deferral Plan dated July 14, 2006 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006, file reference 1-5667, filed with the SEC on August 9, 2006).
10(e) — Group Annuity Contract No. GA-6121 between The Prudential Insurance Company of America and State Street Bank and Trust Company, dated June 28, 1991 (incorporated herein by reference to Exhibit 10(h) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1991, file reference 1-5667, filed with the SEC on December 27, 1991).
10(f)* — Summary of Compensation for Non-Employee Directors (incorporated herein by reference to Exhibit 10(f) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2006, file reference 1-5667, filed with the SEC on December 14, 2006).
10(g) — Asset Transfer Agreement, dated as of June 13, 1995, among Cabot Safety Corporation, Cabot Canada Ltd., Cabot Safety Limited, Cabot Corporation, Cabot Safety Holdings Corporation and Cabot Safety Acquisition Corporation (incorporated herein by reference to Exhibit 2(a) of Cabot Corporation’s Current Report on Form 8-K dated July 11, 1995, file reference 1-5667, filed with the SEC July 26, 1995).
10(h)(i)* — Cabot Corporation Senior Management Severance Protection Plan, effective January 9, 1998 (incorporated herein by reference to Exhibit 10(a) of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1997, file reference 1-5667, filed with the SEC February 17, 1998).
10(h)(ii)* — Amendment to Cabot Corporation Senior Management Severance Protection Plan, effective January 12, 2007 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2006, file reference 1-5667, filed with the SEC on February 9, 2007).
10(i) — Fiscal Agency Agreement dated as of September 24, 2003 among Cabot Finance B.V., Cabot Corporation, and U.S. Bank Trust National Association (incorporated herein by reference to Exhibit 10(l) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
12† — Statement Re: Computation of Ratio of Earnings (Loss) to Fixed Charges.
21† — Subsidiaries of Cabot Corporation.
23(i)† — Consent of Deloitte & Touche LLP.
23(ii)† — Consent of PricewaterhouseCoopers LLP.
31(i)† — Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the ~~Company’s reasonable expenses in furnishing such exhibit.~~
~~Exhibit~~
~~Number~~
Exchange Act.
31(ii)† — Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.
32† — Certifications of the Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350.
*
~~Description~~
~~3(a)~~
—
Certificate of Incorporation of Cabot Corporation restated effective October 24, 1983, as amended (incorporated herein by reference to Exhibit 3.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2005, file reference 1-5667, filed with the SEC on February 9, 2006).
~~3(b)~~
—
The By-laws of Cabot Corporation as of January 11, 1991 (incorporated herein by reference to Exhibit 3(b) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1991, file reference 1-5667, filed with the SEC on December 27, 1991).
~~4(a)(i)~~
—
Indenture, dated as of December 1, 1987, between Cabot Corporation and The First National Bank of Boston, Trustee (the “Indenture”) (incorporated herein by reference to Exhibit 4 of Amendment No. 1 to Cabot’s Registration Statement on Form S-3, Registration No. 33-18883, filed with the SEC on December 10, 1987).
~~4(a)(ii)~~
—
First Supplemental Indenture dated as of June 17, 1992, to the Indenture (incorporated by reference to Exhibit 4.3 of Cabot’s Registration Statement on Form S-3, Registration Statement No. 33-48686, filed with the SEC on June 18, 1992).
~~4(a)(iii)~~
—
Second Supplemental Indenture, dated as of January 31, 1997, between Cabot Corporation and State Street Bank and Trust Company, Trustee (incorporated herein by reference to Exhibit 4 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1996, file reference 1-5667, filed with the SEC on February 14, 1997).
~~4(a)(iv)~~
—
Third Supplemental Indenture, dated as of November 20, 1998, between Cabot Corporation and State Street Bank and Trust Company, Trustee (incorporated herein by reference to Exhibit 4.1 of Cabot’s Current Report on Form 8-K, dated November 20, 1998, file reference 1-5667, filed with the SEC on November 20, 1998).
~~10(a)~~
—
Credit Agreement dated August 3, 2005 among Cabot Corporation, Bank of America, N.A., as Administrative Agent, Swing Line Lender, and L/C Issuer, Citibank, N.A., as Syndication Agent, and the other lenders party thereto (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005, file reference 1-5667, filed with the SEC on August 9, 2005).
10(b)(i)*
—
~~1996 Equity Incentive Plan (incorporated herein by reference to Exhibit 28 of Cabot’s Registration Statement on Form S-8, Registration No. 333-03683, filed with the SEC on May 14, 1996).~~
10(b)(ii)*
—
1999 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999, file reference 1-5667, filed with the SEC on May 17, 1999).

10(b)(iii)*
—
Amendments to Cabot Corporation 1996 and 1999 Equity Incentive Plans, dated May 12, 2000 (incorporated herein by reference to Exhibit 10 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000, file reference 1-5667, filed with the SEC on May 15, 2000).
10(b)(iv)*
—
Amendment to 1999 Equity Incentive Plan dated March 7, 2002 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002, file reference 1-5667, filed with the SEC on May 15, 2002).
10(b)(v)*
—
2006 Long-Term Incentive Plan (incorporated herein by reference to Appendix B of Cabot’s Proxy Statement on Schedule 14A relating to the 2006 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 30, 2006).
10(b)(vi)*
—
Non-Employee Directors’ Stock Compensation Plan (incorporated herein by reference to Appendix B of Cabot’s Proxy Statement on Schedule 14A relating to the 2006 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 30, 2006).
~~10(c)~~
—
Note Purchase Agreement between John Hancock Mutual Life Insurance Company, State Street Bank and Trust Company, as trustee for the Cabot Corporation Employee Stock Ownership Plan, and Cabot Corporation, dated as of November 15, 1988 (incorporated by reference to Exhibit 10(c) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1988, file reference 1-5667, filed with the SEC on December 29, 1988).
10(d)(i)*
—
Supplemental Cash Balance Plan (incorporated herein by reference to Exhibit 10(e)(i) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(ii)*
—
Supplemental Cash Balance Plan, as amended and restated effective January 1, 2002 (incorporated herein by reference to Exhibit 10(d)(ii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
10(d)(iii)*
—
Supplemental Employee Stock Ownership Plan (incorporated herein by reference to Exhibit 10(e)(ii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(iv)*
—
Supplemental Retirement Incentive Savings Plan (incorporated herein by reference to Exhibit 10(e)(iii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(v)*
—
Supplemental Retirement Savings Plan, as amended and restated effective December 31, 2000 (incorporated herein by reference to Exhibit 10(d)(v) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).

10(d)(vi)*
—
Cabot Corporation Deferred Compensation Plan dated January 1, 1995 (incorporated herein by reference to Exhibit 10(e)(v) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1995, file reference 1-5667, filed with the SEC on December 29, 1995).
10(d)(vii)*
—
Amendment 1997-I to Cabot Corporation Deferred Compensation Plan dated June 30, 1997 (incorporated herein by reference to Exhibit 10(d)(vi) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1997, file reference 1-5667, filed with the SEC on December 24, 1997).
~~10(d)(viii)* †~~
—
~~Cabot Corporation Amended and Restated Deferred Compensation Plan dated September 8, 2006.~~
10(d)(ix)*
—
Non-Employee Directors’ Stock Deferral Plan dated July 14, 2006 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006, file reference 1-5667, filed with the SEC on August 9, 2006).
~~10(e)~~
—
Group Annuity Contract No. GA-6121 between The Prudential Insurance Company of America and State Street Bank and Trust Company, dated June 28, 1991 (incorporated herein by reference to Exhibit 10(h) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1991, file reference 1-5667, filed with the SEC on December 27, 1991).
~~10(f)* †~~
—
~~Summary of Compensation for Non-Employee Directors.~~
~~10(g)~~
—
Asset Transfer Agreement, dated as of June 13, 1995, among Cabot Safety Corporation, Cabot Canada Ltd., Cabot Safety Limited, Cabot Corporation, Cabot Safety Holdings Corporation and Cabot Safety Acquisition Corporation (incorporated herein by reference to Exhibit 2(a) of Cabot Corporation’s Current Report on Form 8-K dated July 11, 1995, file reference 1-5667, filed with the SEC July 26, 1995).
10(h)*
—
Cabot Corporation Senior Management Severance Protection Plan, effective January 9, 1998 (incorporated herein by reference to Exhibit 10(a) of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1997, file reference 1-5667, filed with the SEC February 17, 1998).
~~10(i)~~
—
Fiscal Agency Agreement dated as of September 24, 2003 among Cabot Finance B.V., Cabot Corporation, and U.S. Bank Trust National Association (incorporated herein by reference to Exhibit 10(l) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
~~12†~~
—
~~Statement Re: Computation of Ratio of Earnings (Loss) to Fixed Charges.~~
~~21†~~
—
~~Subsidiaries of Cabot Corporation.~~
~~23†~~
—
~~Consent of PricewaterhouseCoopers LLP.~~
~~31(i)†~~
—
~~Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.~~

~~31(ii)†~~
—
~~Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.~~
~~32†~~
—
~~Certifications of the Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350.~~
*Management contract or compensatory plan or arrangement.
† Filed herewith.

(c) ~~(c)~~ Schedules. The Schedules have been omitted because they are not required or are not applicable, or the required information is shown in the financial statements or notes thereto.

~~124~~

~~SIGNATURES~~SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.


CABOT CORPORATION

By:		/s/ KENNETT F. BURNES
		Kennett F. Burnes
		Chairman of the Board, President and Chief Executive Officer

Date: November 29, 2007

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.


Signatures	Title	Date

/s/ KENNETT F. BURNES Kennett F. Burnes	Director, Chairman of the Board, President and Chief Executive Officer	November 29, 2007

/s/ JONATHAN P. MASON Jonathan P. Mason	Executive Vice President and Chief Financial Officer (principal financial officer)	November 29, 2007

/s/ JAMES P. KELLY James P. Kelly	Vice President and Controller (principal accounting officer)	November 29, 2007

/s/ DIRK L. BLEVI Dirk L. Blevi	Director and Executive Vice President	November 29, 2007

/s/ JOHN S. CLARKESON John S. Clarkeson	Director	November 29, 2007

/s/ JUAN ENRIQUEZ-CABOT Juan Enriquez-Cabot	Director	November 29, 2007

/s/ ARTHUR L. GOLDSTEIN Arthur L. Goldstein	Director	November 29, 2007

/s/ GAUTAM S. KAJI Gautam S. Kaji	Director	November 29, 2007

/s/ RODERICK C.G. MACLEOD Roderick C.G. MacLeod	Director	November 29, 2007

/s/ HENRY F. MCCANCE Henry F. McCance	Director	November 29, 2007

Signatures
Title
Date
/s/    JOHN F. O’BRIEN
John F. O’Brien
Director November 29, 2007
/s/    RONALDO H. SCHMITZ
Ronaldo H. Schmitz
Director November 29, 2007
/s/    LYDIA W. THOMAS
Lydia W. Thomas
Director November 29, 2007
/s/    MARK S. WRIGHTON
Mark S. Wrighton
Director November 29, 2007
/s/    SHENGMAN ZHANG
Shengman Zhang
Director November 29, 2007

EXHIBIT INDEX


3(a)	—	Certificate of Incorporation of Cabot Corporation restated effective October 24, 1983, as amended (incorporated herein by reference to Exhibit 3.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2005, file reference 1-5667, filed with the SEC on February 9, 2006).

3(b)	—	The By-laws of Cabot Corporation as amended January 12, 2007 (incorporated herein by reference to Exhibit 3.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2006, file reference 1-5667, filed with the SEC on February 9, 2007).

4(a)(i)	—	Indenture, dated as of December 1, 1987, between Cabot Corporation and The First National Bank of Boston, Trustee (the “Indenture”) (incorporated herein by reference to Exhibit 4 of Amendment No. 1 to Cabot’s Registration Statement on Form S-3, Registration No. 33-18883, filed with the SEC on December 10, 1987).

4(a)(ii)	—	First Supplemental Indenture dated as of June 17, 1992, to the ~~requirements~~Indenture (incorporated by reference to Exhibit 4.3 of ~~Section~~Cabot’s Registration Statement on Form S-3, Registration Statement No. 33-48686, filed with the SEC on June 18, 1992).

4(a)(iii)	—	Second Supplemental Indenture, dated as of January 31, 1997, between Cabot Corporation and State Street Bank and Trust Company, Trustee (incorporated herein by reference to Exhibit 4 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1996, file reference 1-5667, filed with the SEC on February 14, 1997).

4(a)(iv)	—	Third Supplemental Indenture, dated as of November 20, 1998, between Cabot Corporation and State Street Bank and Trust Company, Trustee (incorporated herein by reference to Exhibit 4.1 of Cabot’s Current Report on Form 8-K, dated November 20, 1998, file reference 1-5667, filed with the SEC on November 20, 1998).

10(a)	—	Credit Agreement dated August 3, 2005 among Cabot Corporation, Bank of America, N.A., as Administrative Agent, Swing Line Lender, and L/C Issuer, Citibank, N.A., as Syndication Agent, and the other lenders party thereto (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005, file reference 1-5667, filed with the SEC on August 9, 2005).

10(b)(i)*	—	1996 Equity Incentive Plan (incorporated herein by reference to Exhibit 28 of Cabot’s Registration Statement on Form S-8, Registration No. 333-03683, filed with the SEC on May 14, 1996).

10(b)(ii)*	—	1999 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999, file reference 1-5667, filed with the SEC on May 17, 1999).

10(b)(iii)*	—	Amendments to Cabot Corporation 1996 and 1999 Equity Incentive Plans, dated May 12, 2000 (incorporated herein by reference to Exhibit 10 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000, file reference 1-5667, filed with the SEC on May 15, 2000).

10(b)(iv)*	—	Amendment to 1999 Equity Incentive Plan dated March 7, 2002 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002, file reference 1-5667, filed with the SEC on May 15, 2002).

10(b)(v)*	—	2006 Long-Term Incentive Plan (incorporated herein by reference to Appendix B of Cabot’s Proxy Statement on Schedule 14A relating to the 2006 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 30, 2006).

10(b)(vi)* — Non-Employee Directors’ Stock Compensation Plan (incorporated herein by reference to Appendix B of Cabot’s Proxy Statement on Schedule 14A relating to the 2006 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 30, 2006).
10(b)(vii)* — Cabot Corporation Short-Term Incentive Compensation Plan (incorporated herein by reference to Appendix C of Cabot’s Proxy Statement on Schedule 14A relating to the 2007 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 29, 2007).
10(c) — Note Purchase Agreement between John Hancock Mutual Life Insurance Company, State Street Bank and Trust Company, as trustee for the Cabot Corporation Employee Stock Ownership Plan, and Cabot Corporation, dated as of November 15, 1988 (incorporated by reference to Exhibit 10(c) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1988, file reference 1-5667, filed with the SEC on December 29, 1988).
10(d)(i)* — Supplemental Cash Balance Plan (incorporated herein by reference to Exhibit 10(e)(i) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(ii)* — Supplemental Cash Balance Plan, as amended and restated effective January 1, 2002 (incorporated herein by reference to Exhibit 10(d)(ii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
10(d)(iii)* — Supplemental Employee Stock Ownership Plan (incorporated herein by reference to Exhibit 10(e)(ii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(iv)* — Supplemental Retirement Incentive Savings Plan (incorporated herein by reference to Exhibit 10(e)(iii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(v)* — Supplemental Retirement Savings Plan, as amended and restated effective December 31, 2000 (incorporated herein by reference to Exhibit 10(d)(v) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
10(d)(vi)* — Cabot Corporation Deferred Compensation Plan dated January 1, 1995 (incorporated herein by reference to Exhibit 10(e)(v) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1995, file reference 1-5667, filed with the SEC on December 29, 1995).
10(d)(vii)* — Amendment 1997-I to Cabot Corporation Deferred Compensation Plan dated June 30, 1997 (incorporated herein by reference to Exhibit 10(d)(vi) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1997, file reference 1-5667, filed with the SEC on December 24, 1997).
10(d)(viii)*† — Cabot Corporation Amended and Restated Deferred Compensation Plan dated July 13, 2007.
10(d)(ix)* — Non-Employee Directors’ Stock Deferral Plan dated July 14, 2006 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006, file reference 1-5667, filed with the SEC on August 9, 2006).
10(e) — Group Annuity Contract No. GA-6121 between The Prudential Insurance Company of America and State Street Bank and Trust Company, dated June 28, 1991 (incorporated herein by reference to Exhibit 10(h) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1991, file reference 1-5667, filed with the SEC on December 27, 1991).

10(f)* — Summary of Compensation for Non-Employee Directors (incorporated herein by reference to Exhibit 10(f) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2006, file reference 1-5667, filed with the SEC on December 14, 2006).
10(g) — Asset Transfer Agreement, dated as of June 13, 1995, among Cabot Safety Corporation, Cabot Canada Ltd., Cabot Safety Limited, Cabot Corporation, Cabot Safety Holdings Corporation and Cabot Safety Acquisition Corporation (incorporated herein by reference to Exhibit 2(a) of Cabot Corporation’s Current Report on Form 8-K dated July 11, 1995, file reference 1-5667, filed with the SEC July 26, 1995).
10(h)(i)* — Cabot Corporation Senior Management Severance Protection Plan, effective January 9, 1998 (incorporated herein by reference to Exhibit 10(a) of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1997, file reference 1-5667, filed with the SEC February 17, 1998).
10(h)(ii)* — Amendment to Cabot Corporation Senior Management Severance Protection Plan, effective January 12, 2007 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2006, file reference 1-5667, filed with the SEC on February 9, 2007).
10(i) — Fiscal Agency Agreement dated as of September 24, 2003 among Cabot Finance B.V., Cabot Corporation, and U.S. Bank Trust National Association (incorporated herein by reference to Exhibit 10(l) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
12† — Statement Re: Computation of Ratio of Earnings (Loss) to Fixed Charges.
21† — Subsidiaries of Cabot Corporation.
23(i)† — Consent of Deloitte & Touche LLP.
23(ii)† — Consent of PricewaterhouseCoopers LLP.
31(i)† — Certification of Principal Executive Officer required by Rule 13a-14(a) or ~~15(d)~~Rule 15d-14(a) of the ~~Securities~~ Exchange ~~Act~~Act.
31(ii)† — Certification of ~~1934, the Registrant has duly caused this Report to be signed on its behalf~~Principal Financial Officer required by ~~the undersigned, thereunto duly authorized.~~
~~CABOT CORPORATION~~
~~By:~~
~~/s/ KENNETT F. BURNES~~
~~Kennett F. Burnes~~
~~Chairman of the Board, President~~
~~and Chief Executive Officer~~
~~Date: December 14, 2006~~
~~Pursuant to the requirements~~Rule 13a-14(a) or Rule 15d-14(a) of the ~~Securities~~ Exchange ~~Act of 1934, this report has been signed below by the following persons on behalf~~Act.
32† — Certifications of the ~~Registrant~~Principal Executive Officer and ~~in the capacities and on the dates indicated.~~
Principal Financial Officer pursuant to 18 U.S.C. Section 1350.
*
~~Signatures~~
~~Title~~
~~Date~~
~~/s/ KENNETT F. BURNES~~
~~Director, Chairman of the Board, President~~
~~December 14, 2006~~
~~Kennett F. Burnes~~
~~and Chief Executive Officer~~
~~/s/ JONATHAN~~ p~~. MASON~~
~~Executive Vice President and Chief Financial~~
~~December 14, 2006~~
~~Jonathan P. Mason~~
~~Officer (principal financial officer)~~
~~/s/ JAMES P. KELLY~~
~~Controller~~
~~December 14, 2006~~
~~James P. Kelly~~
~~(principal accounting officer)~~
~~/s/ DIRK L. BLEVI~~
~~Director and Executive Vice President~~
~~December 14, 2006~~
~~Dirk L. Blevi~~
~~/s/ JOHN S. CLARKESON~~
~~Director~~
~~December 14, 2006~~
~~John S. Clarkeson~~
~~/s/ JUAN ENRIQUEZ-CABOT~~
~~Director~~
~~December 14, 2006~~
~~Juan Enriquez-Cabot~~
~~/s/ ARTHUR L. GOLDSTEIN~~
~~Director~~
~~December 14, 2006~~
~~Arthur L. Goldstein~~
~~/s/ GAUTAM S. KAJI~~
~~Director~~
~~December 14, 2006~~
~~Gautam S. Kaji~~
~~/s/ RODERICK C.G. MACLEOD~~
~~Director~~
~~December 14, 2006~~
~~Roderick C.G. MacLeod~~
~~/s/ JOHN H. MCARTHUR~~
~~Director~~
~~December 14, 2006~~
~~John H. McArthur~~
~~/s/ HENRY F. MCCANCE~~
~~Director~~
~~December 14, 2006~~
~~Henry F. McCance~~

~~Signatures~~
~~Title~~
~~Date~~
~~/s/ JOHN F. O’BRIEN~~
~~Director~~
~~December 14, 2006~~
~~John F. O’Brien~~
~~/s/ RONALDO H. SCHMITZ~~
~~Director~~
~~December 14, 2006~~
~~Ronaldo H. Schmitz~~
~~/s/ LYDIA W. THOMAS~~
~~Director~~
~~December 14, 2006~~
~~Lydia W. Thomas~~
~~/s/ MARK S. WRIGHTON~~
~~Director~~
~~December 14, 2006~~
~~Mark S. Wrighton~~
~~/s/ SHENGMAN ZHANG~~
~~Director~~
~~December 14, 2006~~
~~Shengman Zhang~~

~~EXHIBIT INDEX~~
~~Exhibit~~
~~Number~~
~~Description~~
~~3(a)~~
—
Certificate of Incorporation of Cabot Corporation restated effective October 24, 1983, as amended (incorporated herein by reference to Exhibit 3.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2005, file reference 1-5667, filed with the SEC on February 9, 2006).
~~3(b)~~
—
The By-laws of Cabot Corporation as of January 11, 1991 (incorporated herein by reference to Exhibit 3(b) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1991, file reference 1-5667, filed with the SEC on December 27, 1991).
~~4(a)(i)~~
—
Indenture, dated as of December 1, 1987, between Cabot Corporation and The First National Bank of Boston, Trustee (the “Indenture”) (incorporated herein by reference to Exhibit 4 of Amendment No. 1 to Cabot’s Registration Statement on Form S-3, Registration No. 33-18883, filed with the SEC on December 10, 1987).
~~4(a)(ii)~~
—
First Supplemental Indenture dated as of June 17, 1992, to the Indenture (incorporated by reference to Exhibit 4.3 of Cabot’s Registration Statement on Form S-3, Registration Statement No. 33-48686, filed with the SEC on June 18, 1992).
~~4(a)(iii)~~
—
Second Supplemental Indenture, dated as of January 31, 1997, between Cabot Corporation and State Street Bank and Trust Company, Trustee (incorporated herein by reference to Exhibit 4 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1996, file reference 1-5667, filed with the SEC on February 14, 1997).
~~4(a)(iv)~~
—
Third Supplemental Indenture, dated as of November 20, 1998, between Cabot Corporation and State Street Bank and Trust Company, Trustee (incorporated herein by reference to Exhibit 4.1 of Cabot’s Current Report on Form 8-K, dated November 20, 1998, file reference 1-5667, filed with the SEC on November 20, 1998).
~~10(a)~~
—
Credit Agreement dated August 3, 2005 among Cabot Corporation, Bank of America, N.A., as Administrative Agent, Swing Line Lender, and L/C Issuer, Citibank, N.A., as Syndication Agent, and the other lenders party thereto (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005, file reference 1-5667, filed with the SEC on August 9, 2005).
10(b)(i)*
—
~~1996 Equity Incentive Plan (incorporated herein by reference to Exhibit 28 of Cabot’s Registration Statement on Form S-8, Registration No. 333-03683, filed with the SEC on May 14, 1996).~~
10(b)(ii)*
—
1999 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999, file reference 1-5667, filed with the SEC on May 17, 1999).

10(b)(iii)*
—
Amendments to Cabot Corporation 1996 and 1999 Equity Incentive Plans, dated May 12, 2000 (incorporated herein by reference to Exhibit 10 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000, file reference 1-5667, filed with the SEC on May 15, 2000).
10(b)(iv)*
—
Amendment to 1999 Equity Incentive Plan dated March 7, 2002 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended March 30, 2002, file reference 1-5667, filed with the SEC on May 15, 2002).
10(b)(v)*
—
2006 Long-Term Incentive Plan (incorporated herein by reference to Appendix B of Cabot’s Proxy Statement on Schedule 14A relating to the 2006 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 30, 2006).
10(b)(vi)*
—
Non-Employee Directors’ Stock Compensation Plan (incorporated herein by reference to Appendix B of Cabot’s Proxy Statement on Schedule 14A relating to the 2006 Annual Meeting of Stockholders, file reference 1-5667, filed with the SEC on January 30, 2006).
~~10(c)~~
—
Note Purchase Agreement between John Hancock Mutual Life Insurance Company, State Street Bank and Trust Company, as trustee for the Cabot Corporation Employee Stock Ownership Plan, and Cabot Corporation, dated as of November 15, 1988 (incorporated by reference to Exhibit 10(c) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1988, file reference 1-5667, filed with the SEC on December 29, 1988).
10(d)(i)*
—
Supplemental Cash Balance Plan (incorporated herein by reference to Exhibit 10(e)(i) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(ii)*
—
Supplemental Cash Balance Plan, as amended and restated effective January 1, 2002 (incorporated herein by reference to Exhibit 10(d)(ii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
10(d)(iii)*
—
Supplemental Employee Stock Ownership Plan (incorporated herein by reference to Exhibit 10(e)(ii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(iv)*
—
Supplemental Retirement Incentive Savings Plan (incorporated herein by reference to Exhibit 10(e)(iii) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1994, file reference 1-5667, filed with the SEC on December 22, 1994).
10(d)(v)*
—
Supplemental Retirement Savings Plan, as amended and restated effective December 31, 2000 (incorporated herein by reference to Exhibit 10(d)(v) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).

10(d)(vi)*
—
Cabot Corporation Deferred Compensation Plan dated January 1, 1995 (incorporated herein by reference to Exhibit 10(e)(v) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1995, file reference 1-5667, filed with the SEC on December 29, 1995).
10(d)(vii)*
—
Amendment 1997-I to Cabot Corporation Deferred Compensation Plan dated June 30, 1997 (incorporated herein by reference to Exhibit 10(d)(vi) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1997, file reference 1-5667, filed with the SEC on December 24, 1997).
~~10(d)(viii)*†~~
—
~~Cabot Corporation Amended and Restated Deferred Compensation Plan dated September 8, 2006.~~
10(d)(ix)*
—
Non-Employee Directors’ Stock Deferral Plan dated July 14, 2006 (incorporated herein by reference to Exhibit 10.1 of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006, file reference 1-5667, filed with the SEC on August 9, 2006).
~~10(e)~~
—
Group Annuity Contract No. GA-6121 between The Prudential Insurance Company of America and State Street Bank and Trust Company, dated June 28, 1991 (incorporated herein by reference to Exhibit 10(h) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 1991, file reference 1-5667, filed with the SEC on December 27, 1991).
~~10(f)* †~~
—
~~Summary of Compensation for Non-Employee Directors.~~
~~10(g)~~
—
Asset Transfer Agreement, dated as of June 13, 1995, among Cabot Safety Corporation, Cabot Canada Ltd., Cabot Safety Limited, Cabot Corporation, Cabot Safety Holdings Corporation and Cabot Safety Acquisition Corporation (incorporated herein by reference to Exhibit 2(a) of Cabot Corporation’s Current Report on Form 8-K dated July 11, 1995, file reference 1-5667, filed with the SEC July 26, 1995).
10(h)*
—
Cabot Corporation Senior Management Severance Protection Plan, effective January 9, 1998 (incorporated herein by reference to Exhibit 10(a) of Cabot’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1997, file reference 1-5667, filed with the SEC February 17, 1998).
~~10(i)~~
—
Fiscal Agency Agreement dated as of September 24, 2003 among Cabot Finance B.V., Cabot Corporation, and U.S. Bank Trust National Association (incorporated herein by reference to Exhibit 10(l) of Cabot’s Annual Report on Form 10-K for the year ended September 30, 2003, file reference 1-5667, filed with the SEC on December 23, 2003).
~~12†~~
—
~~Statement Re: Computation of Ratio of Earnings (Loss) to Fixed Charges.~~
~~21†~~
—
~~Subsidiaries of Cabot Corporation.~~
~~23†~~
—
~~Consent of PricewaterhouseCoopers LLP.~~
~~31(i)†~~
—
~~Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.~~

~~31(ii)†~~
—
~~Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.~~
~~32†~~
—
~~Certifications of the Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350.~~
*Management contract or compensatory plan or arrangement.
† Filed herewith.

120

~~130~~

~~Delaware~~		~~04-2271897~~
Delaware		04-2271897
(State or other jurisdiction of		~~(I.R.S. Employer~~
incorporation or organization)		(I.R.S. Employer Identification No.)

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


Title of Each Class		Name of Each Exchange on Which Registered
Common stock, $1.00 par value per share		~~Boston Stock Exchange~~
		New York Stock Exchange



PART I

ITEM 1.1.	Business	1 3

ITEM 1A.	Risk Factors	13 14

ITEM 1B.	Unresolved Staff Comments	17 19

ITEM 2.2.	Properties	18 19

ITEM 3.	Legal Proceedings	20

ITEM 4.	Submission of Matters to a Vote of Security Holders	25

PART II

~~PART II~~
ITEM 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	27 26

ITEM 6.	Selected Financial Data	28

ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

ITEM 7A.	Quantitative and Qualitative Disclosures About Market Risk	55 50

ITEM 8.	Financial Statements and Supplementary Data	57 53

ITEM 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	~~117~~ 109

ITEM 9A.	Controls and Procedures	~~117~~ 109

ITEM 9B.	Other Information	~~118~~ 111

PART III

~~PART III~~
ITEM 10.	Directors, ~~and~~ Executive Officers ~~of the Registrant~~and Corporate Governance	~~119~~ 112

ITEM 11.	Executive Compensation	~~119~~ 112

ITEM 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	~~119~~ 112

ITEM 13.	Certain Relationships and Related Transactions, and Director Independence	~~119~~ 112

ITEM 14.	Principal Accounting Fees and Services	~~119~~ 112

PART IV

~~PART IV~~
ITEM 15.	Exhibits, ~~and~~ Financial Statement Schedules	~~120~~ 113

Signatures		~~125~~ 116

Exhibit Index			118


Location		Percentage Interest
Shanghai, China		70% (consolidated subsidiary)
Tianjin, China (rubber blacks)		70% (consolidated subsidiary)
Tianjin, China (performance products)		90% (consolidated subsidiary)
Valasske Mezirici (Valmez), Czech Republic		52% (consolidated subsidiary)
Thane, India		97.7% (consolidated subsidiary)
Cilegon and Merak, Indonesia		84.8% (consolidated subsidiary)
Port Dickson, Malaysia		49% (equity affiliate)
Tampico, Mexico		40% (equity affiliate)
Valencia, Venezuela		47.5% (equity affiliate)


Location		Percentage Interest
Jiangxi Province, China		90% (consolidated subsidiary)
Mettur Dam, India		50% (equity affiliate)

	Years Ended September 30
	2006		2005		2004
	(In millions)
Rubber blacks	$	1,378	$	976	$	863
Performance products	488		469		427
Inkjet colorants	47		39		31
CSMP	4		6		4
Total Carbon Black Business Sales	$	1,917	$	1,490	$	1,325


Period	Total Number of Shares Purchased	Average Price Paid per Share⁽¹⁾		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs⁽¹⁾	Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs⁽¹⁾
July 1, 2007—July 31, 2007	1,074,889	$	46.09	1,074,889	3,455,732
August 1, 2007—August 31, 2007	1,957,604	$	38.74	1,944,104	1,511,628
September 1, 2007—September 30, 2007	1,024,198	$	38.17	1,018,998	5,492,630

Total	4,056,691			4,037,991

	2006 vs. 2005				2005 vs. 2004
	(Dollars in millions)
Raw Material Costs		$	(284	)		$	(70	)
Selling Prices		210				33
Fixed Costs		28				—
Volumes		18				62
Acquisition of Cabot Japan		12				—
Selling, Technical and Administrative Costs		10				(12		)
Foreign Currency Translation Adjustments		1				4
Inventory Change and Other Inventory Charges		(1		)		(53		)

	Payments Due by Fiscal Year
	2007		2008		2009		2010		2011		Thereafter			Total
	(Dollars in millions)
Contractual Obligations
Purchase commitments	$	227	$	235	$	132	$	96	$	94		$	700	$	1,484
Long-term debt(1)	34		12		46		90		38			273		493
Fixed interest on long-term debt	26		24		23		20		18			56		167
Operating leases	20		12		10		10		7			36		95
Total	$	307	$	283	$	211	$	216	$	157		$	1,065	$	2,239

	U.S.		Foreign				Total
	(Dollars in millions)
Fair value of plan assets at September 30, 2006	$	135		$	181		$	316
Projected benefit obligation at September 30, 2006	$	131		$	233		$	364
Funded status at September 30, 2006	$	4		$	(52	)	$	(48	)


	December		March		June		September
Fiscal 2007
Cash dividends per share	$	0.18	$	0.18	$	0.18	$	0.18
Price range of common stock:
High	$	43.94	$	48.50	$	49.87	$	49.14
Low	$	36.54	$	43.00	$	43.11	$	34.48

Fiscal 2006
Cash dividends per share	$	0.16	$	0.16	$	0.16	$	0.16
Price range of common stock:
High	$	36.88	$	39.50	$	36.55	$	37.34
Low	$	30.42	$	33.26	$	31.48	$	30.50

Options
Outstanding

Vested
Options

Aggregate Intrinsic Value (dollars in millions)

Weighted Average Remaining Contractual Term (in years)