I. Critical Accounting Policies and Estimates

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 results could have a material impact on the consolidated financial statements. On an ongoing basis, we evaluate our policies and estimates. We base our estimates on historical experience, current conditions and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The estimates that we believe are critical to the preparation of the Consolidated Financial Statements as of March 31, 2009 and for the three months then ended are presented below. We have other critical accounting policies that are discussed under the "Critical Accounting Policies" heading in management's discussion and analysis in our Fiscal 2008 Annual Report on Form 10-K ("2008 10-K").

Revenue Recognition and Accounts Receivable

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 collectability is probable. We generally are able to ensure that products meet customer specifications prior to shipment. If we are unable to determine that the product has met the specified objective criteria prior to shipment, the revenue is deferred until product acceptance has occurred.

The following table shows the relative size of the revenue recognized in each of our reportable segments. Other operating revenues, which are included in the percentages below, represent less than two percent of total revenues and include tolling, servicing and royalties for licensed technology:

                                     Three months ended      Six Months Ended
                                          March 31               March 31
                                      2009        2008       2009        2008
         Core Segment
         Rubber Blacks Business          60%         59%        62%         58%
         Supermetals Business             5%          7%         6%          8%
         Performance Segment             29%         30%        27%         30%
         New Business Segment             4%          2%         3%          2%
         Specialty Fluids Segment         2%          2%         2%          2%

As indicated above, we derive a substantial majority of revenues from the sale of products in our Rubber Blacks Business and Performance Segment. Revenue from these products is typically recognized when the product is shipped and title and risk of loss have passed to the customer. We offer certain customers cash discounts and volume rebates as sales incentives. The discounts and volume rebates are recorded as a reduction in sales at the time revenue is recognized and are estimated based on historical experience and contractual obligations. We periodically review the assumptions underlying the estimates of discounts and volume rebates and adjust revenues accordingly. Certain Rubber Blacks Business and Performance Segment customer contracts contain price protection clauses that provide for the potential reduction in past or future sales prices under specific circumstances. We analyze these contract provisions to determine if an obligation related to these clauses exists and record revenue net of any estimated protection commitments.

Supermetals' revenues also are generally recognized when the product is shipped and title and risk of loss have passed to the customer.

The majority of the revenue in the Specialty Fluids Business arises from the rental of cesium formate. This revenue is recognized throughout the rental period based on the contracted rental terms. Customers are also billed and revenue is recognized, typically at the end of the job, for cesium formate product that is not returned.

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.

We maintain allowances for doubtful accounts based on an assessment of the collectibility of specific customer accounts, the aging of accounts receivable and other economic information on both an historical and prospective basis. Customer account balances are charged against the allowance when it is probable the receivable will not be recovered. In the current economic environment there could be significant changes in the allowance due to events such as customer liquidity matters or customer bankruptcies. Such changes could impact our results of operations and cash flows. Changes in the allowance were not material to any period presented.

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 $111 million and $140 million higher as of March 31, 2009 and September 30, 2008, respectively. The cost of other U.S. and all non-U.S. inventories is determined using the average cost method or the FIFO method. In periods of rapidly rising or declining raw material costs, the inventory method we employ can have a significant impact on our profitability. Under our current LIFO method, when raw material costs are rising, our most recent higher priced purchases are the first to be charged to cost of sales. If, however, we were using a FIFO method, our purchases from earlier periods, which were at lower prices, would instead be the first charged to cost of sales.

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

We review inventory for potential obsolescence periodically. In this review, we make assumptions about the future demand for and market value of the inventory and based on these assumptions estimate the amount of any obsolete, unmarketable or slow moving inventory. We write down the value of these obsolete, unmarketable or slow moving inventories by an amount equal to the difference between the cost of the inventory and its estimated market value.

Goodwill

We account for goodwill and other intangible assets in accordance with FAS No. 142, "Goodwill and Other Intangible Assets," ("FAS 142"). 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 volumes, costs, future growth rates, capital expenditures and market conditions over an estimate of the remaining operating period at the reporting unit. The discount rate is based on the weighted average cost of capital that is determined by evaluating the risk-free rate of return, cost of debt and expected equity premiums. If an impairment exists, a loss to write down the value of goodwill to its implied fair value is recorded. While this would have no direct impact on our cash flows, it would reduce our earnings. We performed our annual impairment test as of March 31, 2009 and determined that no impairment existed.

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 that has not been designated with a fair value hedge. This portion of long-term debt is recorded at face value. The fair values of our derivative instruments are based on quoted market prices, if such prices are available. In situations where quoted market prices are not available, we rely on valuation models to derive fair value. Such valuation takes into account the ability of the financial counterparties to perform. We use derivative financial instruments primarily for purposes of hedging exposures to fluctuations in interest rates and foreign currency exchange rates, which exist as part of our on-going business operations. We do not enter into contracts for speculative purposes, nor do we hold or issue any financial instruments for trading purposes.

All derivatives are recognized on the consolidated balance sheets at fair value. The changes in the fair value of derivatives are recorded in either earnings or other comprehensive income, depending on whether or not the instrument is designated as part of a hedge transaction and, if designated as part of a hedge transaction, the type of hedge transaction. The gains or losses on derivative instruments reported in other comprehensive income are reclassified to earnings in the period in which earnings are affected by the underlying hedged item. The ineffective portion of all hedges is recognized in earnings.

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.

We carry a variety of different cash and cash equivalents on our consolidated balance sheets. We continually assess the liquidity of cash and cash equivalents and as of March 31, 2009, we have determined that they are readily convertible to cash.

Assets and liabilities measured at fair value are classified in the fair value hierarchy based on the inputs used for valuation. Assets that are traded on an exchange with a quoted price are classified as Level 1. Assets and liabilities that are valued based on quoted prices for similar assets or liabilities in active markets, or standard pricing models using observable inputs are classified as Level 2. As of March 31, 2009, we have no assets or liabilities that are valued using unobservable inputs and, therefore, no assets or liabilities that are classified as Level 3. The sensitivity of fair value estimates is immaterial relative to the assets and liabilities measured at fair value, as well as to our total equity, as of March 31, 2009.

Litigation and Contingencies

We are involved in litigation in the ordinary course of business, including personal injury and environmental litigation. After consultation with counsel, as appropriate, we accrue a liability for litigation when it is probable that a liability has been incurred and the amount can be reasonably estimated. The estimated reserves are recorded based on our best estimate of the liability associated with such matters or the low end of the estimated range of liability if we are unable to identify a better estimate within that range. Our best estimate is determined through the evaluation of various information, including claims, settlement offers, demands by government agencies, estimates performed by independent third parties, identification of other responsible parties and an assessment of their ability to contribute, and our prior experience. Litigation is highly uncertain and there is always the possibility of an unusual result in any particular case that may reduce our earnings and cash flows.

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

Our current estimate of the cost of our share of existing and future respirator liability claims is based on facts and circumstances existing at this time. Developments that could affect our estimate include, but are not limited to,
(i) significant changes in the number of future claims, (ii) changes in the rate of dismissals without payment of pending silica and non-malignant asbestos claims, (iii) significant changes in the average cost of resolving claims,
(iv) significant changes in the legal costs of defending these claims,
(v) changes in the nature of claims received, (vi) changes in the law and procedure applicable to these claims, (vii) the financial viability of other parties which contribute to the settlement of respirator claims, (viii) a change in the availability of insurance coverage maintained by the entity from which we acquired the safety respiration products business, (ix) changes in the allocation of costs among the various parties paying legal and settlement costs and (x) a determination that our interpretation of the contractual obligations on which we have estimated our share of liability is inaccurate. We cannot determine the impact of these potential developments on our current estimate of our share of liability for these existing and future claims. Accordingly, the actual amount of these liabilities for existing and future claims could be different than the reserved amount. Further, if the timing of our actual payments made for respirator claims differs significantly from our estimated payment schedule, and we could no longer reasonably predict the timing of such payments, we could then be required to record the reserve amount on an undiscounted basis on our consolidated balance sheets, causing an immediate impact to earnings.

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 which make the ultimate tax determination uncertain. Furthermore, our tax positions are periodically subject to challenge by taxing authorities throughout the world. We have recorded reserves for taxes and associated interest and penalties that may become payable in future years as a result of audits by tax authorities. Any significant impact as a result of changes in underlying facts, law, tax rates, tax audit, or review could lead to adjustments to our income tax expense, our effective tax rate, and/or our cash flow.

We record our tax (benefit) provision on an interim basis using the estimated annual effective tax rate. This rate is applied to the current period ordinary income or loss to determine the income tax provision or benefit allocated to the interim period. Losses from jurisdictions for which no benefit can be realized and the income tax effects of unusual and infrequent items are excluded from the estimated annual effective tax rate. Valuation allowances are provided against the future tax benefits that arise from the losses in jurisdictions for which no benefit can be realized. In addition, the effects of the unusual and infrequent items are recognized in the impacted interim period as discrete items. The estimated annual effective tax rate may be significantly impacted by nondeductible expenses and our projected earnings mix by tax jurisdiction. Adjustments to the estimated annual effective income tax rate are recognized in the period that such estimates are revised.

Additionally, we have established valuation allowances against a variety of deferred tax assets, including net operating loss carry-forwards, foreign tax credits, and other income tax credits. Valuation allowances take into consideration our ability to use these deferred tax assets and reduce the value of such items to the amount that is deemed more likely than not to be recoverable. Our ability to utilize these deferred tax assets is dependent on achieving our forecast of future taxable operating income over an extended period of time. We review our forecast in relation to actual results and expected trends on a quarterly basis. Failure to achieve our operating income targets may change our assessment regarding the recoverability of our net deferred tax assets and such change could result in a valuation allowance being recorded against some or all of our net deferred tax assets. An increase in a valuation allowance would result in additional income tax expense, 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 (i) severance and other employee benefits to be granted to employees, which are based on known benefit formulas and identified job grades, (ii) costs to vacate certain facilities and (iii) asset impairments. Because these accruals are estimates, they are subject to change as a result of deviations from initial restructuring plans or subsequent information that may come to our attention. These deviations may lead to changes in estimates, which would then be reflected in our consolidated financial statements.

II. Results of Operations

Overview

In the second quarter and first six months of fiscal 2009, operating results decreased compared to the same periods of fiscal 2008. Ongoing global weakness in the tire, automotive, construction and electronics markets led to significantly lower volumes in our key businesses. In the second quarter of fiscal 2009, performance was also unfavorably affected by $42 million from compressed unit margins in our carbon black related businesses as prices have declined as a result of lower commodity costs and difficult market conditions while weak demand has resulted in older, higher cost inventories being reflected in our results. These factors more than offset lower operating expenses from cost reduction activities, improved performance in our New Business Segment, a $9 million favorable impact from the time lag of pricing adjustments in our Rubber Blacks Business contracts and a $9 million benefit in our Rubber Blacks and Performance Products Businesses from our LIFO accounting methodology.

• During the second quarter of fiscal 2009, volumes in our Rubber Blacks Business decreased by 28% due to weakness in the tire and automotive markets. Compressed unit margins in the business unfavorably affected results by $31 million, more than offsetting contract lag and LIFO benefits and the effect of lower operating expenses.

• In the Supermetals Business, second quarter fiscal 2009 volumes decreased significantly due to weakness in the electronics industry, which more than offset the benefits of higher selling prices and a favorable product mix. During the quarter, we announced our intention to suspend tantalum mining and processing activities at our operations in Manitoba, Canada due to global market conditions for tantalum.

• In the Performance Segment, volumes in the second quarter of fiscal 2009 decreased by 36% in Performance Products and by 44% in Fumed Metal Oxides due to weakness in the automotive, construction and electronics industries. Compressed unit margins in Performance Products unfavorably affected results by $11 million, more than offsetting a $6 million LIFO benefit and the positive effect of lower operating expenses from cost reduction efforts.

• Profitability in the Specialty Fluids Segment declined slightly in the second quarter of fiscal 2009 due to a slowdown of drilling activity in the North Sea that more than offset revenues from regions outside the North Sea and lower operating costs.

• Increased revenues and lower costs in the New Business segment led to improved performance.

• During the first six months of fiscal 2009, our cash flow from operations was $287 million and we reduced working capital by $294 million.

• The restructuring of our operations that we announced in January 2009 is proceeding as anticipated and is expected to result in fixed cost savings of at least $80 million in fiscal 2010.

Second Quarter and First Six Months Fiscal 2009 versus Second Quarter and First Six Months Fiscal 2008-Consolidated

Net Sales and Gross Profit



                                              Three months ended         Six months ended
                                                   March 31                  March 31
                                             2009            2008         2009       2008
                                                        (Dollars in millions)
  Net sales and other operating revenues   $     470       $     786   $    1,122   $ 1,497
  Gross profit                             $      (5 )     $     118   $       87   $   234

The $316 million decrease in net sales from the second quarter of fiscal 2008 to the second quarter of fiscal 2009 was due primarily to lower volumes ($261 million) from ongoing weakness in the tire, automotive, construction and electronics markets, the impact of lower selling prices ($39 million), principally in our carbon black related businesses, and the unfavorable effect of foreign currency translation ($26 million). For the first six months of fiscal 2009, the $375 million decrease in sales when compared to the first six months of fiscal 2008 was principally due to lower volumes ($508 million) from global weakness in our key end markets and the unfavorable impact of foreign currency translation ($34 million), partially offset by higher selling prices ($138 million).

Gross profit decreased by $123 million in the second quarter of fiscal 2009, when compared to the second quarter of fiscal 2008, due principally to lower volumes from weakness in the tire, automotive, construction and electronics markets and lower unit margins as older, higher cost inventories affected our results. These factors offset the benefit of lower operating expenses from cost reduction actions, contract lag and LIFO benefits (as described below) in our Rubber Blacks and Performance Products Businesses and improvement in the performance of our New Business Segment. For the first six months of fiscal 2009, the $147 million decline in gross profit when compared to the first six months of fiscal 2008 was principally due to lower volumes from the global weakness in our end markets, partially offset by contract lag and LIFO benefits in our carbon black related businesses and lower operating expenses.

During the second quarter and first six months of fiscal 2009 we recorded $40 million and $41 million, respectively, of pre-tax restructuring related charges as cost of sales in our consolidated statement of operations. In the second quarter and first six months of fiscal 2008, we recorded restructuring related charges of $8 million and restructuring related income of $3 million, respectively. In the first six months of fiscal 2008, the benefit included an $18 million pre-tax benefit from the sale of land at our former carbon black facility in Altona, Australia.

Selling and Administrative Expenses



                                           Three months ended          Six months ended
                                                March 31                   March 31
                                           2009           2008        2009         2008
                                                      (Dollars in millions)

Selling and administrative expenses decreased by $12 million and $13 million in the second quarter and first six months of fiscal 2009, respectively, when compared to the same periods in fiscal 2008. Lower expenses from cost reduction efforts were the principal driver of the decrease.

We recorded $4 million and $5 million of pre-tax charges, principally related to restructuring activities, as selling and administrative expenses in the second quarter and first six months of fiscal 2009, respectively. In the same periods of 2008, we recorded $4 million and $5 million, respectively, of pre-tax charges, principally related to CEO transition costs, in our consolidated statement of operations as selling and administrative expenses.

Research and Technical Expenses



                                          Three months ended         Six months ended
                                               March 31                  March 31