Cabot Corp (CBT) 2003 Q3 法說會逐字稿

Good day and welcome to the Cabot Corporation third quarter earnings conference call.

This call is being recorded.

At this time I would like to turn the call over to the Chairman, President, and Chief Executive Officer, Mr. Kennett Burnes.

Please go ahead, sir.

Thank you, operator.

Good morning.

This is Ken Burnes, Chairman and CEO of Cabot Corporation.

I would like to welcome you all to the Cabot Corporation third quarter earnings teleconference.

With me here on the phone this morning are John Shaw, our Chief Financial Officer, Eddie Cordeiro , Jim Kelly, our Director of Investor Relations, Bill Brady, Dave Elliott (ph), Dennis Fink (ph), Greg Landis (ph), CFO of our carbon black division and Brian Berube General Counsel.

Before I comment on the quarter's results, I will remind you that our conversation today will include forward-looking statements which are subject to risks and uncertainties, including those discussed in our 2002 form 10K filing, a copy of which is available on our website, www.Cabot-corp.com.

Last night we released earnings for the third fiscal quarter along with related supplemental business information.

A copy of the press release and the supplemental business information is posted in the investor relations section of our website.

For those of you on our mailing list you'll receive these either by fax or e-mail.

If you are not on our mailing list and are interested in receiving this information in the future, please contact either our website or our investor relations department.

Before I begin to discuss the financial results of the quarter I'd like to inform you some recent management changes which have taken place.

Bill Brady has been appointed the general manager of the carbon black business, replacing Bill Noglows, who decided to leave Cabot to pursue other opportunities.

Eddie Cordeiro, formerly the Controller, has been asked to replace Bill Brady as the general manager of our fume metal oxide division.

Dave Elliott, formerly our director of internal audits has been appointed to corporate controller.

Jim Kelly, who you've worked with as our investor relations man, is taking over the internal audit function, and Dennis Fink, formerly finance director for North America, has been appointed treasurer, assuming investor relations under that role.

The transitions to these new roles have already begun and are taking place, and will continue over the next several months.

As you may have noticed in the press release last night, we have elected to change the presentation of our income statement by removing the lines called special items.

In the past, these special items had been designated by the company as unusual items that we would not expect to recur.

We have eliminated the use of special items to comply with the SEC's regulation G. As such, we have tried to increase our disclosure on certain items.

I personally find this new disclosure to be quite confusing, and we are happy to answer any questions that you may have in order to help clarify the numbers.

I find it especially confusing this quarter due to the number of unusual items that we have reported.

I will now provide a short overview of the results of the quarter and will then open the line for questions.

Last night the company reported a 3rd quarter loss per share of 7 cents compared to 28 cents of earnings per share for the same period last year.

These amounts included charges for certain items of 49 cents per share in the current quarter.

I will discuss these more fully later.

Despite an increase in segment profit, which used to be referred to as operating profit, from $36 million last year to $43 million this year, the continuation of the weak economic environment as well as the high oil and especially gas prices in carbon black are making this a very difficult period for us.

The chemical businesses reported an increase in segment profit of $3 million from the third fiscal quarter of 2002 and $7 million sequentially.

The improvement compared to the third quarter of last year occurred both in carbon black and fume metal oxide.

In carbon black, it was primarily due to favorable foreign exchange, which more than compensated for lower volumes and lower margins.

Carbon black volumes in North America and Europe were considerably below third quarter 2002 levels, but this was partially offset by continued growth in South America, and particularly in Asia-Pacific.

Fume metal oxide volumes declined slightly compared to the prior year's quarter, but results improved due to the absence of several write-offs which were made in the prior year's quarter.

Currently we are seeing some slight improvements in fume metal oxide volumes in both the traditional silicones and electronics markets.

Cabot's tantalum business earned $14m in operating profits this quarter, which was $4 million higher than last year.

The results were driven by higher contract sales of both finished goods and intermediate products.

The tantalum results were down $23 million sequentially due to lower intermediate product sales and the timing of some contracted finish product shipments as well as the impact of low operating rates in the plants.

As most of you are aware, one of our customer requirement to purchase immediate materials expires at the end of this calendar year.

We expect to shift the final intermediate products under this contract in our current quarter after which we will be faced with a significant challenge of replacing the earnings on these sales.

Our expectation at this time is that our fiscal year 2004 results in the tantalum business will fall somewhat below the results the business achieved in fiscal 2002 unless we see a strong recovery in the electronics industry.

Although we are struggling with the carbon black and tantalum business at this time due to the current economic conditions, both businesses are fundamentally strong, solidly profitable, and are generating substantial cash.

Volumes in the ink jet colorants business grew by 42% but were offset by higher R&D costs and a higher costs associated with our new manufacturing facility in Averill, Mass.

The volumes grew both in OEM and after-market areas.

We are very pleased with the growth of this business and with its prospects for the long term.

The cesium formate business continues to experience low activity levels and incurred the same loss as the prior year quarter.

We were very happy to announce our letter of intent with Stat Oil several weeks ago and expect that we will begin work on these new wells during the current quarter.

Our aero gel business continues to make progress, commercial interest is strong, and we are refining the manufacturing process in our semi-works plant in Germany.

We continue to invest in this business, spending an incremental $3 million on its development compared to the prior year's quarter.

We announced the acquisition of Superior MicroPowders during the quarter.

I am excited about the possibilities that SMP, Superior MicroPowders, brings to Cabot, both in terms of new technology for areas that compliment our existing businesses as well as the possibilities in new, high-value added business areas such as electronic displays and fuel cells.

In addition, I am pleased to announce that we have just entered into a multi-year global contract with an additional major tire manufacturer.

In the past, we have had only regional, short-term supply agreements with this customer.

This contract, which is comparable in size to our other large multi-year contract in the tire business, provides for stable variable margins and significant and increasing volumes over the contract period.

The contract period is five years.

Not included in the third quarter earnings is the news that the company has recently signed an agreement, subject to various approvals, to sell its interest in Aero Corporation for approximately $33.5 million.

This transaction is expected to close during the fourth quarter.

This investment is currently on our books with a zero balance.

As indicated in the earnings release, we reported certain items and income from discontinued operations amounting to an expense of $46 million, or 49 cents per share during the quarter.

These items included $14 million related to the acquisition of SMP, which amount is included in our income statement under R & D expense. $17 million related to the previously announced closing of a carbon black plant in Europe and the creation of a shared service center for our European business, $9 million of which are in cost of goods sold, and $8 million of which are in selling and administration costs. $20 million to reflect our estimated share of liability with respect to existing and future respirator product liability product claims, arising from exposure to asbestos and other materials.

These costs are in selling and administration expense, and finally, $5 million of income related to insurance recoveries, $1 million from continuing operations recorded in selling and admin and $4 million from discontinued operations.

Regarding the reserve for respirator liabilities, as we have previously reported, Cabot and certain third parties and their insurers have product liability exposure in connection with a safety respirator products business that a subsidiary of Cabot acquired in 1990 and disposed of in 1995.

Since 2002, these parties have been in negotiation to allocate these liabilities among themselves.

However, as no agreement has yet been reached, we have been working with a leading expert to assist us in estimating our share of these liabilities.

Our current best estimate indicates that our share of these liabilities is approximately $20 million.

As further refinements to this estimate are made, the company may make adjustments to this reserve.

Our cash balance increased by approximately $48 million during the quarter, driven partly by improvements in working capital.

I'm further pleased to report that the Board of Directors authorized an increase in our quarterly dividend to 15 cents a share, and that during the third quarter, the company repurchased approximately 400,000 shares for approximately $12 million, leaving approximately 2.4 million shares left to repurchase under the current Board of Director authorization.

Overall, we remain very cautious with our business outlook, as we continue to struggle with today's uncertain economic environment.

In both carbon black and fume metal oxides, we are experiencing downward pricing pressure on our non-contracted business, which is making it very difficult to maintain our margins.

In the super-metals business, the electronics industries continues to work through high levels of inventory despite the apparent improvement in the electronic markets.

The super-metals business will also struggle to recover the profit from the diminished intermediate sales next fiscal year.

That being said, I remain encouraged with the developments of our new businesses.

Inkjet is performing very well in the market, and we are very excited with the Stat Oil relationship in our cesium formate business.

I am also confident that both our aero gels and Superior MicroPowders activities will be long-term contributors to the growth and the value of this company.

Just one final note, I'd just like to draw everybody's attention to the fact that over the next two weeks, all of the executive officers of the company will be buying stock of the company and reporting that in the SEC filings, these purchases are the annual purchases under our long-term incentive plan.

Let me repeat.

We will be buying stock, not selling stock.

With that short overview, I will conclude my comments and open the line for questions.

And turn it back over to you, Audra, if I could.

Thank you.

The question is answer session will be conducted electronically.

If you would like to ask a question, press star followed by 1 on your touch-tone telephone.

If you're using a speaker phone, make sure your mute function is turned off to allow you to reach our signal.

Once again, star 1 to ask a question.

First from John Roberts of Buckingham Research.

Morning, John.

Is there any more color you can provide on Bill Noglows departure?

I'm sure he didn't go to a dot com company like Don did a few years ago.

Is it the attractiveness of another opportunity or the weakness in your business you've gotten recently?

It's not the attractiveness of another opportunity, John.

Okay.

Because it seems very abrupt here.

It was -- it's less abrupt than it appeared, but it was disappointing to us.

Secondly, can you provide any guidance at all on how the earnings are going to change in the cesium business here as the Stat Oil contract phases in?

You reported that segment, so it's going to be pretty visible to us whether your costs go up first or whether the income goes up immediately, as you begin to drill those wells?

No, no, no, the costs are pretty much flat, actually.

Just so you'll understand, we have been operating the plant consistently over the last, at least, year at its full capacity and building inventory.

So the only costs related to the new business is a relatively small cost associated with having the drilling engineer on the platform when the material is being used.

So this will be incremental revenue, will be largely incremental profit.

We do hope -- we believe that they're currently in the process we're told, of moving the rig on to location, and our current estimate is that we will have our first activity, our first drilling activity during this quarter, hopefully the job will be completed this quarter so we can show the revenue, but we're pretty confident that that will be undergoing this quarter.

Going forward, John, you know, we expect this -- we're optimistic that this business will be, you know, a modest contributor to this year's profit.

I'm a little unclear precisely how much, but I would hope that it would be in the high single or in the high single digits of millions of dollars of profits this year, in 2004.

Yeah, you didn't mean the September quarter of '03?

No, I did not mean -- we do not expect -- we are in the process of completing two quite substantial jobs in that business, and we expect the business to perform better in the fourth quarter than it has in the recent quarters.

But the bulk of the Stat Oil work really will kick in during the -- during 2004.

They'll have one ring rig at work in the first quarter, and it looks today that they'll have two rigs drilling starting in January and going forward.

It's roughly $80 million over 20 wells, is that correct?

I think it may be 22, but I'm not sure.

Why only high single digits, then, if most of the revenue is incremental profit?

It's spread out over -- it ramps up over a period of time, and it's spread out over 3 to 4 years.

And, you know, the $80 million, remember, is the number that Stat Oil put out.

We didn't put a number out.

All right.

Okay.

And I want to remind you, and I think you're aware of this, John, that the actual revenue is a very unpredictable number because it depends upon the amount of time that the cesium formate actually is utilized.

It sits in the well.

Our experience in the past has been that it tends to get used for longer periods of times than we or our customers originally estimate.

So we're, know, we're going to go at this.

It's a big piece of business for us.

We believe that this is the breaking point, the inflexion point, for this business.

And we're excited about it.

Little unclear to us today precisely how those profits will evolve, but I think you're right.

We think you're going to start to see this business contributing in a reasonable way to the company's profits.

You went out of your way to report that the $80 million was a Stat Oil number and not yours.

Is there a significant difference between what they might report that they’re paying and what you might report as revenue, like Halliburton or something that would make it --

No, no, no difference there at all.

That number, though, is an estimate about how many barrels will be used for how long in each of the wells.

And that is an estimate that is, of course, very difficult to make.

We have, in the past, we have been -- we have been unable to reasonably estimate revenue, generally underestimating because of length of time.

They have a much better view of the size and the magnitude of these jobs than we do.

But our number was not inconsistent with theirs.

Then what is the actual contract for?

You know, they have to use your fluid in all 20 or 22 wells, irrespective of how long they use it or --

No, no, no, this is -- the way the oil industry works, in this situation, is that they give us what is sort of a letter of intent or contract that says, you know, we've decided that your fluid is the best to use in these applications, and assuming we drill these wells, we intend to use your fluid.

If, you know, we drill the first well and it performs terribly, that oil has the right to go use something else.

The history of the use of the fluid and the history of the oil industry is that these things generally take place, and they -- and they generate the kind of revenue we're talking about.

But it's not a formal contract the way our tantalum contracts or tire, rubber black contracts are.

You note we use the term "letter of intent," and this is just the way the oil industry does business.

Okay.

I'll get back and I’ll let somebody else ask the tantalum questions.

I'll get back into queue.

Moving on, Bob Goldberg with New Vernon Associates.

Morning, Bob.

Morning, Ken.

I'll ask the tantalum questions.

Can you help us understand the allocation of this intermediate contract for 2003?

You had a very heavy March quarter and then a lighter June quarter, and you're saying the contract will be completed in September.

Does that imply another heavy allocation in the current quarter?

It applies somewhat heavier allocation in the fourth quarter but not consistent with the second quarter.

Okay.

Right.

So the all else being equal, the results in the September quarter should be somewhere -- and it's a wide range, you could drive a truck through it, somewhere between the March quarter and the June quarter?

Somewhere between the March quarter and the June quarter.

That's right, I apologize for the obscurity of the numbers.

I'll take the opportunity of your asking the question, Bob, to point out and remind you that I have, in the past, committed to you all that I would try to provide some guidance about how this business is going to perform as it settles down.

We think with the termination or the completion of the intermediate product sales in this coming quarter, the business will be at a stable level in terms of predictability, at least insofar as the contracted volume and our costs are concerned.

And the range I gave you in my speaking notes is an effort to give you some sort of guidance about how we think this business will perform absent a significant recovery in the industry.

And I hope that's helpful.

That is helpful.

And just to follow up, Ken, I assume these intermediate products that you're selling to your customer are not being consumed at the moment.

Well, we have information that they have been being consumed, that one of our competitors has been tolling the K-tas, the immediate product and sending it back to the customer in terms of powder, and our information is a little bit murky here.

You know this is the customer that we remain in litigation with.

We believe that they're consuming that powder and that they're not building inventory.

Okay.

So the inventory, you're saying inventories are a bit high.

That's not what you're referring to?

Well, I guess I'd -- thank you for asking the question.

Let me clarify.

We believe that inventory is getting consumed.

We see signs that certain of our customers, it's not universal, but certain of our customers are buying some small increasing amounts outside the contract.

Some from us, surprisingly, particularly our Japanese venture, but also from our competitors.

So we're starting to see maybe a little climb off the bottom in this business.

They're starting, as you're probably aware, starting to see some signs that the overall electronics business is getting back to, say, calendar year 2000 level, which is encouraging.

Now, how dramatic the recovery will be, whether it goes back into overdrive, is, of course, something that none of us know, but we seem to be -- I would describe us as seeming to be off the bottom and some -- the inventory issue starting to recede from the picture.

Give us some sense of the operating rates at your Japanese business?

Below 50%.

In terms of overall capacity.

That's a little confusing, Bob, and I think we mentioned this earlier, but before we purchased the 50% of the joint venture, they had added a very significant increment of capacity.

Roughly 50%, or roughly two times.

So they're close to where they were in -- close to full capacity where they were during the height of the bubble.

But we still have substantial excess capacity in Japan that we have available to us.

Have spot prices moved at all for tantalum powder?

Forward?

I would say no.

But on the ore side, there was recently a sale that indicated a slight up tick.

Still what we regard very cheap.

We actually bid for a parcel that the government -- the DLA, the department of, you know, what's it called?

The Defense was selling and lost the bid because somebody outbid us.

Which we were, of course, disappointed about, at the other end, it was encouraging.

Because maybe people are seeing signs of a recovery coming.

Lastly, did you mention, Ken, that there was some timing shifting of contractual sales in the quarter?

Did that have a material impact?

Well, there was some.

A little bit, you know, volumes were low.

The volumes under the contracts are annual calendar commitments.

And we work -- as you can imagine, Bob, we work as hard as we can within the bounds of the contract to be friendly suppliers in an effort to put the pain of the last few years behind us and become favored suppliers with these customers again.

So we try to accommodate them to the extent that we can.

So you'll see -- have seen and will continue to see what I would describe as uneven volume throughout the calendar year.

So yes.

Long answer, but yes.

Thank you very much.

Thanks, Bob.

Next we'll move to Jay Harris with Goldsmith & Harris.

Morning, Ken.

Hi, Jay.

Coming back to this very confusing new accounting methodology, if I just take the negative 11 cents a share from continuing operations for the quarter just reported, and I add up the write offs and the charges to continuing operations less the $1 million of insurance going to continuing operations, I end up with $50 million of what we used to call special items.

And therefore it looked to me that the ongoing businesses were generating X non-repetitive charges, about 39 cents a share.

However, if I look at your analysis of going from the second quarter of '03 to the third quarter of '03, I end up with 36 or 37 cents a share.

What am I missing?

Well, I think there's -- I may have to turn this over to Eddie to get expert guidance here, Jay.

First of all, I think the number is 42 cents a share.

Well, but that includes the discontinued operations.

No, it shouldn't.

I apologize.

You know, listen, you hope you understand that we're struggling with this the same you are.

Well, I think it's a tribute to the clarity that the SEC is providing to this little old lady in Dubuque, Iowa.

Yeah, I think it's absolutely classic.

I shouldn't make any political comments.

The way I look at it, Jay, you know, our traditional operating earnings are 42 cents a share this quarter.

I think the gap between how you calculate it and 42 cents a share may have something to do with the tax rate, which is a complex issue.

Oh, because a tax rate get adjusted because of the charges?

Correct.

Yes.

Because you've lowered your, what, U.S. income -- U.S. source profits?

No, it has to do with the deductibility of some but not all of the charges.

Right.

Okay.

So we should use 42 cents.

Let me go on.

Incidentally, Jay and anybody, either Jim Kelly or Eddie is available after this call for -- to help anybody sort all of this out if you'd like.

When does Dennis take over?

When does who?

Dennis.

Dennis -- probably -- this is going to be a slower transition because we've got Dennis hard at work -- he comes out of our North American carbon black business.

It's going to be over in the next several months.

Okay.

So for this quarter and any questions you have about what we're talking about today --

Go to Jim.

Jim is here.

All right.

New tire global carbon black contract, prior to that, about 50% of your worldwide carbon black sales were covered by what I'd call margin protecting contracts, where does this drive that percentage?

Well, this is a confusing number.

Let me make sure that we all have the facts.

We have historically had one major tire company signed up to a long-term, stable margin contract with specified volumes, and then another tire company with a much shorter term contract and then other tire companies with annual contracts.

What we've done here today, what we've done here in the last couple of weeks is we have entered into with one of the other major tire companies, a contract for an extended period of time with stable margins, again, formula-adjusted margins, and at volumes that start at a little bit above what today's levels are and increase substantially over the period of time.

And what we believe it will do is that it will provide a very stable and strong underpinning for a significant portion of our global tire carbon black volumes.

This has been something we've been discussing with this company for a number of months.

We were very, very pleased to enter into the contract and, you know, establish this kind of relationship with another of the major tire companies, and we were pleased, of course, as you can imagine, that they were willing and anxious to base load their business with us as opposed to any of our competitors.

Well, maybe it's either -- it's my perception or misperception that up to now 50% of your carbon black revenues were covered by contracts which protected margins with lags, but regardless of whether they were annual or multiple year or global or domestic only.

How does that -- if that number is correct, if it's not correct, what was the number, and if it is correct, how does that number change with this new arrangement?

That number is -- you know, if you take all of the contracts and put them in place that we had in place at any one time, it was probably a reasonable number, but the term of the contracts was an issue for us.

And to a large extent, they were renegotiated every year.

This contract is in place for a five-year period.

No, but -- I understand that.

But in other words, it -- does this just replace some of the annual contracts?

To some extent, but more directly, particularly over time because we have growing volumes over times, it puts a larger percentage of the business in a stable margin position and a stable volume position.

Well, it's obviously a higher multiple arrangement.

A higher multiple?

Yeah, in other words, you're making the cash flow more predictable?

Yes.

It's -- for me, it base loads our big business at a profit level or a margin level that we believe is reasonable given all of the circumstances and lets us focus closely on the quality and cost of the business structure.

Going forward, will SMP generate losses, and if so, at what level?

It's a little unclear right now, Jay.

We have a number of situations.

Candidly, more and more significant than we had anticipated where we have the ability to generate revenue probably starting in the next three to six months that look like they have the potential to cover the ongoing operating costs of the business.

We're right now in the process of trying to decide whether we want to take advantage of those opportunities or whether we would be, you know, licensing the technology and certain applications at too low a price.

So it's a little early to tell.

I expect three months from now I'll be able to answer your question with a greater degree of specificity.

But certainly for the fourth quarter, it will be a slight drag?

Yeah.

It's a $0.5 million.

Okay.

You know, it's a $2 or $3 million a year, I would describe it.

But I'm pretty optimistic, give us six months, we'll be able to cover that and more.

What can you tell us about the level of duplicative expenses in inkjet colorants that you incurred in this recent quarter that will disappear when the qualifications process is completed on your new facilities?

Well, we actually had a long and sort of difficult conversation with the inkjet business a couple of days ago about that because we're trying to get them to get those costs out of the system as soon as they can.

It's in the range of $0.5 million to $1 million a year running rate.

We've been operating both a small facility where we did the -- did a lot of the production work, and we had a contractor at work with some of the chemical treatment.

Both of which looked like they're going to fall away here in the next three months.

But it's, you know, for that business, it's a significant percentage of its profitability, but it's not a huge dollar amount.

Well, with the revenues growing sequentially for the last few quarters at the rates that they have, and you're only running a $0.5 million to $1 million a year of -- we'll call it break-in expenses or phase out expenses, why hasn't the business generated profits?

Because we continue to spend an increasing amount in the R & D area in an attempt that I'm sure you're all aware of, an attempt to procure the next generation of pigment sales into the inkjet business.

And that appears to be coming to an inflexion point, I guess, is what I would describe here in the next three months, three or six months.

We've increased our R & D budget in the inkjet business quite substantially this year in an effort to fund the growth of that business.

You could -- one of the strategic alternatives we looked at is to take the development costs out, and the business becomes, again, solidly profitable, you know, with numbers that you'd see and would have an effect on our bottom line.

The question is, do you invest for the future?

Do you keep trying for the so-called golden ring in an effort to get the business to be a truly major contributor?

And that's the game we're playing today, and there's an inflection point coming with one of the major OEMs here in the next three to six months.

Will your development expenses, have they plateau-ed, and will they go down, or have they plateau-ed and will they stay this way for the next year or so?

I would expect that -- although I don't want to be held to this, but if I had to guess right now, the range of expenses going forward is roughly flat to lower.

That there is little likelihood that we'll spend a lot more in the business than we're spending today, but we could, you know, depending on what happens in the OEM segment, we could be spending that amount or spending a lot less.

Thank you, Ken.

Thank you, Jay.

Next we'll hear from Frank Donahue (ph) with Adage Capital (ph).

Jay just asked all the questions I wanted to ask.

Thanks.

Okay.

If you do find that your question has been answered, you can press the pound key to be removed from the queue.

And next we'll hear from Bill Dazzellen (ph) with Davidson Investment.

Thank you.

I had a couple of questions.

First of all, relative to the extended five-year carbon black contract, what are the volumes that you will be getting initially versus the current volumes you've been getting from the customer, and then what is the differential between future volumes anticipated versus current volumes?

I believe we start, the contract kicks in on January 1, 2004.

So we have another three or four months, five months before it starts.

We start next year with somewhat higher volumes than we will have with that customer this year.

And they will grow over the life of the contract to be close to two times where we are today.

I guess twice the volume is all right?

That's right.

Now, remember, that inevitably in the carbon black business, if we double our volumes with one customer, there are volume movements elsewhere.

And what impact this has on market share is yet to be determined.

Ken -- actually, I'm going to ask you to expand on that, whether you're talking about if you have additional share at a customer, whether competitors then start to behave differently away from that customer?

Absolutely.

If, you know, if over -- one of the reasons why this contract is structured so that it grows incrementally is an effort on the part of both of us the retired customer and ourselves to disrupt the market as little as possible.

But if we went in and took the volumes we're talking about in the first year, you know, it's coming out of another customer, one of our competitors, and they have no choice but to go try to take it away from us somewhere else.

So we've chosen, with the tire can companies to grow these volumes sequentially at what we think or hope is a level that could be equated to market growth in the industry, and therefore not be disruptive of the overall market structure.

Notwithstanding that issue, which is an issue you always have to deal with in a market like this, the good thing about this, of course, is that these are stable margin contracts.

So this chunk of our volume is at a stable margin, like the current long-term big contract.

Versus the contract you currently have with that customer, which is an annual contract, if I understood correctly, that margins are not necessarily stable there?

Well, over the period of time although, you know, annual contracts have been reasonable, they get renegotiated much more frequently because of the way the business works.

This is a completely different business arrangement.

And it is understood by both Cabot and the tire customer to be a fundamental change in the working relationship between the two of us, much more akin to the way we've been working with our other major tire company, the way we worked with Dow Corning in the silicone industry, the way we worked with Cabot Micro in the CMP business.

This is, as Bill you've been with us for a while, we think this is a much, much more effective way for industrial suppliers of commodity products to work together.

In that it allows us -- it will now allow us to focus on quality and shared cost reduction.

Okay.

Maybe you just answered my next question, which is I can understand how this benefits Cabot.

Why would the customer want to enter into a long-term arrangement?

Well, of course, it's an interesting question.

As you can imagine as we went through this, we've been struggling with or thinking about it at great length, trying to make sure that we were doing it at the right time and an appropriate margin.

I think it has to do, and this is supposition.

I think it has to do with some fundamental changes that may be taking place in the industry, and that is that if you look at the carbon black business, particularly in the tire segment over a 10 or 15-year period of time, we're seeing more carbon black move greater distances around the world.

I think you're aware that as one of our problems in Europe has been that we're seeing a lot of imports particularly from Russia and from Egypt.

We've seen a lot of carbon black move great distances in the Pacific region.

I think what may be going on here is that this tire company has chosen or decided that they want to preserve the ability to shop prices and quality for a portion of their business, but they also wanted to have a significant portion of their business base loaded at a predictable price, and with a quality of product and quality of suppliers that they know they can rely on.

I think that's it.

But I can't speak for them.

Thank you.

Let me shift to another area of carbon black quickly.

Natural gas prices were referenced as one of the problems in the carbon black business.

Would you please remind us what natural gas -- where it fits into the process and why the price of natural gas matters?

In most cases, although this is not universal, natural gas is used in the carbon black process as the -- to start the reaction, i.e., you have a natural gas flame into which you inject atomized, high-temperature feedstock or oil-based product.

So natural gas, and in some cases, we're pretty much beyond this, but in some cases natural gas is also used in a fire a dryer, where you dry the carbon black after you've palletized it with water.

So natural gas has always been a significant portion of our energy costs in the business.

We have some situations where we're able to use oil-based products rather than natural gas to fire the reactor, but that results in quality and logistical problems.

And historically, it's been cheaper to use natural gas than feedstock for what we call firing purposes.

Okay.

I thought that that was the case.

I just wanted to make sure that the tires and carbon black itself, that natural gas is not one of the inputs just as the crude oil is one of the actual inputs.

Yeah.

No, it's a utility instructor reaction is the best way to look at it.

And it's very often used as the heating fuel.

And Ken, I thought natural gas prices had been declining versus the first part of the year.

Is that just here more in the month of July that there's been a decline?

I was actually looking at some numbers this morning, Bill.

Yeah, they're still above $5.

Yes.

And history -- as you remember when we were in the LNG business we were dealing with $2, $2.25.

So they're, you know, a big chunk of our costs have more than doubled.

And one of the fundamental problems that I mentioned in my notes that I think we and many, many other people in the chemical industry is experiencing, with the market conditions the way they are and the pressure on pricing because of the conditions, our ability to pass that coupling in a utility cost through in terms of pricing is dramatically limited.

Now, the nice thing about these contracts is the contracts have an adjuster for natural gas and fuel oil.

So they get us into a stable, variable margin.

Let me shift to the capacitor business.

One of the things coming into this call that I was wondering is where you thought we were at in terms of the timing of the work down of the excess inventories at the capacitor manufacturers.

But given your comment earlier in the call that you are seeing some of the customers who are on contract actually buying product from you and away from you that's incremental to the contract, does that imply that inventories are near normal levels now and over the course of the last however many months or quarters have been worked down?

I think we're getting close.

The best -- you know, as you know, this is something we follow quite closely, you know, we read – Ken [inaudible] quarterly statements I'm sure the same way you do.

You know, it's not universal, but there's reason -- I would describe it as, you know, there's some optimism we're seeing the light at the end of the tunnel.

It's slower than we had hoped, and, you know, the business has been volatile, and it's, you know, as I mentioned, we don't anticipate it performing as it has next year.

I continue to -- every morning when I get up -- to thank the Lord for the contracts because they provide us a very stable underpinning in a time of great pain in the rest of the industry.

But I think we're coming -- I think we're starting to see the pickup -- the next pickup in the cycle.

Okay.

Now, the incremental purchases, are these product-specific?

What I'm trying to differentiate between here is generic inventory versus specific types of tantalum inventory required for specific types of capacitors.

I'm sure --

I'm sorry for the ignorance.

No, I'm sure that the purchases from us, particularly our Japanese thing, is for, I can't be 100% sure, but I suspect it's mostly for specific products, high-cap products that we have an advantage on and tie to a specific capacitor.

In the industry generally, I think you'll find some small increase in more generic powders.

As you know, we have been working very hard over a long period of time to move ourselves into what you describe as capacitor-specific powders and away from the generic powders to try to protect ourselves from the commoditization of the business.

Ken, let me -- not exaggerate here, but isn't this a little bit -- I mean, far more than a sliver of good news because we've been in an industry downturn and yet during the downturn, they were able to cut their inventories back to normal levels, the implication being that once we hit an upturn, that not only do you have to increase your volumes up to the consumption level of the downturn, but incrementally up to the consumption levels of the higher rates with the upturn?

I'd like to believe that, Bill.

But, you know, this period has been longer and more confusing than we anticipated.

The data we have -- and this is a very, very confusing industry with -- and it's very hard to get reliable data.

The data we have is that what I call the in-use volume of capacitors i.e., how many capacitors actually get used in your palm pilot or cell phone or computer or whatever.

You know, it certainly stopped growing, and it might have gone down 5 or 10%, but it never went down dramatically because, you know, we all continue to buy cell phones.

And what we are largely dealing with is an absence of growth against an industry that had over expanded its capacity.

Now, the theory that we have been operating under is that that is going to work its way through and that when we get back to normality, we'll be back to levels 2000, 2001 levels in terms of powder consumed, capacitors consumed.

And if that happens, you know, we will be operating, you know, much closer to -- at much higher capacity rates even with the pain between us and the customers in the contracts.

And yes, you could say that we're starting to see the crack, a little sliver of light under the door, how fast it takes place, how big it is, we don't know yet.

But the slope seems to be picking up a little bit for us, which is the first time we've felt that.

And then my final question, completely unrelated, the insurance recoveries, did you mention earlier in the call what those are all about?

No, I didn't.

But I'd love to just expand on that.

We have a bunch of -- two, actually very, very capable lawyers who work for us who set out three or four years ago to what I would describe as mining our old insurance policies, really related to the environmental issues we've had over the years.

And they, you know, go back and dig up the facts and look at the old insurance policies back as far as 20 years.

This latest issue brings this up over close to $25 million in total recoveries over the past few years, and the activities continue.

It doesn't, as you know, relate to our operating earnings, but it's a lot of cash, and it helps pay for, you know, $25 million, as you know, is more than the respirator reserve we've taken.

So from a cash and balance sheet standpoint, it's been a great activity for us, and we plan to continue.

To tell you a funny story, we have on our Board a gentleman who used to be the CEO of a major insurance company.

Every time we reported we'd done this again, he'd hang his head and say "You bastards."

Because it's great business, and the opportunities are there.

And I actually am not going to make that my last question, since you just mentioned the respirator, you took the reserve of $20 million.

When do you anticipate the cash to flow out the door?

I hope never, of course.

But over an extended period of time.

And I want to -- Bill, if I could, just comment.

Everybody needs to understand that, you know, estimating this liability is an extraordinarily complex issue, particularly today with the tendency of the Hatch bill in Congress and the -- what we believe is the increasing awareness of the whole nature of this issue and the efforts to somehow clean it up.

Our situation in particular is very, very complex and confusing because of the multiple parties, the multiple ownership, the short period of time that we owned this business, and the details and the specificities of the indemnity agreement.

This is -- and we've spent a lot of time and effort trying to pin this down.

We've worked on it for a long time.

We hope and believe that this is a conservative number, but one has to recognize in this area that, you know, you don't know.

But I would be -- I would be surprised if we paid out that amount of money in the next three to four years, probably even five.

In fact, I’ve said to the lawyers, I'm 60 years old, have five years to go.

I expect it to be, know, to still have a reserve by the time I retire.

Thank you.

And moving on, we'll take our next question from Jeff Zekauskas with JP Morgan.

Good morning, Jeff.

Good morning.

I have a couple of quick questions.

Just a question of clarification.

Did you say that you thought tantalum profits next year would be below fiscal 2002 levels?

I did.

And just for everybody's reference, I think this is all public, I think the number last year was $80 million.

Right. $70 million, whatever it is.

And we used the term "somewhat below," trying to tell you how far, and then we qualified that with the possibility of an economic recovery that Bill and I were just talking about.

Okay.

What was the tax rate on ongoing operations in the quarter?

And can you talk about your tax rate for this year and next year?

I'm going to turn that over to Eddie if I could, Jeff.

The tax rate on I think what you are thinking about is approximately in the 20% to 22% range.

No, for this quarter.

For this quarter.

It can't be in the range.

It has to be whatever the tax rate is ongoing operations, right?

Well, it was brought -- it is clear, we are driving towards the tax rate of 23% for the year.

Right.

We have been running at a rate of 25% in the first two quarters.

Right.

So I believe the number was -- I'm going to say 20%.

But I'm not 100% sure.

We'll get that clarified and have Jim call you.

Okay.

You'll have to round it off a few, you know.

I guess sort of a last question is was there something surprising that happened in tantalum this quarter, or did -- that is, did you know something that you didn't know previously?

No.

And I apologized before, and I hope this is behind me.

The intermediate product sales and the timing of shipments under the contract are something we've understood and dealt with, and we've known for a considerable period of time that we're going to have a weak third quarter in the tantalum business.

But as you know, we try not to forecast earnings to keep ourselves out of that morass.

No, no, no, I wasn't questioning this quarter, I was questioning next year.

Oh.

Well, we've known, you know, we've known for many -- for more than a year, two years that the K-tas contracts were going to be up this year.

Okay.

Thanks very much.

I appreciate it.

Nothing in that that's surprising.

Okay.

Our next question comes from John Tyes (ph) of Pantom Mayo (ph).

Morning.

Morning.

With respect to tantalum, is there anything noteworthy in the way of possible developments with respect to barrier layer business in ICs?

Yes.

There is.

Or that's an ongoing issue.

For those of you who aren't familiar with what John's talking about, tantalum is being used as the barrier film in the integrated circuits that are using copper in the interconnect layer.

And it's deposited on the integrated circuits through a process called sputtering off sputtering targets, shooting a electron beam at a target, a disk of tantalum. and atoms of tantalum come down and create a layer on the integrated circuit.

Yes, we've seen significant growth in our sales of volume of that material and are positioning ourselves to sell targets as well as disks of material.

And we continue to believe that that is going to be both a significant consumer of tantalum and a substantial growth area for us in the future.

Thanks.

And is it fair to say, though, that you don't expect it to overwhelm the basic capacitor business?

We have seen some estimates of volume out of certain consumers that, you know, you could envision having a very, very significant impact on the tantalum market.

That's the high end of the estimates, you know, three, five seven years out, about how big copper gets.

I think it will have a significant impact.

It will be a significant portion of total tantalum consumed in the world.

I don't anticipate that it's going to be as large or larger than tantalum for capacitors.

Fair enough.

That proves that Yogi Berra was right, uncertainties arise when you're dealing with the future.

On the cesium formate, I've seen several references to high temperature, high pressure wells off Trinidad.

Is there any activity on your part down there?

We are working, I'm not aware of particularly Trinidad, but as I've said in the last quarter, we have, with the success we've had in the North Sea, we have started to market aggressively in the Gulf Coast, and I'm told by the sales people that we have a number of very encouraging prospects.

Good enough.

There are some what we call sweet spot wells in the Gulf Coast that we think would be better drilled using cesium formate.

Um-hum.

Fair enough.

And obviously, that's for the ENP companies or the majors to determine at some point.

Is there a way of transferring or translating the experience and the observations that come out of the North Sea directly to other parts of the world except through single companies that have that firsthand North Sea experience?

You ought to come to work for us.

It's a fascinating issue.

We believe -- well, first of all we believe that virtually every major oil company in the world has been a principal or partner in a well that has successfully used cesium formate.

That's good.

So there’s firsthand experience on the part of the majors?

There is firsthand experience.

We've discovered, however, like Cabot, that the right hand in the major doesn't always know what the left hand is doing, and furthermore, the right hand thinks they know better than the left hand.

Yep.

So getting the information transmitted and understood and believed in these majors is a challenge.

We do a lot of publications.

We do a lot of speaking at oil industry conferences, and I think we're starting to make progress.

There was a recent sales call in the Gulf of Mexico, and we went in there anticipating making a three-hour presentation about why this stuff worked and how great it was.

The people we were calling on said, we don't want to hear that.

We know how well it works.

Let's talk about price.

Saved you a little time and hopefully made some money.

It's an indication, we think that we're starting to get some traction on a global basis.

But it‘s, as you've observed, it's a long slog against these companies.

They call that corporate viscosity, I think.

That's a kind word for what we call it, John.

Okay.

You mentioned the possible sale of the remainder of [air] in the fourth quarter, is that Cabot's fourth quarter or the calendar fourth quarter?

We hope to close that transaction in Cabot's fourth quarter and book the earnings this quarter.

Good enough.

Bouncing around, oh, that DLA sale of tantalum ore, is it possible that the slight up tick may simply reflect [Bayer’s] relatively disadvantage positioned?

No, we don't think so.

We think it was purchased by a trader.

Oh, okay.

And that, of course, is encouraging because the trader thinks he can make money at the price he paid.

Good enough.

One last thing, is there any way to characterize your inkjet technical spending in the context of total corporate R&D?

Where does it --

Can I answer the question?

Where does it fall out with respect to your whole technical effort?

It's in the range of 10 to 15%.

Good enough.

John, answering the question will give me an opportunity to just point out something.

A big chunk of what I call development, which is R & D and marketing spending today is in the manage business.

I did mention in the call we've seen a $3 million quarter quarter increase.

Yes.

Spending a big chunk of what our total spending is in that business today.

But the inkjet business is in the -- I would say 15% of overall.

Good.

Thank you.

And next we'll take a question from Michael Hidalgo (ph) with Future Capital.

Good morning.

Good morning.

On this Superior MicroPowders acquisition --

Yes.

And I apologize if I missed this, I was out of the call for minute. $14 million for in-process and development charge recorded.

Yes.

Is that -- has that been sort of a -- that's not going to be an ongoing type of charge because it was an acquisition?

Yeah, we spent $15.5 million to buy that business.

Right.

And under the accounting rules, you know, you have to allocate that to the assets when the accountants look at the assets, the bulk of it, $14 million, was what the accountants called the process R & D. We had appraisals done, and so we charged that to earnings this quarter, and that's behind us.

We do have going forward, the numbers that I think Jay Harris and I were talking about about the running rate of supporting that activity.

Which is in the range of $2 or $3 million a year, we think.

Okay.

All right.

Thank you.

And we now have a follow-up question from John Robert with Buckingham Research.

Hi, John.

Hello?

Mr. Roberts, your line is open.

John probably had to go to another call.

And moving on, we have a follow-up from Bernard Gaygen (ph) at Gardner Lewis Assets.

Morning, gentlemen.

How are you?

Very well.

Yourself?

Hey, couple questions.

One, you repurchased about 400,000 shares during the quarter, but you also hiked the dividend up a bit.

I'm wondering, does the higher rate of dividend sort of detract away from capital allocation towards increased share repurchases, or is that not a one off?

I would not describe it as a one off.

The dividend increase comes from, you know the company has done better since we did it last time.

And it's, you know, something that we have done consistently over the years.

In part because of the ownership of the company, of the continuing ownership of the company in the Cabot family and the employees, but also in part because of the change in tax laws.

Right.

But we don't anticipate any change -- any substantial change in our share repurchase program as a result.

Okay.

Second question is you spent a lot of time and there's been a lot of questions on the call regarding inventory levels, I guess, in the channel for tantalum.

I know one of the things that you guys were focused on over the last few quarters was lowering your inventory levels internally at the company and better sort of utilizing working capital.

Can you give us some sort of insight into how that's progressed?

Yeah, we made progress in the quarter.

And as I think I mentioned, we generated almost $50 million in cash in the quarter.

Right.

Cash balance is back up -- I think it was $180, close to $200.

But we're still not satisfied.

We still we think we still have room.

We're in sort of an awkward position in the tantalum business because we have these contracted ore purchases, and you may recall if you've been with us for a while, it was the ore contracts that enabled us to position us to get the contracts with our customers, but the ore that we had been required to purchase under those contracts exceeds our ongoing demand.

So we've been building inventory there.

And there's not much we can do about it until the market recovers.

But we're working hard on it.

We've made progress.

We've still got room to do better.

Okay.

I think almost every one of my questions that I could have possibly fathomed have been asked and answered, so I'll let you move on.

Okay.

Thanks.

And that does conclude our question and answer session.

Mr. Burnes, I'll turn the conference back over to you for closing remarks.

Okay.

Audra, thank you very much.

Appreciate everybody's interest.

Once again, I apologize both for the number of what I guess I can no longer call special events or special charges.

But also what I would regard as the obscure presentation of the income statement coming out of reg G. If you have any questions on either of those, Jim and or Eddie are available to help you.

And thank you all.

And we look forward to seeing you in a couple months.

Thank you.

And that does conclude today's conference.

Again, thank you for your participation.