Cabot Corp (CBT) 2006 Q3 法說會逐字稿

Welcome to the third quarter 2006 Cabot earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded for replay purposes.

I would now like to turn our presentation over to our host for today's call, Mr. Ken Burnes, Chairman and CEO.

Please proceed, sir.

Thank you, Eric.

Good afternoon, everyone this is Ken Burnes, Chairman and CEO of Cabot Corporation.

I would like to welcome you all to our third quarter earnings teleconference.

Here with me this afternoon are Jonathan Mason, our Chief Financial Officer;

Bill Brady, General Manager of our Carbon Black product lines;

Eddy Cordeiro, General Manager of Supermetals;

Ravi Paintal, General Manager of Metal Oxides;

Jim Kelly, our Corporate Controller;

Susannah Robinson, Director of Investor Relations; and Brian Berube, our General Counsel.

I will remind you that our conversation today will include forward-looking statements.

Forward-looking statements are subject to risks and uncertainties and Cabot's actual results might differ materially from those expressed in the forward-looking statements.

A list of the factors that could affect Cabot's actual results can be found in the press release we issued last night as well as in our 2005 Form 10-K and subsequent filings with the Securities and Exchange Commission, copies of which are available on our website.

Last night we released results for the third fiscal quarter of 2006 along with related supplemental business information.

Copies of which are posted in the Investor Relations section of our website.

For those on our mailing list you receive this information either by e-mail or fax.

If you are not on our mailing list and are interested in receiving this information in the future, please contact our Investor Relations department.

I will now move on to the key highlights pertaining to the Company's performance for the quarter and will then turn the call over to Jonathan Mason who will provide the detailed financial results.

We will then open the floor to questions.

As I mentioned in our press release last night, we continued to be dissatisfied with our performance as the quarter fell short of our own expectation.

The shortfall was particularly difficult for us because all businesses experienced very strong volume performance during the quarter.

As you know, we have been working hard over the past year to return to what we would regard as our historical margins and earning levels in our Carbon Black product lines in the face of continuously rising feedstock and energy cost.

When we analyze the numbers it is clear that we have made significant progress, but have not recovered completely.

In addition, the Carbon Black product lines were impacted by three cost issues during the quarter, which totaled $9 million.

First, utility costs have increased as a result of the high energy costs.

Second, we made substantial progress in reducing our working capital, driven by improvements in inventory, which causes higher fixed costs per unit.

And third, our subsidiary in Cabot, Japan had higher maintenance costs than expected.

As anticipated, the transition to market based pricing and higher ore costs in the Supermetals business reduced profitability.

The business had a better quarter than we had expected, however, and it is seeing strong market volumes and significant benefits from our previous cost reduction initiatives.

We continue to reduce inventory and are making substantial progress against our previously discussed goals.

We were pleased during the quarter to have our new plants in China for rubber blacks and fume metal oxides and our new inkjet colorants capacity, our existing plant in Massachusetts all successfully come on line.

We are mostly through the process of customer qualification of the materials and look forward to strong utilization of the new capacity to serve growing demand in the markets and developing regions of the world.

Our new business activities also remain promising.

We are extremely pleased to be awarded two appraisal wells in Argentina that we anticipate will begin to be drilled in the fourth quarter.

If successful this work could lead to the use of our fluid in additional wells and our first significant expansion outside of the North Sea, which is is a very exciting progress for the business.

Also over the year a number of tire customers have expressed interest in Cabot's elastomer composite materials, which many of you may know as CEC.

CEC materials are made by combining natural rubber and latex in liquid phase resulting in superior dispersion of Carbon Black relative to conventional processes.

This is a new business opportunity that has existed within Cabot for many years and it is gratifying to see commercial customers validating the potential for significant improvement in tire performance.

Looking forward we believe that our shortfall in performance during the third quarter will put us at the lower end of where we had hoped to be for the full year.

We remain cautious given the energy costs we have all experienced over the past months and the potential impact of political instability in certain regions of the world.

Given this uncertainty and our recent performance we are taking a very close look at all of our costs and are looking for ways to further improve margins to ensure that the Carbon Black businesses continues to earn an acceptable return.

On a more positive note, we have recently seen an improvement in cash generation and a reduction in our net debt position.

In general I am quite optimistic for the prospects for continuing strong demand in our core businesses and for ongoing growth in our new businesses and confident in the underlying strength of the Company.

I will now turn the call over to Jonathan Mason who will review the detailed results for the quarter.

Jonathan.

Thank you, Ken, and good afternoon, everyone.

I want to spend a bit of time analyzing our Carbon Black product lines that Ken was highlighting.

First, our variable margins.

Now, variable margins, to remind you all, include the sales and direct variable costs of making our products, of which feedstock, of course, is the biggest cost element.

Variable margins do not include the fixed costs of running our facility, which have also been impacted by higher oil prices via utility costs.

When looking at our total variable margin, we made progress during the quarter, returning it to the level seen in the third quarter of 2005, which as some will recall was the first of four quarters of continuously rising costs.

We have not been successful, however, at returning to what we would consider historical margins and still remain below that level.

Next, turning to fixed expenses, higher utility costs impacted our profitability by 2 million in the third quarter.

This is an $8 million annual increase in the fixed cost position of the business which, of course, is significant.

As Ken noted, we made progress during the quarter in improving our working capital balance driven principally by lower inventory levels.

The Carbon Black business reduced inventory by $28 million during the third quarter, which lowered profitability by $4 million due to higher fixed cost per unit with lower production levels.

Although we obviously don't like the impact that inventory reduction has on our earnings, our ability to manage working capital is critical to maintaining the earnings and cash generation power of the business.

So we think we have our priorities right.

Inkjet colorants continued its record of strong year-over-year volume growth and the small office home office or SOHO market and successfully brought its new capacity to manufacture products for the high-speed market on line during the quarter.

Profitability declined slightly due to modest expected margin erosion and increased costs related to the new production capacity that is not yet being commercially utilized.

In order to ensure that we are ready to meet the commercial demands of high-speed related launches in 2007, we are currently undergoing qualification of our new capacity with customers and this process will continue through the end of the calendar year.

Moving to fumed metal oxides, our FMO business had a very strong quarter with strong plant utilization, higher volumes, and favorable product mix combined to increase profitability over both the third quarter 2005 and the second quarter 2006.

Within the aerogel product line we were pleased to formally begin working with several customers on qualification trials in the oil and gas insulation market, which we believe could be a substantial application for this new product.

Also in May we entered into a cross-licensing agreement with Aspen aerogels where each party granted certain patent rights to the other.

The agreement calls for Cabot to receive $8 million of cash over a five-year period and the right to receive a modest equity position in Aspen.

These amounts are not included in our results for the quarter and will not be recognized until receipt is certain.

Moving to Supermetals, our Supermetals business had a stronger quarter than we expected with solid market volumes.

Our previous cost reduction initiatives generated significant benefits during the quarter, positively impacting the business by $23 million over the third quarter of last year.

The business, like Carbon Black, again made progress in bringing down its inventory levels during the quarter and improved its position by $46 million year to date.

However, the inventory reduction lowered profitability by $3 million during the third quarter and by $9 million year to date when compared to 2005.

The specialty fluids business experienced a utilization of our total available fluid during the quarter of 9%, which is a reduction from 19% in the third quarter 2005, and from 14% in the sequential quarter.

As mentioned in our press release, a labor strike at one of our large North Sea customers that has since been settled led to the postponement of one completion during the third quarter and could impact our full-year results by as much as $2 million.

I will now turn the call back over to you, Ken.

Thanks, Jonathan.

As most of you know, due to the strain on cash flow that rising Carbon Black feedstock costs have presented over the past year we have not repurchased any shares on the open market this fiscal year.

As you have heard, we made significant progress at improving our cash position this quarter.

Should this trend continue, and given our fundamental belief of the Company, we would intend to return to the market to repurchase shares in line with our historical practice of offsetting dilution of our long-term incentive program and possibly more.

This would all be done in accordance with our current Board of Directors authorization.

In closing, I would like to make it clear that notwithstanding our disappointing quarter, I remain very bullish on this company.

If we can catch a break and get some stable oil prices, I believe Carbon Black is very well positioned to start earning at its historical levels.

I'm very pleased with the work that has gone on in Supermetals, and notwithstanding the difficult market conditions they are facing I believe that business has done very well.

Fumed metal oxides is also performing at a very high level.

And although we, as usual, continue to struggle with the timing of the two new business opportunities, I continue to believe that both CG and Formate, our specialty fluids, and Inkjet will be very valuable additions to our portfolio in the long term.

As an indication of my confidence, you should be aware that rather than selling Cabot shares I raised cash from other assets to purchase the shares issued to me under our most recent long-term incentive grant.

I would like to thank you all for joining us this afternoon and will now open the line for questions.

I will turn it back to you.

[OPERATOR INSTRUCTIONS] Your first question comes from the like of Mike Judd with Greenwich Consultants.

Thanks for taking my question.

What is your -- I'm sure you have some sort of forecast for WTI for this quarter, and where is that relative to last quarter, so we can get a sense of what -- how much raw materials -- and the other thing is I'm wondering whether you have a similar type of forecast on natural gas, too.

I guess that's more pertinent for Europe, though, right?

Yes, we do have forecasts.

I would hasten to make clear that our forecasts are not necessarily any better than any other forecast you can look at.

I have seen a most recent WTI forecast which seems to be -- I would describe it as increasing slowly over the next six months.

Nothing dramatic, but increasing slowly.

I think in the European natural gas market there's some expectation that we will see some other -- some rise in the coming fall and winter season, but not as significant as we saw last year.

I can tell you that -- and I think people are generally aware of this, that our feedstock cost for the past three months have been in the range of being flat, up and down a little bit, nothing significant, but prior to that time, they were up another 5%.

So that the comparisons, which were difficult in terms of margins, is really because we, for this -- for your fiscal third quarter, one should have been looking at the 5% delta on the calendar first quarter versus the calendar fourth quarter of last year?

Is that the issue?

Not quite sure that I can tie it to precisely your question, but I think at least the way we think about it, we did experience some pain in our margins during the third quarter, not as substantial as we had in the past, but nonetheless, significant, because of the rise in feedstock that took place in the first part of the year.

But I guess the implications are, based on your other comment, that because I guess calendar second quarter versus first quarter oil prices were fairly flattish, I guess, the implications are that in your fiscal fourth quarter, there shouldn't be as much of an issue in terms of increase in raw material costs.

Is that the correct implication?

As I think we've made clear in the past, this now being August, we have a pretty clear view of feedstock costs and what it will be in the quarter.

And I would describe it, based on what we see today, as another small negative impact, which arises out of the lag in the formula adjustment, so we bore some of that roughly 5% increase.

We will bear some of that 5% increase in our fourth quarter.

It will not be as substantial as we've seen in the past, but nevertheless, it will continue to bother us a bit.

If we can continue the monthly trend that we've experienced in the last few months this will hopefully disappear from our earnings calls in the future.

Just finally, I think we now understand the raw material issue, but on the pricing front, given that the deltas in terms of the increases are flattening out, would you be able to increase prices enough to actually see margins remain flattish in the fiscal fourth quarter, or do you think they're still a little bit behind?

Well, in the fiscal third quarter they are a little bit behind.

I would tell you that there have been some price increases put in effect as of the beginning of the fourth quarter which should help us.

I would also tell that you by and large, capacity in the industry remains tight across the world, which we believe should help the industry over time.

Okay.

So just make sure I'm not being stupid here, but you're basically saying you think that there should be some margin expansion in the fiscal fourth quarter in Carbon Black?

I would -- given the bite we've had in feedstock, a little unclear from me, if we get a little bit of margin expansion in the fourth quarter it would be good.

I think the real issue is can we -- can the industry do something in the fourth calendar quarter.

Thanks a lot for the help.

Your next question comes from the line of Saul Ludwig with Keybanc.

Please proceed.

Doing great, except for the way your Red Sox are treating our Indians.

How about two games in a row, two outs in the 9th inning, Saul.

We don't like that.

I know you've been doing a lot of strategic thinking about both aerogels and cesium formate with a view that if you keep doing things the same way and expect a different outcome that's not too good.

Is there any plan to -- maybe you could elaborate on this deal with Aspen.

That's the first I'm hearing about that.

But what's going to happen with -- let's say on aerogel, the expense level, or the hit to your earnings going forward, and on cesium formate, what steps are you taking to move the needle there?

Well, let me deal with cesium formate first.

It's the easiest.

You heard about the new business we appear to have in Argentina which is, I think has the potential to be a very significant breakthrough for us.

This is a field that, is -- we believe is using cesium formate because believe that cesium formate will substantially reduce what is known as skin damage and increase the flow of the material through the porous rock into the hole.

They had drilled a previous well in the same field that -- where they had very disappointing results and they have now committed to use cesium formate in two additional wells.

If, as we all anticipate, it goes well, there is substantial additional drilling activity which should follow.

So if this goes well it should be our first significant breakthrough outside the North Sea.

We are also feeling much more optimistic about the prospects for significant business in the Gulf of Mexico, and we are working hard and re-examining the whole concept of how we market the product and how we sell the product in the Gulf region, the eastern Mediterranean and the Gulf region and in the Caspian.

The Caspian continues to look like a very probable long-term user of the product, but it's not in the immediate future.

So we are continuing to look very closely at how we're marking it and where our penetration is.

I feel a lot better today at this quarter about the way that business is going than I did three months ago.

We spent considerable time with the business examining where it's going and how it's marketing, making some -- giving some advice, making some suggestions, but I feel better about it, Saul.

On aerogel, we are right in the midst of a significant effort to see if we can reduce the spend rate, the burn rate in that business, and we'll know in the next month or so, certainly by the next call, how successful we are, but we're being aggressive, and I expect a not insignificant impact to the bottom line through that.

I would on the other hand, remind you, I mentioned in the notes that we have made considerable progress in hopefully penetrating into the subsea oil and gas pipeline activity, and are pretty optimistic that we'll get some significant business in '07.

So it's still an area of concern for us.

We are working hard on it.

The work is continuing, and will continue, and we'll give you a further report in the next call.

The Aspen deal is we think a good one.

Aspen, as you know, Saul, and others may know, is the competitor.

They make the product in a different way.

They've been at it a bit longer than we are and a little bit further ahead.

It turned out that we had some intellectual property that we believe gave us some rights versus Aspen with regard to what they were doing.

And we had had an extended negotiation with them and ended up with cross-licensing some technology.

We took some technology from them and gave them rights to our core technology, and will receive a not insignificant amount of consideration for that.

The $8 million comes in over five years.

The equity will come in immediately as soon as they have finished financing that they're currently doing.

And we believe it has the potential to be of significant value to the Company.

More importantly, we think that this is a validation, both the financing and the whole structure, of the importance of this market and the value of the core product going forward.

Second question relates to Inkjet.

You commented about there was two impediments to your profitability this quarter.

One was some margin erosion.

Secondly, there was cost related to the new capacity.

What was the magnitude of the hit, let's say on a year-over-year basis, as a result of those two items, and how should we think about this going forward?

Are we going to see another hit, negative hit, in the fourth quarter before it gets better, later on?

Here's a business that was running ahead, nicely ahead, in top line and bottom line for the last many, many quarters, and this little reversion in trend comes a little bit of a surprise.

Well, I don't think it should, and it certainly didn't surprise us.

First of all, remember that the volume continued to grow very nicely.

And we're very pleased with that and remain very excited about the business.

The PBT was down slightly instead of growing at 20 or 30%, which it had been doing in the past number of quarters for two reasons.

One of which was the -- and we mentioned this the last call.

As we sell more and more commercial product into the SOHO we're experiencing some margin pressure from some segments, but also converting to long-term commercial pricing rather than development pricing.

And that's almost an inevitable consequence of converting your business and taking more and more market share with new products.

The second issue was perfectly understandable.

We have spent roughly $25 million on a new line largely aimed at the high-speed printing application.

We are -- the line is complete and operating, and as I mentioned, we're in final qualification of a product coming out of that line.

That line ultimately is intended to make products for the high-speed printing application.

We needed to bring it on line and get it qualified with the customer well before their commercial launch so that they would feel comfortable that we have the ability to satisfy their market -- their anticipated demands, and those costs are costs we had to bear.

I actually think it's a pretty positive sign that we've got the line up and running and completed and are ready and supplying the customer as we speak.

So you'll have a little detriment in profit in the fourth quarter as well?

I would anticipate, a little hard to know right now, we haven't seen much volume in from it, but I would anticipate that those two cost items, particularly the new product line has been absorbed, and we should see the growth which we would anticipate -- we would be back in being profitable during the quarter.

We love the business, Saul.

I continue to believe it is and will be a great business.

The other relevant question for everybody, you talked about taking steps to improve the profitability of Carbon Black.

What are you going to do differently?

You've been in this business for along time.

You know all the different nooks and crannies.

What are you going to do differently?

And are there going to be any up-front costs as you do it?

I tell you, I'm glad you asked the question.

We're doing two things, hopefully, and I hope I'm not too old to do this, hopefully we are continuous learners, and that we learn continually how to operate our system more efficiently.

We have started an initiative throughout the Carbon Black business and the Company, in honesty, where because large parts of our overhead structure serves the Carbon Black to see if we can prune judiciously.

And that activity is ongoing as we speak.

I anticipate that we'll save -- we'll reduce costs in that business year-over-year, '06 to '07 is, by multiple millions of dollars through that initiative.

How many?

I can't tell you yet, but I can assure you we're being aggressive because we're not happy with the way the business is performing.

The other thing we do, and we do this continually, is closely examine our capacity to see if there's ways of making the capacity more efficient and better utilized and therefore lowering costs.

We've identified a couple of small opportunities that we're working on.

Not clear to me how they're going to come out.

One of the issues we have today as I mentioned is that the industry and ourselves is pretty close to sold out, and so it's a little bit hard to make too many moves in your capacity.

If any of those mature, and I do not believe they'll mature in the fourth quarter, they might result in a small charge.

The first -- the pruning activity I would, unless it's much more substantial than I would anticipate, we would expect to absorb it in our operating results and tell you what the costs were.

Thank you very much.

Your next question comes from the line of David Begleiter with Deutsche Bank.

On the new high-speed line in Massachusetts, how many years of growth do you think that line can handle before you to add new capacity, and what's the revenue potential of that line?

I'm not sure that we're at liberty to give you the second number, but I can tell you that we are hard at work with the customer trying to be conservative on how much time that line can serve.

We have seen and are working with them on a number of different models.

We do not need to start right away with the next line, but I would anticipate that it won't be too far along, probably this time next year we'll be thinking about it, and it will -- I hope it's a very short period of time.

I think it's probably in the range of a year and a half to two years.

And would the next line cost less as it could piggybacking on the existing infrastructure?

That's an intriguing question.

Yes, if we can build it at the same site where we think we have space.

No, if we decide with the customers that we should have a second site to be sure that we can satisfy their demands in all circumstances.

And those are conversations that are again taking place as we speak.

There's also a debate going on about the location of the long-term production facilities, and whether they should be in the Far East as opposed to the United States.

Those conversations are ongoing, serious, we're deeply engaged with them.

Ken, just on Carbon Black, you mentioned returning to historical margins.

How long will that take, and what is your view of what the margins were?

Were they 12, 13%, or somewhat lower given the structural rise in feedstock prices?

Well, that's an intriguing problem.

Let me answer the first one, first question, I think I can answer that quickly, then talk about the second.

If you look at it, your margin improvement in a business like ours either by a reduction in raw material costs or an increase in prices.

We would of course love to see a 10 or 15% decline in our feedstock costs which would result in a significant expansion in our margins.

Given what I see happening in the Middle East and in the other places that produce a lot of our oil, I don't rely on that to make this business profitable.

On the pricing side we have been aggressive in the last few months on price.

And given the largely sold out capacity of the industry I think we will continue to be so.

Those are efforts that are ongoing throughout the business, you're never quite sure how successful you will be, it depends on customer response and the like.

So we'll find out.

But I'm feeling better about it.

The other question is a complex one.

This business, if you look at it over a long period of time, earned 12, 13, 14%.

And those are the kind of financial performance that I would expect this business to generate over any period of time.

I hope and believe that the last year with the energy price increase has been an abnormal period in the business.

It's certainly been abnormal in my 19 years in the business.

Now, I do wonder, as I look at the business and I look at the margins and I look at where we're making product, and I look at where tire is being made, as to whether or not the increasing energy costs will cause -- will put pressure on those historical margins.

And I hope not.

We're struggling to make sure that doesn't happen on the margin side, but the principal reason we are engaged, we have engaged the whole company in the cost side is to do whatever we can that's within our control to protect those historical margin and earnings levels.

And it's just -- you could sit around and assume you're going to get back to normal through price, and we might well do that, but we decided as we looked at the business that we really should we as aggressive as we possibly could on the cost side to do whatever we could to guarantee the long-term health of this business.

And I would tell you I'm feeling pretty good about it.

This has not been a pleasant time.

Every time we wake up in the morning we look at energy prices and we look at our feedstock costs and it hasn't been a great period of time, but I'm feeling better than I have in the past year.

Lastly, in Supermetals is the $9 million a good run rate for Q4 of profitability?

We don't give those numbers out, as you know, and you guys are always very clever in trying to get there, but it's close.

Thank you very much.

Your next question comes from the line of Jay Harris with Goldsmith Harris.

Please proceed.

Coming back to the new capacity for Carbon Black, the metal oxides business, China, and the capacity expansion for Inkjets colorants.

Can you quantify in an aggregate number in the sense of start-up expense what that cost per quarter?

Oh, man, that's good question, Jay.

It's in multiple millions of dollars.

When you say that, is it below five?

Between five and ten?

I don't have the precise number, Jay, but I would say it's in the four to five range when you look at all three of the businesses.

As you go forward in subsequent quarters, are there likely to be ongoing similar expenses?

Well, I would tell you that the two new plants, the Carbon Black plant and the fume silica plant in China are up and running fully as we speak.

In both of those plants we're in the final stages of product qualification.

We are experiencing commercial revenue from all of the units, and that is going very, very well.

We are -- the Inkjet line is -- an early part of the line is being used today to generate some of our SOHO product, the full complexity of the line will not be utilized until the high speed printers material is used?

Then the final expansion is the unit we have in Brazil, and we're working on the final, hopefully the final permitting stage.

That -- we had a public hearing a week ago that went very well.

We are optimistic that we'll get the final permits here in the next 30 to 60 days.

Well, is the -- do you consider this -- I'm switching to Inkjet colorant -- do you consider this a high-speed line where you're sending samples or selling samples to your customer to be on line?

Are you depreciating that yet, or are you going to wait until you get orders?

I believe -- I'm quite sure -- let me -- before I answer the technical question, let me give you the business question.

That line is currently being used, a portion of the line is currently being used to produce products for what I would describe and you would hear as the SOHO product line.

There is later portions of the line that will only be used for the significant treatment, the complexity of the treatment we're putting in the high speed printing.

So I believe -- I know we're bearing all of the operating cost and I think we are depreciating it as we speak.

So it's fully hitting our income statement as we speak.

And that started in--?

This quarter.

In the fourth quarter?

In the third quarter.

Oh, in the third quarter.

All right.

The line has been mechanically complete since the beginning of the third quarter, maybe even at the end of the second quarter.

All right.

But that's the principal reason.

When the previous gentleman asked for precise numbers I did not give precise numbers about the breakdown, but in my mind the principal issue that we dealt with and the positive of the inkjet is that we all of a sudden absorbed the cost of operating and depreciating that line with very little income off that line.

And that -- and the income should go up modestly, but up in the first quarter, and then hopefully some acceleration in the first quarter of next year?

Well, I didn't say first quarter and I'm not really at liberty to comment on that but we have said early in 2007.

Fair enough.

Going back to Carbon Black, were the consecutive volume gains that you show in the June versus the March quarter as high as they have been traditionally?

I thinking if you look at the volume without showing Cabot, and remember if you look at year to year as opposed to sequential quarters, the year-over-year includes Shaw Cabot which sort of is artificial.

I think the volume growth in Carbon Black was roughly 2% quarter over quarter which is pretty solid historical volume growth in the Carbon Black business.

In fact, I would tell you that I think that's probably a little bit higher.

Okay.

We did have, and I think this was mentioned, if not in the call, I think it's in the supplemental, we had significant volume growth in the performance products group.

In fact, we recaptured in the third quarter a lot of the volume that we had struggled with earlier in the year.

Just clarify, if your raw material costs stay flat going forward, for an extended period of time what would you expect to see happen to the margin structure in Carbon Black?

Well, there's two issues there.

If you assume, as I'd love to flat feedstock costs, for the next year, we would -- the margins that are guaranteed to us in the contracts would come to us, and we would stop experience what we've come to know as the lag in those contracts.

And we've experienced lag of multiple millions of dollars in each of the last four quarters.

We had a little bit this quarter.

We are looking at a very small amount next quarter, but if you get flat from here those will go away.

That is in the range of 60% of our business.

The balance would be what would be back to what we can do to expand the margins in what you might call the spot or noncontracted business.

That, of course, depends on market conditions and capacity utilization and customer needs.

And we're working hard on that.

Well, would you get back to your objective operating margins?

I would be very disappointed if we did not get to be -- if we got flat feedstock costs if we would not recover to the more historical level.

I would hope to do better, I want to be clear about that, but if we hit flat feedstock costs I would think that this business would start earning where it historically has.

And if I -- looking at your presentations, the 12, 13, 14%, I'll call it objective -- I guess operating margins on Carbon Black, how are we to analyze that, because historically you've buried other businesses in your Carbon Black segment?

Well, and it's even more complex than that Jay.

It depends on what you take the 12, 13, 14% off of.

If you take it off sales, that's unfair.

Because we can't expect with our customers to earn 12 or 13 or 14% in the increases in feedstock costs that we have all absorbed.

We can and have -- the way the contracts are sort of sorted out is to give us a margin, which, as Jonathan pointed out is what we call our variable margin, that gives us a reasonable return on our fixed assets.

And so, as feedstocks -- if you try to do that calculation off revenue, it should -- below when we had very high feedstock costs, and higher when we got lower feedstock costs.

So you have to factor that into your thinking.

So when I'm talking about the 12, or 13, or 14%, that would be more relative to -- that's a number I have in my head based on our asset base and it's really probably at $40 oil, or roughly there.

And we don't -- we traditionally think of a profit level on our asset base and a cash flow coming on the investment rather than a return on revenue because revenue is a number that changes up and down, and the customers of course aren't going to pay us a profit for having to buy higher priced oil, and we, of course, are not going to give them back money unless we have to for getting lower price oil.

I have two more questions.

Can I go on?

Please.

The oil field in Argentina, how large is that in terms of the number of wells relative to an oil field in Norway?

Substantial.

Larger?

At least as large.

All right.

And what is the earnings cost, if any, for the inventory reduction in the tantalum business?

I think it's roughly $9 million year to date.

I think it was 3 in the quarter.

Thank you very much.

Okay.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Lavon van Redding with Hocking Capital.

Couple questions.

Are you able to quantify what the raw material drag was from the lag in pricing in the Carbon Black business in the quarter?

It's in the 2 to $3 million range.

And in terms of the utilities, I guess you kind of pointed that out, was there something different or new that happened this quarter?

I don't recall offhand whether or not you guys have kind of highlighted that.

We've mentioned utilities in the past.

It's to some extent new.

I don't know.

We're certainly experiencing this in all of our businesses.

The utilities that we all buy, whether it's electricity or steam in some cases, or natural gas or whatever, our experiencing the same ripple effect that a high energy is causing us, and we try, of course, to resist it.

We don't want to pay the increased costs, but when you get the kind of increase in the base raw material costs, they get passed through.

If you're a customer, you hope to prevent the pass-through for as long as you can.

If you're a seller, you want to do it right away.

And so we're sort of caught in between, and we have been fighting against utility cost increases, but inevitably, and don't tell any of my suppliers, but appropriately, we're losing.

You're losing at your home, too, I think.

Absolutely.

In terms of just also thinking, Mike had asked the question regarding fourth quarter Carbon Black margins, and if I'm paraphrasing you correctly, you kind of said you were going to have a little bit more of this lag from pricing with raw materials.

That's your expectation.

But you're also not going to have some of the inventory reduction initiatives, I would assume, that are also dragging on the fixed cost portion of the business.

Is your thinking that one will offset the other and that we will get margin expansion or we won't?

Let me give you a little bit more information and I might not have been clear when answering Mike's question.

The lag, we're looking at a small lag, probably less than we had this quarter on the 60% of the business that is subject to the contracts where you have the lag.

I also mentioned we had some price increases in the other portions of our business, so the net effect of it, we don't know yet, but hopefully it's not -- hopefully it might even be positive to neutral, but we're not sure yet.

So that should be helpful to us.

And just also, in terms of Carbon Black, just trying to make sure I understand the market.

Obviously we have capacity that you're going to be adding.

You said that demand is very strong, and pretty much, I think you mentioned it was sold out.

The capacity -- our capacity and the industry capacity appears to be very well utilized today.

Sold out is a hard term in the Carb Black industry but we're in high utilization rates.

But you had enough inventory that you could run your existing plants at a lower level of production and kind of keep things in line.

Just trying to understand that in context of if you ran your plants at a more normalized rate instead of the inventory reduction what that would mean to the overall market?

Well, let me come back and answer the second part of your first question, then come back to that one.

The business is starting to believe that it squeezed as much finished goods inventory out of the system as it can.

I'm continuing to squeeze the business to get more, because it all goes to cash and we did have an excellent quarter in cash generation, and I would tell you that we had an excellent month of July in cash generation.

Now, we have determined, we have made a decision in the business, and this has been controversial and difficult, that because of the increased cost of carrying both raw material and finished goods inventory, that we needed to learn how to operate our system with fewer days of raw materials, both in finished goods and raw materials.

And have done an excellent job with that.

We don't think we've published I'd certainly keep you interested -- but we've reduced the number of days of both categories by a lot in an effort to keep the total investment in the business at a more reasonable level.

I don't anticipate allowing that to go back to more historical levels if energy prices come down.

I think we are learning how to operate the business more efficiently and take the cash out and keep it it out.

Okay.

The other question we wanted to talk a little bit about, was the multiyear opportunity in Inkjet.

If you could kind of review that, obviously you're adding a second line, and you think a year from now you may be potentially adding another line.

What does that mean either from volumes, I guess we make our own assumptions in terms of revenues, but what does that mean in terms of overall volumes?

And are these long-term commitments from these customers that they are guaranteeing they will take a certain amount of volume from you over that period of time?

Just trying to size up the overall opportunity itself.

Well, that that's an interesting question.

You just -- remind you or tell you that the Inkjet business today looks, in the time period you're talking about of having two separate segments.

One is what we call the SOHO market, which is the printers that we all have behind our desks and at our home.

And that market for us has been growing in the range of 30 to 40% a year for the past three or four years.

That can't go on indefinitely, but we feel pretty good that that market is going to continue to grow at a very attractive rate for the foreseeable future.

The additional market is what we described as the high-speed market which is based on some new technology and new printing capability that one and possibly a few other customers are working on.

We hope and believe that that will be very substantial in volume, but we, of course, and the customer have no assurance of that.

But we're pretty optimistic that the printer will be -- that printing technology and that printing capability will be very successful and will enable to us grow quite rapidly.

I will tell you that we have seen numbers that are very, very exciting.

Whether they come true or not, of course, you never know.

But we're sufficiently confident to have invested $25 million in a production line, to have spent a lot of money in R&D, to continue to spend a lot of money in R&D, and as I mentioned earlier, to continue to look at how we're going to further expand production if the market demands it.

So we're feeling good.

I'm not really at liberty to give you numbers or volumes because of a customer relationship but we're excited about it.

Last question from me, related to aerogels, you said there were certain things you were looking to do with aerogels, I guess to try to reduce that drag on earnings.

Could you elaborate a little bit in terms of some of the things you're looking at?

I mean you had previously talked about a set amount of dollars that you plan to invest in the business.

Are you -- I don't want to say giving up on aerogels, but just making a conscious decision to lower the amount that you're going to spend, take a longer term view of it?

No, listen, I -- we do not anticipate giving up on aerogels.

In fact, although it is a subject of constant debate within the Company I would tell you that there are significant numbers of us who continue to believe that it's going to be a wonderful business in the future.

We've been through now for a number of years the evolution of these new businesses.

And historically they've gone through a period of cash drain, and when they're draining cash and hurting earnings, you work as hard as you can to get them to be break even.

And when they're break even, you sort of take a deep breath and say, well, it's not costing any money, I'm sort of playing it for free now, and then you hope it grows into being the next Inkjet or cesium formate.

And both of those business went through the same evolution.

Aerogels, which is the most substantial investment, or cash drain the Company has ever incurred has been burning cash at the significant rate and I think we then determined that both the maturity of the business, the evolution of the market, is that it's time to start putting the -- turning the big screw and getting some cost out of the business, putting more pressure on revenue generation and getting the cash drain down.

And as you know we have a September 30, fiscal, so we're right in the midst of the planning for next year, and that -- the squeeze from me and Ravi, who is here, he's doing the work, we're all committed to getting the cash drain down and we're looking both for reducing expenses and increased revenue next year.

Thank you.

Your next question comes from the line of John Roberts with Buckingham.

Afternoon.

Thanks for moving the call to this time.

No problem.

John, I hope everybody's happy with it.

I bet there are people on the West Coast who like it.

Ken, it's been long time since CEC was an opportunity here.

Has it evolved substantially from the last time it was a significant opportunity?

Well, yes and no.

No, to us within Cabot, there are a few of us in Cabot who believed in it all along.

John, you've been with us a long time.

What it is for those of you who don't know we take Carbon Black and mix it -- mix it in a slurry with water, and then mix that stream with liquid latex.

And so we're causing the mixture of -- the dispersion of the Carbon Black into the natural rubber in liquid form, and then we dewater the resulting compound and produce a bail of rubber mixed with Carbon Black.

As you've heard before, John, a number of us both on the business side and the technology believed when we saw the efficiency of the dispersion that there was significant value there.

When we originally did it back in the '90s, we couldn't get any significant customers interested, and as a result, we cut -- back to the previous caller, we cut the burn rate of the spending back down into the 1million, 1.5 million, $2 million level, and even at that level there was significant debate within the Company whether we ought to continue the process.

Fortunately, we made a decision to continue to spend that money.

In the last year we've had a number of our major tire customers who have looked closely at the compound, made tires, run tires, and have concluded that both the dispersion and the compound, the performance of the compound, which has been mixed.

John, I know you have technical background -- mixed without beating it up in a banbury has the appearance and the results in certain tire tests of making a -- of providing substantial benefit.

In rolling resistance or wear or traction.

It gives you a much -- appears to give you a much, much better compound, and it appears to have the potential to enable you to significantly improve the performance of at least truck and bus tires.

We have a number of customers who are very interested.

We have a customer who is running in the midst of major tire test, and we're pretty excited about it.

If I remember right I thought there were tire tests being done in China and some places where maybe the legal risk was a little bit lower during this interim period so that this tire company may not have been doing it but is there a fairly extensive field database that you've accumulated over the years?

We have -- we do have, I would tell you that we do have quite a bit of information.

I would also tell you that we appear to be in the -- we clearly understand the dispersion.

That's pretty easy.

The performance of the compound that seems to have some significant advantage because of the way the mixture takes place is something that we're -- some technical work that we're just doing to try to fully understand.

But it's clear that the stuff performs at a much, much higher level.

And the thought back then was you would ship black rubber from the plant and the freight was therefore born by the rubber and the Carbon Black?

There is that is well.

You have a great memory.

One of the initial business cases was that the Carbon Black would ship it to the tire plant for free, because it ships already mixed into the natural rubber.

Those issues are all being thought about, rethought about and reexamined.

Where you make it probably in -- at the places where you have natural rubber, you know that our Carbon Black plant in Malaysia where this plant is located is in the midst of the natural rubber area.

If it turns out to be the kind of business that we hope and believe it will be, you'll have the whole kind of issues of -- do you build Carbon Black capacity in other natural rubber locations?

How far can you ship the latex, how much of the issues are being worked on.

It has the -- I would tell you two things about it.

I personally have been a believer in this in a long time.

And I would tell you that today I believe it has the potential in the long term to be a very -- have a very significant impact on the performance of tires, certain types of tires, and possibly all tires.

But that's not yet.

But having said that it's still years away.

As you know the tire companies appropriately take a long time to introduce these products.

They test them carefully.

And if it works out we have capital issues, because you're going to have to build these plants and all the rest.

But I -- it's certainly from my perspective today the most significant, has the potential to be the most significant evolution in Carbon Black, and if Carbon Black for tire technology that I have seen in my 20 years.

Thank you.

We have a follow-up question from the line of Saul Ludwig.

Hey, Saul.

-- been typically making about $5 million a quarter.

Now that you had this hit for 3 million does that mean they made 2?

And was this 3 million sort of very, very unusual and has it gone away?

I missed your first part of the question, Saul.

Who are you -- what are you talking about?

[Shoal].

You made $5 million typically quarter from them.

Obviously it was a little less this quarter.

Can they go back to that run rate or?

We called that cost out, Saul, those costs were two things.

We had a turnaround, which was a little bit unusual.

They generally do one every either 24 or 36 months.

We had one that cost us a significant amount of money.

There were some issues relating to sorting out whether we capitalized or expensed maintenance costs on a historical level that were corrected this quarter.

No, we do not see anything going on in that business that would not indicate that it would perform at its historical level.

So they should go back to making $5 million?

Other than seasonal activity, I can't honestly tell you what the seasonal Carbon Black market is in Japan, but the business is operating well and doing fine.

The performance products, you had the big increase in the volume.

How did they do profit-wise, either sequentially or year-over-year?

They did better.

We're not -- we believe that the margins there, which is where the margins are subject to the market forces, we believe the margins are strengthening substantially, but we -- we're optimistic and aggressive about the future, we're not back to where we'd like to be, but we're in better shape.

Usually you've given us this number ach quarter.

Did it move $0.01 $0.02?

Usually in your supplementary, I didn't see it --.

I knew we had to change that.

Let me tell you why.

I know Jay has noticed that and mentioned it to Suzanne, at least in a phone message.

He put me up to this.

Well, the trouble with those numbers is that that requires an allocation of costs within the Carbon Black business.

Remember that those -- those two product lines are served by the same overhead and more importantly the same production units.

And the same production units used for different proportions of the time each month, each quarter.

So it's not really -- we can't give you numbers that we think -- that we have true confidence in at that level.

And I do believe, and so it's a consequence -- our inability to give you those numbers is a consequence of the change, of the segmentation, which is driven to some extent by the rules of the SEC, and how they're interpreted by the various powers that be, and that resulted in the segment -- in the change that we did in the beginning of the year.

I'm sorry about it.

My final question, is you talked about the gross margins in the third quarter in Carbon Black.

Got back to where they were in the third quarter a year ago.

Yes.

Third quarter a year ago was a little bit of a disaster, as I recall.

It was not -- now remember, you're absolutely right, Saul, and thank you asking the question.

We pointed that out with malice aforethought and we also pointed out that the $9 million of special costs that we thought we had this quarter that we did not have last -- the third quarter last year.

Got you.

Okay.

Very good.

Hopefully we'll see better news in the future, Ken.

Saul, you and I both feel the same way.

Thank you.

Anything else, Eric?

Our next question, and our final question, comes from the line of Mike Judd.

Please proceed.

Thanks for taking another one.

The tax rate in the fourth quarter on a sort of clean basis what should we be using, please?

Jonathan?

An estimate would be in the low 20s, 21 to 24%.

Okay.

And then also on CapEx.

Higher.

For the full year, what's your estimate?

I think we're going come to in in the 240, 250 range for the full year, and I mentioned earlier, we're looking at 150 next year.

Incidentally, we're having a little discussion about the tax rate because I think we mentioned in the past we anticipate a tax event coming out of some settlement of some audits, so maybe, John, do you want to reanswer the question?

Okay.

There's a couple different items.

First the normal tax rate.

Let me qualify that.

Up to sort of 25, 27%.

So a little higher than the 21, 24.

We also expect, and we'll explain00.

You said 25%?

Yes, 25 to 27.

Okay. 26 then.

Yes.

Now, in addition, we think we're going to have a release of a tax reserve in the fourth quarter with a $7 million impact on our operations.

Is that considered one-time?

I would consider it one-time.

It will show up in operations.

Then 3 million in discontinued operations.

It was operating income when it was taken, and, therefore, under the rules, it's operating income when it comes back.

So this implies with CapEx that you're going to spend around 90 million in the September quarter.

Is that about right?

That's what the businesses are forecasting, candidly, Mike, I don't believe it, and I would tell that you that in an effort to position the Company, we're squeezing people.

Okay.

Fair enough.

Thank you.

Thank you.

Eric is that it?

We're showing no more questions at this time.

Thank you very much, everybody.

Hope to have better news in three months and hope the rest of the -- everybody's summer goes well.

Thank you.

Thank you for your participation in today's conference.

This concludes our presentation.

You have a great day.