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Executives

Gail Gerono - Vice President of Investor Relations & Corporate Communications

John Stanik - Chairman and Chief Executive Officer

Leroy Ball - Chief Financial Officer

Analysts

Michael Horwitz - Pacific Growth Equity

Rosemarie Morbelli - Ingalls & Snyder

Matt Schaenen - Somerset Capital

Corey Amen - Rice Voilker

Michael Gaugler - Brean Murray Carret

Calgon Carbon Corp. (CCC) Q3 2007 Earnings Call November 5, 2007 1:30 PM ET

Operator

Good afternoon, and welcome to the Calgon Carbon Third Quarter 2007 Results Conference Call. For your information, all participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation and instructions will follow when the first question session begins. (Operator Instructions) Please note that this conference is being recorded.

At this time, I would like to turn the call over to Ms. Gail Gerono. Ms. Gerono?

Gail Gerono

Thank you, Keith. Good afternoon and thank you for joining us. As usual, our speakers today are John Stanik, Calgon Carbon's Chairman and CEO; and Leroy Ball, our CFO. After John makes some brief introductory remarks, Leroy will provide the standard review of the third quarter financials, and John will make some additional comments on third quarter performance, provide an update on the mercury removal market, and comment on the fourth quarter.

As always, before we begin, I would like to remind you that the Private Securities Litigation Reform Act of 1995 provides the Safe Harbor for forward-looking statements. John's or Leroy's comments, or perhaps some of the comments during the Q&A may contain certain statements that are forward-looking relative to Calgon Carbon's future strategy and performance.

They involve known and unknown risks and uncertainties that may cause the company's actual results for future periods be materially different from any future performance discussed in the presentation.

Further, the company operates in an industry where it may be influenced by economic and other factors beyond the company's control. The information in this conference call related to other forward-looking statements may be relied upon, subject to the previous Safe Harbor Statement, as of the date of this call and may continue to be used while this call remains on Calgon Carbon's website or on PRE's website. John?

John Stanik

Thank you, Gail. Good afternoon everyone. In the third quarter, we continued to implement our initiatives to improve performance, and are pleased with our year-over-year progress. Once again, compared to last year's third quarter, revenue, margin, net income and EPS all increased.

While there were some factors, which affected the quarter from a cost perspective, we were successful in managing price and controlling costs. After Leroy's presentation, I will cover a number of topics.

The organizational change we made in October, costs that hit SG&A in the third quarter, the impact of the Chinese VAT rebate cancellation and higher freight expenses, which have led to a new price increase. I will also provide an update on the mercury market and preview the fourth quarter.

Leroy will discuss the tax provision, which had a major impact on third quarter earnings. Leroy?

Leroy Ball

Thanks, John. Good afternoon everyone. Looking at the consolidated entity, total sales for the quarter were $84.9 million, as compared to $79.7 million in the third quarter of last year, which equates to an increase of $5.2 million, or 6.5%. Sales were up in the carbon and service segment by $4.5 million, or 6.6%.

Third quarter 2007 carbon and service sales were stronger than the comparable 2006 quarter in all geographies with the largest increase, 37%, being shown in the company's Asian region. Equipment sales were up by $0.5 million, or 5.9% compared to last year, due almost entirely to stronger sales of UV and odor control equipment technologies.

Consumer sales in 2007's third quarter were $0.2 million, or 6.9% higher than the similar 2006 quarter, due to positive currency translation of $0.5 million, partially offset by lower home product sales.

Overall, currency translation had a positive $2 million effect on the quarter-to-quarter sales comparison. Consolidated gross profit before depreciation and amortization, as a percentage of net sales was 32.1% in the third quarter of 2007 versus 26.1% in the third quarter of 2006, an increase of a full six percentage points.

The margin increase is driven almost exclusively by the carbon and service segment through a combination of price and the stronger Euro making sales of our products more profitable in Europe. While the third quarter margin of 32.1% stepped back slightly compared to the second quarter margin of 32.7%, it was not entirely unexpected, considering the lower sales quarter.

Operating expenses were $16.3 million during the third quarter of 2007 versus $17.7 million last year, a decrease of $1.4 million, or 8%. The decrease is the result of reduced legal spending of $1.4 million, the non-recurrence of $800,000 of pension settlement charges from Q3 2006 related to changes in the company's pension plans and other benefit cost savings of approximately $0.5 million, partially offset by increased incentive comp for employees and directors and costs associated with the recent reorganization of the company's operating regions from three to two.

During the third quarter of 2006, the company recorded a gain of $3.2 million from the settlement of its business interruption insurance claim related to the disruption of business caused by Hurricane Katrina during the latter part of 2005.

Net interest expense was $0.9 million in 2007's third quarter versus $1.3 million in 2006. The decrease is the result of lower average interest rates paid on the company's borrowings since its debt restructuring in August 2006 and higher interest income from the company's increased cash position.

Other expenses net were $0.5 million in the third quarter as compared to $0.7 million last year. The decrease is primarily related to a reduction in taxes other than income tax. The company recorded a tax provision of $0.4 million, which equates to an effective tax rate of 7.7% in 2007's third quarter versus a provision of $0.1 million in 2006's third quarter.

Our tax rate for the third quarter was lower than the U.S. corporate statutory rate of 35%, primarily due to the company recognizing a $1.4 million benefit for the reversal of tax contingencies due to statute expirations.

Our year to date effective tax rate of 37.7% approximates our expected rate for the remainder of the year, which is considerably lower than the 52% rate we had recorded as of June 30, 2007, primarily due to the previously mentioned $1.4 million benefit, which contributed an 8.7% reduction to the year to date rate and approved 2007 forecast, which has diluted the negative impact of the company's permanent tax differences.

As mentioned on the prior call, we have undertaken a tax-planning project that is expected to conclude in the fourth quarter. At this point, however, it is still too early to tell what impact this project might have on our ongoing effective tax rate.

As a general comment, the recently adopted accounting standard, FIN 48, has brought increased volatility to company's tax rates and will continue to make it somewhat difficult to forecast our effective tax rate on a quarter by quarter basis.

But we'll continue, however, to try and give you a feel for the longer-term trend of our overall effective tax rate, excluding discretionary items which continues to move downward. Equity income from our Japanese joint venture was $0.3 million in 2007 versus $31,000 in 2006.

While the third quarter of 2007 equity income exceeded expectations, the fourth quarter is not expected to be as strong. The net result of everything I've just reviewed is a net income from continuing operations for the third quarter of approximately $5 million, or $0.10 per diluted share, versus a net loss of $0.5 million, or $0.01 per diluted share in 2006.

The $0.02 of dilution experienced in the third quarter and the $0.04 of dilution experienced year-to-date in 2007 are the result of the effect of our increased stock price on the value of the equity component of our convertible notes.

The number of diluted shares included in our share count for the third quarter was 8.9 million shares. I will remind everyone again that the amount of diluted shares included at various stock price levels associated with the convertible notes are disclosed in tabular form in each of our quarterly SEC filings, the next of which is to be filed some time around the middle of this week.

Items of note on the balance sheet include a cash balance that has increased by $13.7 million since year-end. For the quarter, cash increased by $2.7 million in spite of the company contributing $3.9 million to our U.S. defined benefit pension plans in September.

Inventories have increased by $7.9 million since yearend. $6.8 million of that increase occurred in the third quarter and is primarily the result of the company building inventories in Europe to its needed pre-Hurricane Katrina levels.

Exchange translation also contributed $1.4 million and $0.9 million to the increase in the year-to-date and quarter numbers respectively. We’ve spent approximately $7.6 million on capital expenditures during the first nine months and expect to spend an additional $4.4 million over the remaining three months.

At the end of the third quarter, we're carrying approximately $76.7 million of debt on the balance sheet, $63.8 million of which is being carried as short-term due to our share price at the end of the quarter exceeding the strike price of the convertible notes.

I will now give it back to John.

John Stanik

Thank you, Leroy. As Leroy noted, revenue was up 6.5% overall. Each business segment showed growth in all three regions, Americas, Europe and Asia, posted increases in revenue compared to last year's third quarter.

Most of the increase came from the carbon and service segment and was due to price.

At roughly $85 million, the third quarter sales were consistent with the seasonality of our business. As I've noted in the past, third quarter revenue usually falls between the range of the first and second quarters.

Market segment volumes were a bit unusual for the quarter. The third quarter is historically a stronger one for drinking water. But, that wasn't the case this year. In fact, our year-over-year volume was down significantly for this market.

But we're not concerned. This does happen occasionally. One sizable new fill, which will generate revenue in excess of $1 million, was postponed from September to December because construction of the new filters had not been completed by the municipalities contractor.

Hopefully it will occur before the end of the year. Unlike municipal, industrial volume was up significantly for the quarter. It's important to note that activated carbons manufactured by Calgon Carbon continue to be sold out for the year.

However, coconut and outsourced coal-based carbons provide us with an opportunity to grow revenue. Equipment and consumer sales increased -- increases for the quarter were explained in the press release.

As Leroy related, margins were up over the third quarter of last year, but they were not up sequentially. And there are two main reasons for this. The first has to do with the volume of business in the second quarter, as it relates to the third quarter. As I've said many times, the second quarter's usually our largest revenue quarter of the year and the higher volume of business and products sold absorbs more plant and supply chain overhead expense.

The second reason has to do with cost increases. One I already mentioned, paying the additional Chinese VAT. As I said during the second quarter call, the July 1 Chinese VAT rebate cancellation impact was expected to have a negative effect until we were able to pass through price increases to offset it.

That negative impact occurred in July and August, as expected. Another cost in increase in the third quarter was freight, particularly overseas freight costs. Both of these factors directly impact cost of goods sold.

Now, let's spend a few moments talking about price. I told you during the last quarter's call that we intended to pass through the Chinese VAT rebate cancellation to customers via a price increase.

You may be wondering why the effect of the increase was not reflected in the third quarter results. The answer is that we believe it is more effective to implement a customer-specific pricing strategy, and this approach takes time.

Beyond the Chinese VAT pass through price increase, we also decided to implement a general price increase for the Americas region effective October 1st and one for our Europe and Asia region shortly afterward.

Let me update you on our general price increase program. We are ahead of schedule and achieving our $15 million price target for the year. This time, since we have not completely defined our new global price increase program, I won't give you an estimate of how this will effect our original $15 million target in 2007 and the $10 million target that we previously established for 2008.

But we feel very good about our pricing strategy to date and expect that the new prices will stick.

Let's look at some additional costs. SG&A expenses for the third quarter were hit with approximately $1.2 million of unusual charges. There are three buckets that comprise the charges.

Approximately 25% was severance, stemming from our organizational change, which I'll talk about later. Approximately 45% is related to long-term incentive value impact caused by the increase in our stock price.

And the final 30% was for foreign exchange translation expenses. The total of these items is significant and detracted somewhat from an outstanding quarterly operational performance.

Moving on, I want to address the organizational change. It is significant and was done to optimize our organizational structure for the short-term. Calgon Carbon produced carbons are in short supply.

Coconut and coal-based outsourced products are important for growth in 2008. We are in a period of time where our supply chain must be razor sharp to ensure we don't miss growth opportunities because of product delivery.

With the new two-region structure, virgin activated carbon manufacturing capability exists in both regions and can be controlled to a greater extent directly by each region. Additionally, the new organization provides for two outsourced carbon supply chains that will provide carbons for sale entirely based upon the specific needs of each region and in a timely fashion.

The consolidation of the Europe and Asia regions does not represent a change in philosophy or strategy regarding the growth of Asia. We continue to consider Asia to be an area of the world with great growth potential and the reorganization should not slow the region's growth.

I expect this change to be temporary until new capacity comes on stream and/or the size of the Asian business rose to a point, which demands an independent organization. At that time, we would then go back to a three-region organization.

On the legal front, there's some news regarding the AST case. Early in October, the trial judge denied all post-trial motions: the motion by the opposition for retrial and our motion for pretrial interest.

We have been informed bit opposition that they intend to appeal the jury's verdict and we have informed them that we will appeal the judge's decision for pretrial interest. The company is open to discussion with the opposition to encourage conclusion of this ridiculously long and drawn out case, and realizes that post-trial interest is accumulating.

Let's discuss the mercury market. First of all, the market size. There has been a significant increase in the number of utility companies that are interested in having activated carbon supply for the mercury market.

We are in discussion with more than a dozen companies now, whose demand for 2010 significantly exceeds €300 million. Since we believe there will be additional companies that will require carbon by 2010.

We now believe that the total demand will approach €400 million for that year. The needs of the customer for our first supply contract have become clearer during the quarter. The customer has communicated their short-term needs during the quarter and we have finalized the contract.

The customer's projected demand is nearly €4 million in 2008, increasing to €6 million in 2009 and beyond. We continue to test our products at numerous locations and this is extremely important, as I have explained to you in the past.

So far, each utility has required testing, including full scale testing. Our products have tested very well, and are gaining approval. Other than contract negotiations with prospective customers, this is the most important activity related to this market and we are focusing a lot of attention on it.

We've talked about the size of the market, the expected demand for 2010 and the qualification of our products. What we haven't talked about is when the contracts will be awarded other than the one we already have.

We are negotiating terms and conditions with potential customers who indicate that they would like to award business before the end of the calendar quarter. Utility companies from Illinois are on a more aggressive schedule, but our prospects for business in Illinois are a little more complicated than for other states.

Illinois is the only state that requires specific product approval by the Illinois EPA. Calgon Carbon does not have that approval as yet, but we expect it very shortly. Hopefully, we will receive approval prior to the award of contracts by the two major utility companies in that state.

Based on our testing, we are entirely confident that the marketplace reviews our products as at least equivalent in performance to the competitions.

Because of our confidence in the mercury market and partially because of granular activated carbon demand, we approached our board of directors in last week's board meeting to approve a portion of the capital expense to bring back BEE-Line back on stream and we received approval. This project will generate a minimum of £4 million of granular activated carbon beginning in April of 2008.

This project accomplishes two objectives. Obviously it gets us additional volume in the short-term for growth next year, but secondly, it also gets a significant portion of the production line on stream, which will help expedite the schedule of getting the full line running when we need it.

Let's preview the fourth quarter, and as usual, begin with a statement about the seasonality of our business. Divestiture of the charcoal business, the magnitude of the seasonality is not as great as it once was. But some seasonality still remains. Historically, revenues for the fourth quarter have been next to the lowest of the calendar year.

This is usually due to the lack of potable water treatment sales in the fourth quarter and of course reduced demand due to the holidays, a time during which some industrial customers suspend operations for annual maintenance. Considering the one postponed municipal carbon fill that I talked about earlier that is now scheduled to be shipped in December, we would expect revenues to be closer to the third quarter than the first. Furthermore, our price increases should begin to roll in and have some positive effect.

That concludes our presentation and we are happy to open up the call now for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Michael Horwitz from Pacific Growth Equity.

Michael Horwitz - Pacific Growth Equity

Hello.

John Stanik

Hi, Michael.

Michael Horwitz - Pacific Growth Equity

John, you sound a little sick.

John Stanik

Yes.

Michael Horwitz - Pacific Growth Equity

Hope you feel better in time for our conference in a couple days. My question is, given the size on the market as you just described it for mercury, is there, are there discussions being had at the board level to move more quickly than you currently are, and it's nice to see you start that process.

Are you waiting for a larger off-take agreement from one of these utilities before you really pull the trigger on more aggressive plans?

John Stanik

Yes. We, this is an environmental regulatory market. As you know, throughout our history, we've been involved with situations like this, and in some cases, the market has slowed because of states or regions ability to get the regulations to be postponed.

Now, that does not seem to be happening now. And by virtue of the statistics that I gave you during my presentation, the fact that we are now talking to well over a dozen customers that were involved in terms and conditions, negotiations, it does seem to be happening. But we're not aware of any major contracts.

We have the one and the one that I mentioned during the presentation is the one that we've been selected for, I guess nearly a year now. So we just feel more comfortable and considering the fact that we have the luxury of not having to put that line on stream at this point, because it's a very short construction project to get it back on stream and still have enough time to build some inventory before the July 2009 deadline hits, should we get any business in Illinois, which is the state that should have the first major volumes actually consumed.

Michael Horwitz - Pacific Growth Equity

And so, and I also assume for any capacity expansion and any financing around that, it becomes an easier proposition with a large off-take agreement.

John Stanik

It does, but frankly, we have no concerns whatsoever about financing BEE-Line. We will be able to do that within our own cash generation within existing debt structure. So there's no worry about that.

However, there is value in what, in the fact that we do have taker pays, we do have commitments from customers, which make us feel a little bit better about making that investment there, as opposed to investing it perhaps in some other area.

Michael Horwitz - Pacific Growth Equity

And then lastly, in your discussions with some of these folks, clearly there are multiple injector systems out in the marketplace and it doesn't appear to us that they have to go hand in hand, meaning that you have to sell them an injector system to then get the activated carbon sale.

How many different channels can you go through to get to that customer, or are those utilities buying these things separately and really coming to you for your capacity?

John Stanik

The latter there is, first of all, there are at least three or four companies that we feel comfortable going to, should we need to acquire injection technology. However, that hasn't been necessary and we don't expect it to become necessary.

The power companies have informed us that they consider Norit and Calgon Carbon as the activated carbon manufacturers in the United States. They realize those are the two parties that they are going to have to deal with, and they are prepared to do that.

Michael Horwitz - Pacific Growth Equity

Are they also prepared to deal with the tariff and get activated carbons or carbons from other where, other places in the world or because of the capacity constraints?

John Stanik

We'll see how that plays out, Michael. In our presentation that we're planning for this week, we'll talk a little bit more about the company's options. And I've talked about them in a previous call. We feel fortunate because not only do we have BEE-Line, but we have the ability to switch existing capacity to this market.

If that proves to be a, let's see, how I put it, a good way for us to achieve all, to achieve supply of all of the market demand that we have. So we have four options. We have the BEE-Line option, which is one that we will certainly exercise first and have ready in time for market demand.

The second would be that we could consider switching current capacity to this market and supply granular activated carbon market needs via outsourced products. The third would be to directly outsource products from our huge network of suppliers in China to serve this market and then the fourth would be to expand greenfield or brownfield site capacity, say, at Pearl River.

Now, thus far the utility companies have indicated a preference to not deal with outsourced products from overseas. I believe that they are concerned with a number of different things. The logistics, the amount of containers that have to be shipped, the storage of product in the United States, anything that might jeopardize them getting their product in time to keep their plant running.

So I think that's one major issue. And then the other issue we've talked about in the past is the vast majority of Chinese manufacturers are very small capacity companies, where the typical Chinese producer make anywhere between £5 million and £10 million a year, and they are uncomfortable with dealing with a whole collection.

One of the values that Calgon Carbon can bring is because of the net, the large network of suppliers that we have in China, we can serve as the coordinator of this and we can bring those capacities together, if that would be an option that we would select. It might not be the one that we would select.

And again, because of the tariffs, there is an economics part of this that is very big, significant from a numbers standpoint and a profitability standpoint that could drive us to that second option, which would be to convert existing capacity to this market.

Michael Horwitz - Pacific Growth Equity

Okay, great. And then just as a follow-up to what you just said, John, so what kind of returns can we look at if you could just give us a range, when you're exploring these options, what kind of returns can we expect by either bringing idled capacity online or switching or what have you?

John Stanik

My answer is BEE-Line is huge. It's almost. Do you want to answer?

Leroy Ball

Well, the return from bringing BEE-Line up would be well in excess of 50% based upon the small amount of, or modest amount of capital that we would have to invest to get the capacity that we are bringing online.

Michael Horwitz - Pacific Growth Equity

But something like additional lines at Pearl River, what kind of returns would you be getting out of that kind?

John Stanik

Well over the cost of capital, maybe in the high 20s.

Leroy Ball

Yes.

Michael Horwitz - Pacific Growth Equity

Okay. Great. That's very helpful. I'll jump back in the queue.

John Stanik

Thank you.

Operator

Thank you. And the next question comes from Rosemarie Morbelli from Ingalls and Snyder.

Rosemarie Morbelli - Ingalls & Snyder

Good afternoon, all.

John Stanik

Hello, Rosemarie.

Rosemarie Morbelli - Ingalls & Snyder

Continuing on the, on this particular line of questioning regarding the mercury market, there is one thing that you did not mention, John, and it is the fact that ADA-ES is looking for permits in the U.S. to build two and maybe four Greenfield activated carbon plants.

Could you give us some idea as to how quickly they can get it, what are the potential problems and what kind of competitors, how well the industry operates. It's no longer being Calgon Carbon and Norit. Now you will have a whole lot of additional problems from ADA-ES if they can proceed with their plan.

John Stanik

Well, I'm not sure I'm comfortable talking about what their plans are and what they can accomplish and what they can't accomplish. Being a world leader in granular carbon manufacturing, being, in fact, an experienced plant manager who knows the difficulties associated with manufacturing activated carbon, I can tell you that there are certain challenges that need, will need to be made, or will need to be met and overcome to become a reliable and dependable manufacturer.

There will be some logistics issues that will have to also be met to become a reliable and dependable supplier of product quality. I'm not saying that they can't meet those. I have no idea. I don't have any idea how the states that they’re trying to receive permits, how that's going to go and how quickly and how smoothly it will go.

I will say this. I think that if everybody's market estimates are correct, if we're talking about in excess of £1 billion, or if you take Calgon Carbon's forecasts, which are somewhere between £750 million by the middle of next decade, I don't think that that's going to jeopardize the kind of improvement and increase in our performance that we're expecting from this market.

So, if you just pick some numbers. If it is £750 million and assume there are three suppliers, we're talking about £250 million per year of activated carbon. And if you multiply that by an average price of - pick one, if it's brominated, it could be $1 or more, if it's not brominated, it could be $0.60 or $0.70 So, if you take £250 million times $0.80, just as an average, just to throw some wild numbers out, talking about incredible numbers, whether ADA-ES is in the picture or not, I think it's a little too early to be concerned about that. They are going to have, their hands full, I think, getting ready.

I'm not saying that they can't, but I am saying that the market's going to be big enough and there's going to have to be and the impact of this market is going to influence the entire global supply and demand situation. So, maybe in other words, there will be room for ADA-ES in the global picture, if they can somehow pull this off.

Rosemarie Morbelli - Ingalls & Snyder

And just continuing on the global supply, you said that you can act as a coordinator and therefore the power plants are not going to be dealing with thousands or hundreds, let's say, of small Chinese producers. They will deal for all of that capacity, but you can obviously put it all together and then eliminate a lot of the concerns.

There are a lot of other brokers out there. If they can do it, I mean, if you can do it, couldn't someone else do it as well and therefore, the market could be floated by all of that excess carbon capacity in Asia, or am I not looking at this properly?

John Stanik

I think that our brokers could serve as brokers. We are the largest importer in the country today, so obviously we’ve proven that we can do this. I'm not sure I understand the question. The…

Rosemarie Morbelli - Ingalls & Snyder

Well, what I mean is that you are saying that you are in a very good and Norit are in a very good position because you are the only U.S. suppliers and that the power plants really don't -- are not that interested in going through dealing with a lot of small producers in Asia.

But if you can not put all of those small producers together, then I am assuming that someone else will do it because it is just brokering and therefore they could be additional competition from Asia at lower prices versus the U.S. manufacturers.

John Stanik

Again, there's the tariff to deal with, which will limit the lowness, if you will, of whatever competitive price. But, yes, I think I follow your logic and I think it's possible. I just think it will be difficult for those types of brokers to be successful.

Rosemarie Morbelli - Ingalls & Snyder

And the tariff, John, when are they expiring?

John Stanik

'12. 2012.

Rosemarie Morbelli - Ingalls & Snyder

Okay. All right. I'll get back in queue. Thank you.

John Stanik

You're welcome.

Operator

Next question comes from Matt Schaenen from Somerset Capital.

Matt Schaenen - Somerset Capital

Hey, John. Couple related questions for you. I sort of missed what you said earlier in response to the returns on Greenfield capacity. Is that high 20%, that's an EBITDA margin?

John Stanik

That, Matt, would not be an EBITDA margin. That would be a return on capital.

Leroy Ball

Invested capital.

Matt Schaenen - Somerset Capital

Okay. And maybe you can speak, I guess, that's probably two calls ago now, where you gave, I guess, I’d say loose guidance of kind of $55 million to $60 million EBITDA figure. And obviously running through the math, looks like things have maybe changed a bit.

I was wondering, I don't know, how much you're able to speak to this or maybe if you can speak directionally, but as things in terms of market opportunity and perhaps timing have clarified themselves, I'm wondering if you have sort of updated numbers that you could share with us.

John Stanik

I'm glad you bring that up actually. The call you're referring to was the one that occurred shortly after Board approval of our strategic plan. If you look at our EBITDA for the third quarter and I guess, it's not something, I'm permitted to talk about, but you can calculate the EBITDA for the first nine months, all right. Never mind.

And it's a significant improvement over what the EBITDA was in 2006 obviously, and exceeds what we expected when we put the strategic plan together. The other thing that was the condition when we had that first quarter call was the mercury market was a hell of a lot more unknown than it is now.

The market has developed quite a bit in the past six or seven months since, we had that conversation. And obviously, the impact, the volume of the market, the size of the market and the fact that we're being accepted as one of the two leaders at this point in time with a potential market size of £400 million, or up to £400 million by the year 2010, would imply EBITDA margin or would imply revenue and contribution margin that would significantly blow by the number that you mentioned, if we were successful in achieving a minority of that volume increase.

So, the answer to your question is we've got to be successful in the mercury market. We've got to continue to do things that we said we were going to do with respect to our strategy in other parts in other markets. And the fact that we're considerably beyond where we thought we would be at this point in time all indicates that that number I gave you two quarters ago is a more than conservative number, a number that potentially as these markets develop, a number that we should blow by rather easily.

Matt Schaenen - Somerset Capital

Okay. Terrific. Thanks so much.

John Stanik

You're welcome.

Operator

Thank you. And the next question comes from Corey Amen from Rice Voilker (ph).

Corey Amen - Rice Voilker

Hey, guys.

John Stanik

Hi, Corey.

Corey Amen - Rice Voilker

I wanted to ask you, what is your target for SG&A? I mean you had indicated in a prior call what your target was either in terms of percentage of sales or in absolute dollar amount. And I just can't seem to find that.

John Stanik

We were if I remember correctly in 2006, 19 and a fraction.

Corey Amen - Rice Voilker

Okay.

John Stanik

And what I've set as our target is, that we would like to reduce SG&A as a percent of sales by a minimum of 1% per year between now and 2010 when we conclude this strategic planning period that we just talked about in the first quarter.

What additionally we’ve said is there will be increases, we're not saying that we're going to decrease it in terms of whole dollars, but we feel that if we are able to get that number staff of 15 eventually

Corey Amen - Rice Voilker

Okay.

John Stanik

That we would feel better than we, than we do if we don't manage to get it above, or if we don't manage to get it below 15%.

Corey Amen - Rice Voilker

Okay. So that's a pretty good target, the 15%, you think?

John Stanik

Yes, 13% to 14%to 15%, Leroy and I work on this continuously, we're looking ahead to see, we haven't finished our 2008 business plan. We'll do that over the next four weeks and then we'll have a better snapshot again as to what we're going to be able to accomplish next year.

But we feel pretty good that the, that we can get to the 15%, but we would like to get a little bit lower than that, I'm not sure we're going to do that by the year 2010, but it's certainly an internal target that he and I have for each other.

Corey Amen - Rice Voilker

Okay. On BEE-Line, how much will this cost, again, and how will this show up in the financial statements over the next two quarters, and if it does affect the income statement, are you going to break it out?

John Stanik

The additional £4 million I talked about?

Corey Amen - Rice Voilker

Yes.

John Stanik

We will try and get that capacity online as quickly as possible. We will get nothing from it until after it comes online, which should be April, this is Northern Kentucky, so we have some weather issues, which means that we probably won't get online until after the weather breaks, which will be late March, mid-April, something like that.

Corey Amen - Rice Voilker

I'm talking more in terms of the costs. Like how much will it cost you and should we expect to see some excess expenses in the income statement associated with those costs?

John Stanik

No, the capital cost that was approved by the board was $1.4 million, or $1.5 million.

Corey Amen - Rice Voilker

Okay.

John Stanik

It represents a lot of work. The reason the number looks small compared to the $15 million to $20 million I've talked about previously is because essentially we're not buying new equipment.

We're just getting the instrumentation and the equipment back online, performing what I would call a much more intensive maintenance turnaround and rehabilitating some of the coal delivery conveyor equipment from our coal supply to the pressroom, which is if I remember correctly somewhere around 300 yards or 400 yards away.

So that's where the money's really going, as opposed to the rest of the production line where we're going to have to buy new environmental abatement equipment to satisfy Kentucky environmental requirements.

Corey Amen - Rice Voilker

Okay. Final question and I'll jump back into queue. If the drinking water volume is so short in the September quarter by a material amount, I mean what's going on there? Are the utilities waiting longer to replace the carbon? Are they having to get budget approval to pay higher prices? Can you just, I mean what do you think is happening?

John Stanik

Maybe some of both. The everybody's trying to get more out of everything. Doesn't have anything to do with the tariffs, doesn't have to do anything with anything. All companies are trying to get as efficient as possible, get the most for their dollar as possible.

So, the municipalities in many cases aren't any different. Now there are some municipalities that replace their carbon on a calendar on a clock and it doesn't matter really what their analyses say. They replace it on the basis of time.

But some do on the basis of when the carbon's spent. The other thing is the reason that our business is seasonal, the reason that this happens, varies from quarter to quarter is as they do have to get approvals and they do spend their money usually on a calendar quarter and when they run out of money, which is typically as they get close to the fourth quarter, that's why there aren't any municipal fills.

I honestly don't think that this is anything significant. This has happened in the past it doesn't happen every year, doesn't happen every other year, but it does go in cycles. Now, this big fill that we had predicted -- or not predicted, that we had had the business we got the contract in March, the shipment was supposed to occur in September, and the construction wasn't complete.

And that happens pretty frequently, and for those of you that are listening in that know the company for several years, you've heard the CEO talk about that previously. We were short about £3 million in the third quarter. That's the materiality. That is a fairly big number.

And we're going to pick up some of that in the fourth quarter if, if that December shipment does in fact go in December. Now, it's a southern state, so I'm hoping weather won't have any influence.

Corey Amen - Rice Voilker

Okay, great. Thank you.

Operator

Thank you. And we have a follow-up question from Rosemarie Morbelli from Ingalls and Snyder.

Rosemarie Morbelli - Ingalls & Snyder

Looking at the fourth quarter, John, you are expecting I mean it is usually smaller than the third quarter, but you are expecting that £1 million to come through $1 million, I'm sorry, £3 million, into the fourth…

John Stanik

No, no, Rosemarie please excuse me. I didn't say £3 million. It's more than $1 million.

Rosemarie Morbelli - Ingalls & Snyder

Okay. What was the £3 million you were just talking about, saying that you were short?

John Stanik

We were short in volume third quarter of this year over third quarter of last year by £3 million of municipal water carbon.

Rosemarie Morbelli - Ingalls & Snyder

Okay, but it is not this it is a lot more than this one fill that has been postponed from September to December?

John Stanik

Yes.

Rosemarie Morbelli - Ingalls & Snyder

So if we look at that additional business out of Q3 into Q4, would that translate into similar margins for the carbon in service in Q4 versus Q3?

John Stanik

Well, let since I can't give you guidance, let me talk about let me see what I can say. We are making progress passing through the VAT costs. We are putting a price increase in place for the Americas October 1. So it's effectively already begun.

Europe and Asia will probably have little to no price increase in the fourth quarter at all. So, the freight costs are what they are. I'm not sure that we're expecting in any significant deterioration the VAT costs aren't changing, so we shouldn't expect any deterioration.

We should expect an improvement. So I would say that there's no reason to believe that the margins would be any worse than they were in the third quarter. In fact, there might be some reason to expect the opposite.

Rosemarie Morbelli - Ingalls & Snyder

Okay, and so the reason the margins were lower in the third quarter versus the fourth, and I am only talking in that business. I mean you only had 2.5, top-line was only short by $2.5 million, more or less, Q3 versus Q2, and the margin was substantially lower.

So could you give us a little more flavor? I am assuming that it is the VAT costs that you were not passing through. It is a little less volume. Was there anything else in that operating margin for that particular…

John Stanik

The freight.

Rosemarie Morbelli - Ingalls & Snyder

Okay.

John Stanik

The freight. The fact as I think you've got them all. When you sell less volume our plant overhead in our production service expense, our warehouse expenses, our supply chain overhead, are not being covered as well at the lower sales volume, and then the addition of the VAT expense and the freight, and we're talking about 0.6 percentage points over the $85 million. So…

Leroy Ball

Well, the $0.5 million -- not the $0.5 million. I'm sorry. The $0.25 million that we essentially were up in, on the operating expense line third quarter versus second quarter also was primarily driven into carbon. So you had that affecting the third quarter margins as well.

Rosemarie Morbelli - Ingalls & Snyder

Okay. When we look at 2008, you are still not going to have anything from mercury removal in those numbers, are you?

John Stanik

Yes, we'll have a bit and I'll know more about that in a month, but when I look at what our commercial folks expect to have for the one customer, the one contract that we do have, there will be consumption in 2008. I think in the presentation, I said £4 million. If I didn't, I'll say it now.

Rosemarie Morbelli - Ingalls & Snyder

You probably did and I missed it. I apologize.

John Stanik

Oh, that's okay. We'll have that for we expect to continue to be doing full scale testing. Full scale testing can mean up to truckloads, 40,000-pound truckloads, multiple for tests.

So there we expect there will be some level. I just don't know what that number is and I won't know it until the first week of December.

Rosemarie Morbelli - Ingalls & Snyder

But it will be so small that it is fair to assume that you won't get, it will be at a cost to you going through this exercise?

John Stanik

A cost to us …

Rosemarie Morbelli - Ingalls & Snyder

You are not going to make any money. You probably are going to lose money on the mercury going, I mean, on the carbon going into the mercury market in 2008.

John Stanik

No, no.

Rosemarie Morbelli - Ingalls & Snyder

No?

John Stanik

No, we'll be selling it at prices that we believe we can get from the market. Now, if you're saying, are you saying, are you asking is testing prices the same as commercial prices for long-term contracts, I'll have to get you an answer.

I don't know the answer to that question. If the question is, are we charging customers full price for testing, I don't know the answer to that. I don't think I've never suggested we'll lose money in 2008 for the mercury market. We'll make money.

Rosemarie Morbelli - Ingalls & Snyder

Okay. And could you talk about the progress you are making in the UV and ion exchange businesses, because those are the ones with the highest margins? And are they popping up into carbon activated carbon and service or are they split between that and equipment?

John Stanik

There is a service component in UV and a service component from ion exchange that are represented in the carbon and service segment. The numbers are relatively small, but they are nice margin projects, and they are included in service.

Regarding just the equipment segment, there we have the after-market, which is sale of spare parts, etcetera, and then the large equipment or the new equipment sales are incorporated into, into the equipment segment.

Rosemarie Morbelli - Ingalls & Snyder

And what kind of, what kind of gross are we seeing in those two businesses? Do you have a lot of new contracts? Could you bring us up to date on the outlook for that?

John Stanik

Sure. We're doing, we continue to do what we expect with UV business, which is continue to grow it at a greater than 25% rate from a year from an annual standpoint, so we're still very pleased about that.

The ion exchange business is not growing. Nothing really has changed in terms of perchlorate to at least nothing significant has really changed to cause a lot of growth in the perchlorate market, which is the reason that we're not seeing a lot of growth in ion exchange sales.

And I'm talking about the equipment segment now. And we again, in that business plan for 2008, I'll get an idea of what our folks in California are projecting for 2008. I understand there are a number of projects that they expect to be awarded in 2008, but California really is becoming the tour from a perchlorate standpoint.

Rosemarie Morbelli - Ingalls & Snyder

All right, and what about, I can't remember the name of it, but leftovers from fertilizers that was a big…?

John Stanik

Nitrates?

Rosemarie Morbelli - Ingalls & Snyder

Yes, thank you.

John Stanik

What's the, what about…?

Rosemarie Morbelli - Ingalls & Snyder

Well, are you making any progress on that, or is that you are not talking about that business that had a lot of potentials in prior conversations, probably a couple of years ago? I was wondering whether anything was happening in there.

John Stanik

Not really. We're not pursuing that market aggressively. We have a product or two that we offer in that market, but we have not put a lot of development money into treatment for nitrates.

It's an ion exchange technology. It can utilize the service equipment that we utilize for other ion exchange type business. It's just not one that we have been pursuing aggressively.

Rosemarie Morbelli - Ingalls & Snyder

Okay, thank you. Good luck.

Operator

Thank you. And we have a question from Michael Gaugler from Brean Murray Carret.

Michael Gaugler - Brean Murray Carret

Good morning, John. I'm sorry. Good afternoon. Hello?

John Stanik

Yes, can you hear me?

Michael Gaugler - Brean Murray Carret

I can hear you now, John. Thank you. I was taking a look at the balance sheet and I've noticed that cash position is building pretty nicely. I was wondering, what your thoughts were in terms of future uses of cash?

John Stanik

CapEx for one, Michael. As I mentioned a little earlier in the call, we're not concerned about BEE-Line. The other, the other part, because we believe we can support it and pay for it from operating cash flow.

There's another major project that's heading down the path, which is grinding capacity. We are making powdered activated carbon for the mercury market and we are expecting to install grinding capacity, material handling capacity, tanks, truck loadouts, rail car loadouts for the mercury market and we're in the process.

Right now the board has approved engineering study to come up with a project scope and an estimate for the capital project to, associated with this grinding, will not be a small project. It could be north of $10 million, maybe even $15 million worth of capital.

When you add, so that's $20 million roughly or $15 million or $20 million for BEE-Line, $15 million, let's say, for grinding capacity, plus we have other projects elsewhere in the world. We're talking about a significant amount of capital that we're going to be spending here in the next three years for growth.

So that's the first priority for us in terms of use of our capital.

Michael Gaugler - Brean Murray Carret

Okay. Just as kind of a follow-up to that, are you primarily focused on organic growth at this point or are you still looking potentially at acquisitions if something good comes along?

John Stanik

If something good comes along, something like the Waterlink acquisition we made in 2004, in other words, something with really high synergy value, consolidation, a competitor that is something that would be very advantageous for us.

So we would look hard at doing something like that. In terms of getting outside of what we're doing right now, I don't think it would be a good idea, primarily for the reason that we're really working hard at these market opportunities and we're very focused.

I wouldn't want to take on anything new at this point in time that's very different from what we do now. But if there's something that's in our wheelhouse, so to speak, we'll definitely be interested.

Michael Gaugler - Brean Murray Carret

All right, thanks, John.

John Stanik

You're welcome.

Operator

Thank you. And we have a follow-up question from Corey Amen from Rice Voilker.

Corey Amen - Rice Voilker

Hi, guys. Hey, with the mercury emission powder carbon business are you concerned about locking in prices now over the span of multiple years?

I mean if we're dealing with a situation of demand exceeding supply, I would hate to see you cap your prices over the course of multiple years, when Calgon Carbon's been under earning and now we have an opportunity to over earn for a few years.

Do you have any thoughts on that?

John Stanik

It's, it's a tough one. We've talked about it (inaudible) here. We, we want to have our cake and eat it, too. So we want take or pays. We want commitments. We want to make sure that the capital investments that we make, forget BEE-Line.

If we decide to build an expansion at Pearl River, which is very possible and we talk about committing another $75 million to a new production line, we want to be comfortable that we've got the, a sufficient backbone of that capacity committed. So if we're satisfied with the operating margin that we're going to make in these take or pay contracts, and we can get three years out of them for major volumes, that will make us feel more secure about investing the money and it will also allow some things to play out so that if the global supply and demand does strengthen -- let me see. I'll say that better.

So that if the demand situation globally strengthens to a point where there's a lot more value and a lot more price potential in activated carbon, that we can take advantage of it at that time.

Corey Amen - Rice Voilker

Okay. That's fair. Are you seeing signs of curtailment of Chinese-activated carbon imports into the U.S. in the past three to six months above what you expected?

John Stanik

Yes.

Corey Amen - Rice Voilker

Okay, and do you think that's the value that situation, causing that?

John Stanik

I think, let's spend a minute. That's a good question. Let's spend a minute talking about it. There is a lot of things happening in China right now. The VAT is one of them, obviously. That's a 13% effect that when you bring it in and put the tariff on top, makes it a 21% impact. So that's a sizable number.

If you pick up any periodical and you read about it nowadays, you hear about what's happening to coal, you hear about what's happening to labor costs in China, hear about environmental pressures. China is changing very, very quickly. The currency pressures, if you think that there's a currency pressure between the United States and China, think about what the Euro versus China is.

So China is a place that's going to undergo significant change. I'm not sure, I'm not smart enough to know what's going to happen a year from now or two years from now, but I know that their cost advantage appears to be weakening, and legitimately so. And you're right.

The import statistics that we've seen have shown that at least in 2006, the imports were down dramatically. Now, that could be completely the effect of the tariff and people not knowing how bad the tariff was going to be until it was finalized in April, but I'll bet based on what we're seeing, that we're going to see the 2007 imports also be down compared to 2005.

Corey Amen - Rice Voilker

Okay. My final question is from speaking to people in the industry, I'm hearing that the reactivation market is really heating up. When will we see some benefit in your numbers from react?

John Stanik

You're seeing it already in Asia and Europe, and if you remember the discussions I've had about Asia, strategic plan and Europe strategic plan really center a great deal about reactivation. Central Europe and southern Europe are big reactivation growth areas in Europe. China and other parts of Asia are big growth opportunities in Asia, and we are being very aggressive in those. We've seen new projects in 2007.

We'll see more new projects in 2008 and that's kind of an exciting part of our growth. Not a lot happening yet in the United States, but there are, there are some things that are developing in the United States.

There's a large reactivation potential in Southwest United States, in Arizona, where three communities are getting together to talk about a potable reactivation facility, potable meaning that municipal carbon from three areas may be pooled and reactivated.

That would be new. That would be a major volume. Those three areas are supposed to consume about £55 million of activated carbon, which would be reactivated. Naturally they are talking to us and our competitors to see what our interest level is.

And there's another project in eastern-central United States of the same ilk. So there are reactivation opportunities in the United States also. They just seem to be happening a little bit slower than the ones in Europe and Asia. So we, let's remember, we love service and it's our favorite, it's our favorite way business model. So we're excited about that.

Corey Amen - Rice Voilker

Okay, great. Thank you very much. That's all I had.

Operator

(Operator Instructions) All right. There appear to be no more questions at the present time. Do you have any closing remarks?

John Stanik

Yes, I do have a closing comment. First of all, thank you for joining our call. I apologize for my coughing. We're pleased with the outcome of the third quarter, both from a financial perspective and for the changes that we've made to the organization and the work that we've completed to prepare for growth in 2008, and there will be growth in 2008.

We believe we're on course for continued improvement. We will manage our global price increases over the next few months. We'll continue to aggressively pursue the mercury market and solidify our position in that market. We'll put the new organization in place as quickly as possible, and we'll finish the 2008 business planning during the next four months. Thank you.

Operator

Thank you. That does conclude today's teleconference. You may now disconnect your phone lines.

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Source: Calgon Carbon Q3 2007 Earnings Call Transcript
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