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Calgon Carbon Corp. (NYSE:CCC)

Q3 2007 Earnings Call

November 5, 2007 1:30 pm ET

Executives

Gail Gerono - Vice President of Investor Relations & CorporateCommunications

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

Operator

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

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

Gail Gerono

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

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

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

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

John Stanik

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

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

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

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

Leroy Ball

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

Third quarter 2007 carbon and service sales were strongerthan 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 $0.5million, or 5.9% compared to last year, due almost entirely to stronger salesof UV and odor control equipment technologies.

Consumer sales in 2007's third quarter were $0.2 million, or6.9% higher than the similar 2006 quarter, due to positive currency translationof $0.5 million, partially offset by lower home product sales.

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

The margin increase is driven almost exclusively by thecarbon and service segment through a combination of price and the stronger Euromaking sales of our products more profitable in Europe. While the third quartermargin of 32.1% stepped back slightly compared to the second quarter margin of32.7%, it was not entirely unexpected, considering the lower sales quarter.

Operating expenses were $16.3 million during the thirdquarter of 2007 versus $17.7 million last year, a decrease of $1.4 million, or8%. The decrease is the result of reduced legal spending of $1.4 million, thenon-recurrence of $800,000 of pension settlement charges from Q3 2006 relatedto changes in the company's pension plans and other benefit cost savings ofapproximately $0.5 million, partially offset by increased incentive comp foremployees and directors and costs associated with the recent reorganization ofthe company's operating regions from three to two.

During the third quarter of 2006, the company recorded again of $3.2 million from the settlement of its business interruption insuranceclaim related to the disruption of business caused by Hurricane Katrina duringthe latter part of 2005.

Net interest expense was $0.9 million in 2007's thirdquarter versus $1.3 million in 2006. The decrease is the result of loweraverage interest rates paid on the company's borrowings since its debtrestructuring in August 2006 and higher interest income from the company'sincreased cash position.

Other expenses net were $0.5 million in the third quarter ascompared to $0.7 million last year. The decrease is primarily related to areduction in taxes other than income tax. The company recorded a tax provisionof $0.4 million, which equates to an effective tax rate of 7.7% in 2007's thirdquarter 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 statuteexpirations.

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

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

As a general comment, the recently adopted accountingstandard, FIN 48, has brought increased volatility to company's tax rates andwill continue to make it somewhat difficult to forecast our effective tax rateon a quarter by quarter basis.

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

While the third quarter of 2007 equity income exceededexpectations, the fourth quarter is not expected to be as strong. The netresult of everything I've just reviewed is a net income from continuingoperations for the third quarter of approximately $5 million, or $0.10 perdiluted share, versus a net loss of $0.5 million, or $0.01 per diluted share in2006.

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

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

Items of note on the balance sheet include a cash balancethat has increased by $13.7 million since year-end. For the quarter, cashincreased by $2.7 million in spite of the company contributing $3.9 million toour 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 primarilythe result of the company building inventories in Europe to its neededpre-Hurricane Katrina levels.

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

At the end of the third quarter, we're carryingapproximately $76.7 million of debt on the balance sheet, $63.8 million ofwhich is being carried as short-term due to our share price at the end of thequarter 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 thirdquarter.

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

At roughly $85 million, the third quarter sales wereconsistent 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 secondquarters.

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

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

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

However, coconut and outsourced coal-based carbons provide uswith 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 oflast year, but they were not up sequentially. And there are two main reasonsfor this. The first has to do with the volume of business in the secondquarter, as it relates to the third quarter. As I've said many times, thesecond quarter's usually our largest revenue quarter of the year and the highervolume of business and products sold absorbs more plant and supply chainoverhead expense.

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

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

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

You may be wondering why the effect of the increase was notreflected in the third quarter results. The answer is that we believe it ismore effective to implement a customer-specific pricing strategy, and this approachtakes time.

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

Let me update you on our general price increase program. Weare 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 increaseprogram, I won't give you an estimate of how this will effect our original $15million target in 2007 and the $10 million target that we previouslyestablished for 2008.

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

Let's look at some additional costs. SG&A expenses forthe 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 ourorganizational change, which I'll talk about later. Approximately 45% isrelated to long-term incentive value impact caused by the increase in our stockprice.

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

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

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

With the new two-region structure, virgin activated carbonmanufacturing capability exists in both regions and can be controlled to agreater extent directly by each region. Additionally, the new organizationprovides for two outsourced carbon supply chains that will provide carbons forsale entirely based upon the specific needs of each region and in a timelyfashion.

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

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

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

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

Let's discuss the mercury market. First of all, the marketsize. There has been a significant increase in the number of utility companiesthat 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 believethere will be additional companies that will require carbon by 2010.

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

The customer's projected demand is nearly €4 million in2008, increasing to €6 million in 2009 and beyond. We continue to test ourproducts at numerous locations and this is extremely important, as I haveexplained to you in the past.

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

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

We are negotiating terms and conditions with potentialcustomers who indicate that they would like to award business before the end ofthe calendar quarter. Utility companies from Illinois are on a more aggressiveschedule, but our prospects for business in Illinois are a little more complicatedthan for other states.

Illinois is the only state that requires specific productapproval 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 theaward of contracts by the two major utility companies in that state.

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

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

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

Let's preview the fourth quarter, and as usual, begin with astatement about the seasonality of our business. Divestiture of the charcoalbusiness, the magnitude of the seasonality is not as great as it once was. Butsome seasonality still remains. Historically, revenues for the fourth quarterhave been next to the lowest of the calendar year.

This is usually due to the lack of potable water treatmentsales in the fourth quarter and of course reduced demand due to the holidays, atime during which some industrial customers suspend operations for annualmaintenance. Considering the one postponed municipal carbon fill that I talkedabout earlier that is now scheduled to be shipped in December, we would expectrevenues to be closer to the third quarter than the first. Furthermore, ourprice increases should begin to roll in and have some positive effect.

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

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes fromMichael 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 coupledays. My question is, given the size on the market as you just described it formercury, is there, are there discussions being had at the board level to movemore quickly than you currently are, and it's nice to see you start thatprocess.

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

John Stanik

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

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

We have the one and the one that I mentioned during thepresentation is the one that we've been selected for, I guess nearly a yearnow. So we just feel more comfortable and considering the fact that we have theluxury of not having to put that line on stream at this point, because it's avery short construction project to get it back on stream and still have enoughtime to build some inventory before the July 2009 deadline hits, should we getany business in Illinois, which is the state that should have the first majorvolumes actually consumed.

Michael Horwitz - Pacific Growth Equity

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

John Stanik

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

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

Michael Horwitz - Pacific Growth Equity

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

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

John Stanik

The latter there is, first of all, there are at least threeor four companies that we feel comfortable going to, should we need to acquireinjection technology. However, that hasn't been necessary and we don't expectit to become necessary.

The power companies have informed us that they considerNorit and Calgon Carbon as the activated carbon manufacturers in the UnitedStates. They realize those are the two parties that they are going to have todeal with, and they are prepared to do that.

Michael Horwitz - Pacific Growth Equity

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

John Stanik

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

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

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

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

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

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

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

Michael Horwitz - Pacific Growth Equity

Okay, great. And then just as a follow-up to what you justsaid, John, so what kind of returns can we look at if you could just give us arange, when you're exploring these options, what kind of returns can we expectby 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 toanswer?

Leroy Ball

Well, the return from bringing BEE-Line up would be well inexcess of 50% based upon the small amount of, or modest amount of capital thatwe 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, whatkind 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 thequeue.

John Stanik

Thank you.

Operator

Thank you. And the next question comes from RosemarieMorbelli 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 questioningregarding 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. tobuild two and maybe four Greenfield activated carbon plants.

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

John Stanik

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

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

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

So, if you just pick some numbers. If it is £750 million andassume there are three suppliers, we're talking about £250 million per year ofactivated 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, justto throw some wild numbers out, talking about incredible numbers, whetherADA-ES is in the picture or not, I think it's a little too early to beconcerned 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 themarket's going to be big enough and there's going to have to be and the impactof this market is going to influence the entire global supply and demandsituation. So, maybe in other words, there will be room for ADA-ES in theglobal picture, if they can somehow pull this off.

Rosemarie Morbelli - Ingalls & Snyder

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

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

John Stanik

I think that our brokers could serve as brokers. We are thelargest importer in the country today, so obviously we’ve proven that we can dothis. 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 avery 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 ingoing through dealing with a lot of small producers in Asia.

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

John Stanik

Again, there's the tariff to deal with, which will limit thelowness, if you will, of whatever competitive price. But, yes, I think I followyour logic and I think it's possible. I just think it will be difficult forthose 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 SomersetCapital.

Matt Schaenen - Somerset Capital

Hey, John. Couple related questions for you. I sort ofmissed 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 areturn on capital.

Leroy Ball

Invested capital.

Matt Schaenen - Somerset Capital

Okay. And maybe you can speak, I guess, that's probably twocalls ago now, where you gave, I guess, I’d say loose guidance of kind of $55million 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 speakto this or maybe if you can speak directionally, but as things in terms ofmarket opportunity and perhaps timing have clarified themselves, I'm wonderingif 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'rereferring to was the one that occurred shortly after Board approval of ourstrategic 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 theEBITDA for the first nine months, all right. Never mind.

And it's a significant improvement over what the EBITDA wasin 2006 obviously, and exceeds what we expected when we put the strategic plantogether. The other thing that was the condition when we had that first quartercall 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 orseven months since, we had that conversation. And obviously, the impact, thevolume of the market, the size of the market and the fact that we're beingaccepted as one of the two leaders at this point in time with a potentialmarket size of £400 million, or up to £400 million by the year 2010, wouldimply EBITDA margin or would imply revenue and contribution margin that wouldsignificantly blow by the number that you mentioned, if we were successful inachieving a minority of that volume increase.

So, the answer to your question is we've got to besuccessful in the mercury market. We've got to continue to do things that wesaid we were going to do with respect to our strategy in other parts in othermarkets. And the fact that we're considerably beyond where we thought we wouldbe at this point in time all indicates that that number I gave you two quartersago is a more than conservative number, a number that potentially as thesemarkets 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 fromRice 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? Imean you had indicated in a prior call what your target was either in terms ofpercentage of sales or in absolute dollar amount. And I just can't seem to findthat.

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 toreduce SG&A as a percent of sales by a minimum of 1% per year between nowand 2010 when we conclude this strategic planning period that we just talkedabout 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, butwe 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'tmanage 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 thiscontinuously, we're looking ahead to see, we haven't finished our 2008 businessplan. We'll do that over the next four weeks and then we'll have a bettersnapshot 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 the15%, but we would like to get a little bit lower than that, I'm not sure we'regoing to do that by the year 2010, but it's certainly an internal target thathe and I have for each other.

Corey Amen - Rice Voilker

Okay. On BEE-Line, how much will this cost, again, and howwill this show up in the financial statements over the next two quarters, andif 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 aspossible. We will get nothing from it until after it comes online, which shouldbe April, this is Northern Kentucky, so we have some weather issues, whichmeans that we probably won't get online until after the weather breaks, whichwill be late March, mid-April, something like that.

Corey Amen - Rice Voilker

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

John Stanik

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

Corey Amen - Rice Voilker

Okay.

John Stanik

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

We're just getting the instrumentation and the equipmentback online, performing what I would call a much more intensive maintenanceturnaround and rehabilitating some of the coal delivery conveyor equipment fromour coal supply to the pressroom, which is if I remember correctly somewherearound 300 yards or 400 yards away.

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

Corey Amen - Rice Voilker

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

John Stanik

Maybe some of both. The everybody's trying to get more outof everything. Doesn't have anything to do with the tariffs, doesn't have to doanything with anything. All companies are trying to get as efficient aspossible, 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 aclock and it doesn't matter really what their analyses say. They replace it onthe basis of time.

But some do on the basis of when the carbon's spent. Theother thing is the reason that our business is seasonal, the reason that thishappens, varies from quarter to quarter is as they do have to get approvals andthey do spend their money usually on a calendar quarter and when they run outof money, which is typically as they get close to the fourth quarter, that'swhy 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 happenevery other year, but it does go in cycles. Now, this big fill that we hadpredicted -- or not predicted, that we had had the business we got the contractin March, the shipment was supposed to occur in September, and the constructionwasn't complete.

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

And we're going to pick up some of that in the fourthquarter if, if that December shipment does in fact go in December. Now, it's asouthern 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 RosemarieMorbelli from Ingalls and Snyder.

Rosemarie Morbelli - Ingalls & Snyder

Looking at the fourth quarter, John, you are expecting Imean 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 overthird 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 fillthat 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 Q4versus Q3?

John Stanik

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

Europe and Asia will probably have little to no priceincrease 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 VATcosts aren't changing, so we shouldn't expect any deterioration.

We should expect an improvement. So I would say that there'sno reason to believe that the margins would be any worse than they were in thethird 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 thirdquarter versus the fourth, and I am only talking in that business. I mean youonly had 2.5, top-line was only short by $2.5 million, more or less, Q3 versusQ2, and the margin was substantially lower.

So could you give us a little more flavor? I am assumingthat it is the VAT costs that you were not passing through. It is a little lessvolume. 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. Whenyou sell less volume our plant overhead in our production service expense, ourwarehouse expenses, our supply chain overhead, are not being covered as well atthe 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 linethird quarter versus second quarter also was primarily driven into carbon. Soyou 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 haveanything from mercury removal in those numbers, are you?

John Stanik

Yes, we'll have a bit and I'll know more about that in amonth, but when I look at what our commercial folks expect to have for the onecustomer, 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 tobe 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'tknow 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 youwon'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 goingto lose money on the mercury going, I mean, on the carbon going into themercury 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 getfrom the market. Now, if you're saying, are you saying, are you asking istesting prices the same as commercial prices for long-term contracts, I'll haveto get you an answer.

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

Rosemarie Morbelli - Ingalls & Snyder

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

John Stanik

There is a service component in UV and a service componentfrom ion exchange that are represented in the carbon and service segment. Thenumbers are relatively small, but they are nice margin projects, and they areincluded in service.

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

Rosemarie Morbelli - Ingalls & Snyder

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

John Stanik

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

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

And I'm talking about the equipment segment now. And weagain, in that business plan for 2008, I'll get an idea of what our folks inCalifornia are projecting for 2008. I understand there are a number of projectsthat they expect to be awarded in 2008, but California really is becoming thetour 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 youare not talking about that business that had a lot of potentials in priorconversations, probably a couple of years ago? I was wondering whether anythingwas happening in there.

John Stanik

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

It's an ion exchange technology. It can utilize the serviceequipment that we utilize for other ion exchange type business. It's just notone 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 fromBrean 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 atthe balance sheet and I've noticed that cash position is building prettynicely. I was wondering, what your thoughts were in terms of future uses ofcash?

John Stanik

CapEx for one, Michael. As I mentioned a little earlier inthe 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 themercury market and we are expecting to install grinding capacity, materialhandling capacity, tanks, truck loadouts, rail car loadouts for the mercurymarket and we're in the process.

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

When you add, so that's $20 million roughly or $15 millionor $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 asignificant amount of capital that we're going to be spending here in the nextthree years for growth.

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

Michael Gaugler - Brean Murray Carret

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

John Stanik

If something good comes along, something like the Waterlinkacquisition we made in 2004, in other words, something with really high synergyvalue, consolidation, a competitor that is something that would be veryadvantageous for us.

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

I wouldn't want to take on anything new at this point intime that's very different from what we do now. But if there's something that'sin 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 Amenfrom Rice Voilker.

Corey Amen - Rice Voilker

Hi, guys. Hey, with the mercury emission powder carbonbusiness are you concerned about locking in prices now over the span ofmultiple years?

I mean if we're dealing with a situation of demand exceedingsupply, I would hate to see you cap your prices over the course of multipleyears, when Calgon Carbon's been under earning and now we have an opportunityto 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. Wewant commitments. We want to make sure that the capital investments that wemake, forget BEE-Line.

If we decide to build an expansion at Pearl River, which isvery possible and we talk about committing another $75 million to a newproduction line, we want to be comfortable that we've got the, a sufficientbackbone of that capacity committed. So if we're satisfied with the operatingmargin that we're going to make in these take or pay contracts, and we can getthree years out of them for major volumes, that will make us feel more secureabout investing the money and it will also allow some things to play out sothat if the global supply and demand does strengthen -- let me see. I'll saythat better.

So that if the demand situation globally strengthens to apoint where there's a lot more value and a lot more price potential inactivated 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 ofChinese-activated carbon imports into the U.S. in the past three to six monthsabove 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'sspend a minute talking about it. There is a lot of things happening in Chinaright now. The VAT is one of them, obviously. That's a 13% effect that when youbring it in and put the tariff on top, makes it a 21% impact. So that's asizable number.

If you pick up any periodical and you read about itnowadays, you hear about what's happening to coal, you hear about what'shappening to labor costs in China, hear about environmental pressures. China ischanging very, very quickly. The currency pressures, if you think that there'sa currency pressure between the United States and China, think about what theEuro versus China is.

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

The import statistics that we've seen have shown that atleast in 2006, the imports were down dramatically. Now, that could becompletely the effect of the tariff and people not knowing how bad the tariffwas going to be until it was finalized in April, but I'll bet based on whatwe're seeing, that we're going to see the 2007 imports also be down compared to2005.

Corey Amen - Rice Voilker

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

John Stanik

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

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

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

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

And there's another project in eastern-central United Statesof the same ilk. So there are reactivation opportunities in the United Statesalso. They just seem to be happening a little bit slower than the ones inEurope 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 nomore questions at the present time. Do you have any closing remarks?

John Stanik

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

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

Operator

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

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Source: Calgon Carbon Q3 2007 Earnings Call Transcript

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