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Susannah Robinson

- Director of IR

Patrick M. Prevost - President and CEO

Jonathan P. Mason - EVP and CFO

Ravijit Paintal - VP and General Manager, Fumed Metal Oxide/Aerogel

William J. Brady - EVP and General Manager, Carbon Black

Analysts

Saul Ludwig - KeyBanc Capital Markets

Mike Judd - Greenwich Consultants

Laurence Alexander - Jefferies & Company

Cabot Corporation (CBT) Q2 FY08 Earnings Call May 1, 2008 2:00 PM ET

Operator

Good day, ladies and gentlemen and welcome to the Second Quarter 2008 Cabot Earnings Conference Call. My name is Fab and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions].

I would now like to turn the presentation over to Susannah Robinson, Director of Investor Relations. Please proceed.

Susannah Robinson - Director of Investor Relations

Thank you, Fab. Good afternoon, everyone. This is Susannah Robinson, Director of Investor Relations. I would like to welcome you to the Cabot Corporation Second Quarter Earnings Teleconference. Here this afternoon are Patrick Prevost, Cabot's, President and CEO; Jonathan Mason, Chief Financial Officer; Bill Brady, General Manager of our Carbon Black product line; Eddie Cordeiro, General Manager of Super Metals; Roby Paintal, General Manager of Metal Oxide; Fred von Gottberg, General Manager of Inkjet Colorants; Jim Kelly, Corporate Controller; and Brian Berube, General Counsel.

Last night, we released results for the second fiscal quarter of 2008, copies of which are posted in the Investor Relations Section of our website. For those on our mailing list, you'll receive this information either by e-mail or fax. If you are not on our mailing list and are interested in receiving this information in the future, please contact Investor Relations.

The slide deck that accompanies this call is also available in the Investor Relation portion of our website. The slides will be available for download for two weeks following the earnings teleconference in conjunction with the replay of the call. I will remind you that our conversation today will include forward-looking statements. Forward-looking statements are subject to risks and uncertainties and Cabot's actual results might differ materially from those expressed in the forward-looking statements. A list of factors that could affect Cabot's actual results can be found in the press release we issued last night as well as in our 2007 Form 10-K and subsequent filings with the Securities and Exchange Commission, copies of which are available on our website.

As we typically do during our second quarter teleconference, I would like to remind you that over the next several months in conjunction with our long-term incentive equity program, you should expect to see certain officers of the company selling shares to pay taxes and in some instances loans associated with the vesting of an earlier award and to raise the cash necessary to purchase new shares awarded to them this year.

I will now turn the call over to Patrick Prevost, Cabot's President and CEO, who'll discuss the key highlights and business details pertaining to the company's performance for the quarter and our outlook for the future. We will then turn the call over to Jonathan Mason, Cabot's Chief Financial Officer, who will provide the corporate financial details. We will then open the floor for a brief question-and-answer period. Patrick?

Patrick M. Prevost - President and Chief Executive Officer

Thank you, Susannah. Good afternoon. It is a pleasure to be with you today. As I review our financial results for the quarter with you, we will focus on four key takeaways. First, we had a solid underlying performance in both carbon black and metal oxides during the quarter, arising from strong demand. Second, carbon black continues to experience an unfavorable contract lag due to rising feedstock costs. Third, supermetals and specialty fluids had a weaker than anticipated quarter. And finally, high feedstock costs continue to unfavorably affect our cash and working capital position.

Additionally, I will talk about several aspects of the carbon black business, to help you better appreciate our global leadership position. The carbon black business experienced a significant unfavorable contract lag during the second quarter. In spite of this, the business performed well, expanding unit margins quarter-over-quarter in both the rubber blacks and performance product lines. As a reminder, the contract lag represents the time lag in our ability to recover feedstock cost increases through the pricing adjustments in our rubber black contracts.

During the second quarter of 2008, the impact of the contract lag and LIFO on PBT was an unfavorable $20 million, the highest single quarter impact ever. To give you some context for that, oil has nearly doubled since the second quarter of last year. As you can see from the orange bars on this graph, the PBT of our carbon black business in the second quarter of 2008 adjusted for the contract lag and LIFO impact was at a record level for the business. If feedstock costs remain where they are today, it is fair to assume that the unfavorable impact of the contract lag and LIFO in the third quarter should not be as significant as in the second quarter.

In the inkjet colorants product line, we continue to see signs of improvement in both the OEM and aftermarket segments of the small office home office market segment. We are pleased with the improvement, but anticipate a slowing of this recovery in coming quarters. As we mentioned in the press release, progress in the high-speed inkjet market segment remained slow. However, we continue to be optimistic about the future of the high-speed inkjet market overall.

The metal oxides business segment performed well during the second quarter. Demand in our niche and electronics market segments remain strong. We did, however, experience some softening of demand in the silicon segment, principally in North America and in Europe. Additionally, during the quarter, we were forced to shut down a manufacturing facility in China for nearly three weeks as a result of severe winter weather conditions. This shutdown unfavorably affected our profitability by approximately $1 million during the quarter.

During our recent annual meeting of shareholders, we are pleased to announce our first multi-million dollar order for aerogel in the oil and gas market segment. Since that announcement, we have received our second aerogel order for the same application. We anticipate the orders to be delivered during the third and fourth quarter of this fiscal year and they will materially improve our aerogel results.

Turning to the supermetals business. We are experiencing a softening in demand that we believe is due to a weakening in the U.S. economy. We also continue to face a highly competitive market environment and remain focus on generating cash. Although we continue to buy ore in accordance with our agreement with Talison, the former Sons of Gwalia, through this December, we are purchasing significantly less ore than we are consuming and working through existing inventory layers to deliver cash. Due to our LIFO accounting methodology this could have an additional, unfavorable non-cash PBT impact in excess of $5 million this year, which should, however, be positive for the coming years.

Availability and cost of ore remains a concern, as does market pricing for finished tantalum products. With the uncertainty surrounding the market dynamics and profitability in this business, we will continue to focus on cash. We would also be cautious about entering into any long-term arrangements and will continue to position ourselves for a market recovery.

The specialty fluids business performed solidly during the second quarter. In general, the performance of this business fluctuates significantly on a quarterly basis. This is due to the industry's way of initiating and completing wells in batches and the variability of the residents [ph] time of the fluid on a given well. We're continuing to actively pursue multiple opportunities in new geographic regions at this time.

Now let us look a bit more deeply at the carbon black business. As you can see by this slide, our business has done very well over time even in the face of significant increases in feedstock costs. We have been successful at roughly doubling the profitability of our business over five years, during which time WTI prices nearly quadrupled. We are focused on several levers over the past years to accomplish this. They are; focus on margins, strategic capacity management, alignment with lead customers, and growth in emerging markets.

One example of this is China. We have the leading market share in China today. This success has been driven by our early entry, aggressive capacity growth and by being the supplier of choice to our customers. As you can see, this growth has been significant over the past seven years. I would also remind you that this success should continue with two new rubber black units being built at our existing facility in Tianjin, China. They are expected to begin production by early calendar year 2009. We also commissioned a new performance products unit last October at that same site.

Overall, despite the feedstock cost issues we have faced over the past two years, the carbon black business is very strong and has significant growth potential for this company.

Finally, and before I turn the call over to Jonathan for the corporate financial details, I would like to take a moment to note that the second quarter marked a significant event for the company. At the end of March, our carbon black plant in Waverly, West Virginia ceased production. The Ohio River Plant, as we call it, produced its last pound of carbon black forty years to the month from where it started operations. The employees at the facility are truly a remarkable group of people who managed the closure of the plant with great professionalism and integrity. I would like to personally thank them for their contributions to Cabot over the years and for their excellence in the overall planning, preparation and safe execution of the closure.

To remind you, we took these steps in response to the declining tire market in the U.S. and to enable us to reduce our fixed cost base in the region. We will achieve approximately $10 million per year in fixed cost savings after the closure of the facility is complete. As a result, we will now operate three large rubber black facilities in North America and are in a much more favorable position to weather the difficult market conditions in this region.

I will now turn the call over to Jonathan Mason who will review some of the financial details of the quarter. Jonathan?

Jonathan P. Mason - Executive Vice President and Chief Financial Officer

Thank you, Patrick, and good afternoon everyone. During the second quarter, our earnings were unfavorably impacted by approximately $0.06 per diluted common share from the reversal of a portion of the tax benefits from China investment credits that were approved and recorded during the first quarter. This reversal was due to changes in Chinese tax regulations issued during the second quarter. Excluding this reserve, our tax rate on continuing operations would have been approximately 27%. We continue to anticipate a tax rate between 26% and 28% for the full year excluding the impact of current and possible future settlements on the tax rate.

Turning to capital, we invested approximately $40 million during the quarter in capital expenditures. These expenditures included spending on the rubber black expansions in China that Patrick referenced earlier and on energy centers. The company anticipates spending approximately $200 million in total CapEx for the full fiscal year 2008.

Also during the quarter, we repurchased 732,000 shares on the open market for a cash cost of approximately $21 million. This was an average price of about $29 a share. And finally, during the quarter, our operations generated about $37 million in cash, despite a $27 million increase in working capital on a constant dollar basis. The rise in working capital was driven by increased carbon black feedstock costs.

Looking a little more deeply, we've been successful over the past two to three years at managing our working capital position, cutting our working capital base by 35%. With the continued increases in carbon black feedstock cost, we're aggressively looking for ways to further reduce our working capital levels. These reductions are much more difficult than those in 2006 and 2007 as we've taken out most of the low hanging fruit already. Since each day is worth more at these levels, however, we are looking for every opportunity.

Back to Patrick.

Patrick M. Prevost - President and Chief Executive Officer

Thank you, Jonathan. In conclusion, we are focused on recovering rising carbon black feedstock costs and continue to aggressively manage margins in all of our businesses. Additionally, we are taking all opportunities available to improve the cash and the working capital position of the company. And lastly, we remain committed to improving the speed with which our new businesses begin to contribute materially to the company's earnings.

Finally, I am pleased to announce that we are in the process of planning an Analysts Day to be held on Thursday, May 29th, near our corporate headquarters in Boston. This is the first such day in several years for the company and we look forward to the opportunity to discuss our vision, strategy and portfolio of businesses. A press release with details for the day and associated webcast will be forthcoming shortly, or you can contact our Investor Relations department directly.

I would like to thank you once again for your… for joining us today and I look forward to speaking with you at the end of May.

Susannah Robinson - Director of Investor Relations

Thank you, Patrick. Fab, we will now turn the call back over to you for a brief question-and-answer session.

Question and Answer

Operator

Thank you. [Operator Instructions]. And your first question will come from the line of Saul Ludwig with Keybanc. Please proceed.

Saul Ludwig - KeyBanc Capital Markets

Good afternoon. In the press release, you talked about decisions that were made in North America and Europe to change the customer and product mix with the idea of giving up some volume and increasing profits. Would you just elaborate a little bit on that rebuild? And how do you do that so quickly, in other words, this carbon black is a little bit under longer-term contracts, and is this the first quarter that we have seen this shift and therefore should we be thinking about more moderate volume numbers going forward in light of the change in the mix, a little clarification would help?

Jonathan P. Mason - Executive Vice President and Chief Financial Officer

Well, so I would start by saying, optimize…our goal is to optimize the margins, so the pricing and volume gives and takes that we do, we do it with that ultimate goal in mind. Now, the reason you saw a fair amount of activity in this quarter is because on January 1st, the annual contracts came due and we had one of our long-term contracts that came due as well. And so we made some trade off at that time in all of those contracts.

Saul Ludwig - KeyBanc Capital Markets

Is this… does this not [ph] affect your profitability under the new setup versus what it would have been under the old setup?

Jonathan P. Mason - Executive Vice President and Chief Financial Officer

The net effect was positive.

Saul Ludwig - KeyBanc Capital Markets

Okay. And should we be thinking about the effect of lower volume, particularly in South America and in North America as we look at the next… the quarters throughout this calendar year?

Jonathan P. Mason - Executive Vice President and Chief Financial Officer

I think it should be more stable than what we saw at the turn of this past quarter.

Saul Ludwig - KeyBanc Capital Markets

Okay. Next question I had is the… for Patrick, or Roby maybe. On the aerogels order, what’s sort of the magnitude of the two orders… and you mentioned that we’ll have materially improved results. What do you think that will do to the loss, let's say, in the back end of the year compared to what the loss in aerogels was in the front end of the year? So two questions, the sales volume and impact on profitability.

Patrick M. Prevost - President and Chief Executive Officer

Thank you. So, this is Patrick speaking, and we are very pleased to see the orders coming through in an application where we can get significant orders to help the development of that business. However, we need to realize that this is a business that’s still at the new business development stage, and as you… as we have mentioned in the past, this is still a business that is in cash-negative situation and will remain so even through the rest of this year. However, the significance of these two orders in the oil and gas segment have improved the situation dramatically and we are seeing actually through those two orders a recognition of our capability with our aerogel to solve critical technical problems for this industry. And I will ask Roby if there is anything he would like to add?

Ravijit Paintal - Vice President and General Manager, Fumed Metal Oxide/Aerogel

No, the only thing I would add, Saul, is that for obvious competitive reasons we can’t tell you what the value of the orders is, but they will… but together they would add up to multi-million dollars.

Saul Ludwig - KeyBanc Capital Markets

Okay. What I am trying to get out is, Patrick, you alluded to maybe a $5 million hit that maybe luring [ph] thinking about in supermetals as you reduce your inventory in the back end of the year, and I'm wondering if the… these two orders could possibly reduce your losses by an amount that would maybe offset the hit that you are going to have in the supermetal business?

Patrick M. Prevost - President and Chief Executive Officer

I would say that certainly aerogel is going to help Cabot going forward.

Saul Ludwig - KeyBanc Capital Markets

Yes, you used the word material and I don't take that lightly?

Patrick M. Prevost - President and Chief Executive Officer

Material in the context of aerogel.

Ravijit Paintal - Vice President and General Manager, Fumed Metal Oxide/Aerogel

Right. And it is a business that is still going through a growth phase in their early stages of development. But certainly the aerogel orders are going to help in that respect and will improve the situation for Cabot.

Saul Ludwig - KeyBanc Capital Markets

Okay. Thank you very much.

Patrick M. Prevost - President and Chief Executive Officer

Thank you, Saul.

Operator

Your next question will come from the line of Mike Judd with Greenwich Consultants.

Mike Judd - Greenwich Consultants

Hi, yes, good afternoon. In light of the meeting at the end of the month, I was just wondering given that you’ve, no doubt, been doing a strategic review, but there… you have some tit-bits that you might want to share with us or preview, so to speak, in terms of what some of your conclusions are that you've come to… since you’ve been there?

Patrick M. Prevost - President and Chief Executive Officer

Thank you, Mike. I think we are going to have to be patient until the end of May in that respect. But as you asked this question I think that the two slides that we actually included in today's presentation on the carbon black business, what I would call perhaps tit-bits in relation to the kind of analysis and work we are doing with regard to our various businesses, and here we wanted to highlight the strength of carbon black even in the face of extremely dire conditions from a feedstock point of view, and we will go into more detail as we discuss the portfolio and the various opportunities coming for us at our Analysts Day on May 29th.

Mike Judd - Greenwich Consultants

Okay. And just as a follow on to your comment, especially with the contract lag, your predecessor basically believes that it's a nature of the business that… they are these lags. Have you come to any conclusions in regard to how these contracts can perhaps be repositioned or otherwise change so that perhaps some of these raw material costs will flow through on a faster basis or a quicker basis?

Patrick M. Prevost - President and Chief Executive Officer

Mike, I think this is a very critical item for Cabot and it has a material effect on the performance on the company. Therefore we are looking at ways to mitigate those. Clearly, some of these contracts were negotiated at a time when oil prices and raw material prices first were much more stable and they did not create the type of effects we are seeing today. So we are in the process of looking at how we're going to deal with the situation, contracts will come up for renewal and we will consider ways to mitigate the lag and work with our customers to make sure that both sides can actually live with a perhaps improved contract structure.

Mike Judd - Greenwich Consultants

Thanks for the help.

Operator

Your next question will come from the line of Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies & Company

Good afternoon. I guess the first question is on carbon black. Can you give us an update on the pricing trends in performance blacks?

Patrick M. Prevost - President and Chief Executive Officer

I'll let Bill answer that question, that's okay Laurence?

Laurence Alexander - Jefferies & Company

Yes.

William J. Brady - Executive Vice President and General Manager, Carbon Black

Hi, Laurence. Yeah, pricing trends in performance blacks continues to be strong and I would say we continue to do a very timely job there of recovering feedstock increases, and the higher the value in the application, the better we're doing. So, very positive trend and going very well.

Laurence Alexander - Jefferies & Company

And when you look at the underlying profit improvement in carbon black excluding their raw material LIFO lag, how much of that… can you walk us through some of the drivers for that and how much of that should be sustainable going forward?

William J. Brady - Executive Vice President and General Manager, Carbon Black

Well, I think if you look at the performance relative to last year, it's an incremental improvement over last year. And I think it tells you that that we're at about that earnings level, the quarter-over-quarter comparison. And I think it shows our growing business in China and Asia, as one of the key drivers and also our ability over this time to take out high cost places in the company, at the same time we are building up in the emerging regions. And I think when you do that, you work hard on the feedstock piece of the equation as we do and you put it all together, you get to those level of earnings, which I think is sustainable.

Laurence Alexander - Jefferies & Company

And then lastly on carbon black in North America, with Waverly shut, what's your sense of your utilization rates versus your competitors, and is North America still profitable, and then do you think your competitors are profitable at this point?

William J. Brady - Executive Vice President and General Manager, Carbon Black

Well, our utilization rate in North America after the closure of a Waverly is pretty high for rubber blacks. And I can't speak for our competitors. I only know what you know. So I think you have to ask them about their utilization rates. For the industry in North America, it’s pretty low. I think it is in the 80s, but we are pretty high and I think the closure of that facility, and as Patrick mentioned, the three larger facilities that we now have left are in a much stronger competitive position to weather the storm in North America.

Laurence Alexander - Jefferies & Company

Yeah, thank you.

William J. Brady - Executive Vice President and General Manager, Carbon Black

Sure.

Operator

That concludes the Q&A portion of today's conference call. I would now like to turn the call back over to Susannah Robinson for closing remarks.

Susannah Robinson - Director of Investor Relations

Thank you, Fab. We appreciate everyone joining us today. We look forward to speaking with you at the end of May.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.

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Source: Cabot Corp. F2Q08 (Qtr. End 03/31/08) Earnings Call Transcript
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