Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

GrafTech International Limited (NYSE:GTI)

Q4 2012 Earnings Call

February 26, 2013 11:00 AM ET

Executives

Kelly Taylor – Director, IR

Craig Shular – Chairman, President and CEO

Lindon Robertson – VP and CFO

Analysts

Martin Englert – Jefferies & Company

Arun Viswanathan – Longbow Research

Sal Tharani – Goldman Sachs

Luke Folta – Jefferies

Michael Gambardella – JP Morgan

Mark Parr – KeyBanc

Rob Pohly – Samlyn Capital

Chris Haberlin – Davenport & Company

Ray Rund – Shaker Investments

Zahid Siddique – Gabelli & Company

Chuck Bradford – Bradford Research

Thomas Horan – Acorn Capital

Operator

Good morning. My name is Jody and I will be your conference operator today. At this time, I would like to welcome everyone to the GrafTech Fourth Quarter and Year Ended 2012 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like to turn the conference over to Miss Kelly Taylor. Please go head, ma’am.

Kelly Taylor

Thank you, Jody. Good morning and welcome to GrafTech International fourth quarter and year-end 2012 conference call. On the call today is GrafTech’s Chief Executive Officer, Craig Shular; and our Chief Financial Officer, Lindon Robertson. We issued our earnings release this morning. If you did not receive a copy, please contact Marie Noar at 216-676-2160 and she’ll be happy to fax or e-mail a copy to you.

As a reminder, some of the matters discussed during this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Please note the cautionary language about our forward-looking statements contained in our press release. That same language applies to this call.

Also, to the extent that we discuss any non-GAAP financial measures, you will find reconciliations in our press release which is posted on our website at www.graftech.com in the Investor Relations section.

In particular on this call, we will be discussing for the periods reported, the non-GAAP financial items of adjusted EBITDA, operating income, net income and EPS that exclude the non-cash impact of fourth quarter pension-related charges as well as certain discrete tax benefits. Any year-to-year to growth comparisons reflect these same adjustments. Further information on the methods we use to calculate these items can be found in our SEC filings. For your reference, a replay of the call will be available on our website.

At this time, I’d like to turn the call over the Craig.

Craig Shular

Thank you, Kelly. Good morning, everyone. Thank you for joining GrafTech’s call. Today, we’ll take you through our full year and fourth quarter highlights, provide commentary on our 2013 outlook, and then open it up for Q&A.

Recapping 2012, we achieved sales of $1.2 billion, our second highest sales in company history. Our Engineered Solutions segment grew 18% to $223 million, slightly – I’m sorry, an all-time record for that business. EBITDA came in at $247 million, slightly ahead of guidance, a solid performance in a very difficult environment. Net income was $113 million or $0.81 per share.

The 2012 market environment for our company was a challenging one. The EU recession, where approximately 30% of our sales typically reside, and the sizable carryover of GrafTech electric inventories our customers had in Q1 were significant headwinds.

Furthermore, many of our steel customers globally incurred large losses in 2012 which contributed to the difficult environment. We responded to the challenging market dynamics by reducing our workforce almost 10%, freezing pay increases for the top 90 in the global leadership team, and reducing planned CapEx and overhead expenses.

Other highlights in 2012 include the development of a super-premium grade of needle coke and successful commercialization of this breakthrough product in the second quarter of 2012. This represents a key development in expanding Seadrift’s ability to service the full range of customer needle coke needs.

In addition, the development of super-premium needle coke marks an important strategic milestone in our ability to internally source our needle coke requirements, providing us with greater procurement flexibility and less dependence on third-party suppliers. Our Seadrift facility has been a very important part of our 2012 results and we believe represents a sustainable competitive advantage.

Rounding out 2012 highlights, we celebrated the successful landing of the Mars rover, Curiosity, in August. The thermal solutions used in the Mars rover’s heat shield, which protected it from the intense heat and friction generated during descent through the Martian atmosphere were developed and manufactured by a subsidiary of our Engineered Solutions segment.

Our team has a rich history of developing innovative graphite solutions to manage thermal issues for a number of industries and end markets. We continue to leverage this core competency and position our company as a premier, advanced materials company.

Turning to our Q4 results, total company sales improved 7% to $371 million. EBITDA came in at $75 million. Net income was $34 million or $0.25 per share.

In our IM segment, sales increased 5% to $310 million. Operating income for the segment was $44 million. It’s important to note that 2013 marks the final year of a third-party take-or-pay type needle coke agreement triggered by the acquisition in which – sorry, the acquisition of Seadrift in which GrafTech is required to purchase specific needle coke quantities. Going forward, this will provide us with increased flexibility to further optimize our vertical integration with Seadrift and manage inventories.

In our Engineered Solutions segment, sales increased 19% to $61 million. Operating income was $7 million or 11% of sales. Our Engineered Solutions business finished the year with record sales of $223 million, achieving a more than 20% annual growth rate the past three years. The capital investments we made and the new products we developed in our R&D center in recent years helped propel this growth.

Turning to outlook, based on current International Monetary Fund projections, the estimate for global GDP growth in 2013 is 3.5%, a slight downward revision from the IMF’s last projection in October 2012. The IMF notes that although global economies are expected to recover at a gradual pace, downside risk remained significant. The IMF highlights that recessionary conditions in Europe persist and that the euro region continues to pose the largest downside risk to the global outlook.

According to the World Steel Association and other published reports, global steel production is expected to increase 3.2% in 2013. Steel customer confidence, however, remains subdued due to the continued economic uncertainty and the very tough year they’ve had in 2012.

Overall, we expect higher volumes in our Industrial Materials segment in 2013 due to anticipated restocking of inventory and improvement in steel production levels across our global customer base.

There have been several electric arc steel furnaces that are coming back on recently in key geographies for us that will benefit our 2013 volume. As a result, we expect to run our facilities at approximately 70% op level in the first quarter, up from around 65% Q4 last year.

The graphite electrode market has become increasingly competitive with the addition of approximately 100,000 metric tons of capacity coming online over the past year of which approximately 65,000 metric tons are located in China.

In addition, an estimated 130,000 metric tons of additional graphite electrode capacity expansions have been announced, of which 100,000 metric tons are located in China and these are expected to be operational in 2013/2014. These additions have further exacerbated a global electrode industry which already had excess capacity.

In the needle coke market, additional supply has come online with the restart of a major Asian producer whose operations had been suspended for several months in 2012. This producer appears to be currently fully operational resulting in additional available capacity this year.

The graphite electrode and needle coke capacity additions described above are compounded further by a still recovering global economy and a challenging steel market in which many steel producers continue to struggle to achieve acceptable profitability levels.

The modest improvement in global economies and our steel end market, while encouraging, is not enough to offset the negative impact of the graphite electrode and needle coke capacity additions. As a result, these factors are contributing to downward pricing pressure on both graphite electrodes and needle coke for 2013.

Over time, we believe the aforementioned excess graphite electrode capacity could be absorbed by growth in the EAF furnace sector. Based on CRU International and other estimates, it’s expected that approximately 100 million metric tons of new EAF steel capacity will come online over the next five years.

We are well positioned to manage through the cycle and will focus on managing those items within our control. We will continue to provide our customers with superior service, quality, and product innovation; we’ll maximize the cost competitiveness of our advantaged backward integrated business model, and finally growing our ES business to diversify our company.

On the cost front, we will further reduce overhead expense through additional rightsizing initiatives, hiring restrictions, suspension of the 2013 salary merit increases, and reductions in travel and other discretionary expenses. We expect overhead expense to be down $15 million this year as compared to last year.

We’ve also reduced targeted capital expenditures from 2012 levels. In our IM segment, at the mid-point of our range, CapEx is expected to be approximately $60 million; $55 million for maintenance and the remaining $5 million will be invested on product innovation to grow our competitive advantages.

In our Engineered Solutions segment, we plan to invest approximately $45 million. $35 million will be growth capital to support increasing demand for our products used in advanced consumer electronics, such as OLED, LED, LCD displays, tablets, smartphones and e-readers, and in the energy sector, items such as our work on lithium ion batteries and the oil and gas industries. The remaining $10 for ES is related to maintenance spend. These investments position our company for future growth and support our target of double-digit revenue growth and operating income margin expansion for the ES segment in 2013.

On a standalone basis, i.e., excluding the shared corporate allocations, we expect the Engineered Solutions business will generate sufficient cash to fund itself in 2013. GrafTech’s Lean Six Sigma efforts will also contribute to drive additional productivity improvements, eliminate waste and drive quality improvements throughout the organization which will result in savings and value to our customers.

Secondly, we have capitalized on our advantaged low cost business model by continuing to optimize our Seadrift assets to the benefit of our entire graphite electrode network. Seadrift is making the best needle coke it has ever made. And with the breakthrough on super premium needle coke, we can now internally source the full range of our needle coke requirements. Recall that this is our last year of the third party take-or-pay type wind-down agreement triggered by our acquisition of Seadrift.

Thirdly, our Engineered Solutions business will continue to grow in this challenging environment and will partially mitigate the downside variability of the cyclical steel environment that we face. We anticipate solid top line growth and improved margin profile in this segment as our ES product portfolio shifts to higher margin businesses. We expect double-digit revenue growth for the full year and operating income margins to be in the range of 13% to 15% in the second half of 2013.

For our full year guidance, we are targeting EBITDA to be in the range of $175 million to $205 million. We expect the first quarter will be our weakest with EBITDA targeted to be in the range of $30 million to $40 million. The first quarter of 2013 will be negatively impacted by seasonally lower graphite electrode volumes and higher cost inventory due to the carryover of third party needle coke acquired in 2012.

In the second half of 2012, we expect improved profitability due to the higher sales in both business segments and lower cost in our IM segment as we work off higher cost third-party needle coke and reflect lower fixed cost per unit as operating rates improved over the year. We are targeting cash flow from ops to be in the range of $150 million to $180 million. It should be a strong year for us. That’s probably up about 60%, 65% over last year.

We are targeting an effective tax rate to be in the range of 33% to 36% as the tax benefit inherent in our operating model is reduced due to less favorable mix of jurisdictional profitability. It’s important to note, however, that our cash tax rate is estimated to be approximately 10 percentage points lower or 23% to 26% as we effectively utilize foreign tax credits.

Through our strong business model, low cost production and backward integration, GrafTech is positioned as one of the best graphite material science companies in the world with a team that has a proven track record of successfully managing through electrode industry cycles. Our goal is to come out of this difficult environment better than we entered, just as we did during the 2009 global recession.

Our advancement in graphite electrode and needle coke quality, combined with our industry leading customer tech service and global production platform, position us best to serve our worldwide customers. In addition, our Engineered Solutions segment, which has produced double-digit revenue growth over the past three years, provides us with a sustainable base for further diversification.

Finally, I’m confident that our company is up to whatever challenges the global economy presents, team GrafTech will seize growth opportunities and emerge from these tough economic times with an even stronger business model and a sustainable strategic advantage to drive long-term shareholder value.

That’s the end of our prepared remarks. Jody, could you open it up for Q&A, please?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Martin Englert at Jefferies & Company.

Martin Englert – Jefferies & Company

Hi, good morning, everyone.

Craig Shular

Good morning, sir, how are you today?

Martin Englert – Jefferies & Company

Not too bad, and yourself?

Craig Shular

Oh, excellent, Martin. Thank you very much.

Martin Englert – Jefferies & Company

So, I wanted to get a sense of what kind of declines you were seeing in the graphite electrodes and needle coke year-on-year that’s baked into the 2013 guidance?

Craig Shular

And when you say declines, you mean in prices?

Martin Englert – Jefferies & Company

Yes, sir.

Craig Shular

Yes. In graphite electrodes, it varies by geography. But I would say, the decline in prices are probably around 8% to 12% in graphite electrodes. And needle coke would be probably around 8% to 10% decline. And that would be 2013 versus what we saw last year.

Martin Englert – Jefferies & Company

Okay, thank you. Was there any material shift in the – I guess, or how much of the order book have you had built out so far for the electrodes and what do you anticipate for the needle coke order book on 2013?

Craig Shular

Yeah. If I look at both books, I would say when starting high level, I expect higher volume in both books than last year. We’ve started to see some improvements in most of our geographies, so demand will be a little bit better than last year. And then especially in the electrode book, recall last year there was virtually no Q1 and also a soft Q2 due to the big overhang and carryover from the prior year of graphite electrodes. So what I see this year is better demand, almost every jurisdiction for graphite electrodes. And then I don’t see as much – near as much carryover that affected Q1, Q2 last year.

So part one, higher volumes in both those businesses and then what I would say, in some of the geographies where we have local manufacturing, South America, South Africa, we’ve started to see some furnaces come on online that were off for much of last year. And we’re so well positioned to serve those furnaces.

So I see some items where we’ll benefit maybe even more than the overall growth in steel where last year we were – we probably felt it even harder because those segments and those geographies were so important to us.

Martin Englert – Jefferies & Company

Thanks. That’s helpful. In addition, is there anything materially different about the mix of electrode products that you’ll be selling in 2013 versus 2012? Anything weighted more towards ladle grade more or less than you did?

Craig Shular

No. When you look at ladle and melter, it’s not a major swing at all. And then, as far as the percentage of the book done, you had asked, we’re a bit over 60% done on the electrode book and needle coke is probably between 50% and 60%. So it’s been an orderly process other than the slide in price and I’d look to round that out probably over the next couple of months, customers are coming in quite frequently now for their requirements.

Martin Englert – Jefferies & Company

If I could, one last question.

Craig Shular

Please.

Martin Englert – Jefferies & Company

On the release, you had talked about the new Chinese capacity coming online or that’s been ramping up or expected to ramp up. Can you talk about how, I guess, to the extent that they play in the international market or they’re exporting that material to other regions outside of the country?

Craig Shular

Yeah, they do a lot of export and if we recap kind of last year, the Chinese graphite electrode industry last year probably had one of its worst years ever; very, very large losses, a lot of excess capacity in the domestic market and they really struggled to make any money locally. Credit terms and payment stretched out six months, nine months, a year and a half, in some cases, in the local markets.

So, think of the local producers in China, most of them have lost significant amounts last year in the dogfight that’s been in the Chinese market, a lot of excess capacity.

All of them try to export because the local market really doesn’t give them anything. So, their exports are in virtually every country and depending on the type of furnace, the customers’ requirements or the customers’ willingness to wrestle with some of the Chinese supply, which sometimes can be variable, they’re a factor, no doubt about it. They tend to be the low price – the low quality, low price guy and when the steel industry is struggling, as it did very much so last year, like any industry, any company, they look at every opportunity they can to reduce costs.

So, they’re a factor. They tend to be the lowest price and they also tend to be at the low end of the quality range.

Martin Englert – Jefferies & Company

Thank you very much. I’ll get back in queue.

Craig Shular

Thanks, Martin. Have a good day.

Operator

Our next question comes from the line of Arun Viswanathan from Longbow Research.

Craig Shular

Good morning, Arun, and how are you today?

Arun Viswanathan – Longbow Research

I’m well. Thanks, Craig. Thanks for taking my question. I guess the first thing was on needle coke. You said that you’re running out of your take-or-pay contracts here. So, where will you take your internal consumption over time and how do you see that playing out in 2013?

Craig Shular

Well, time will tell, Arun. We’ve been taking about 70,000 metric tons out of Seadrift. That coke, since we’ve owned it, if you think of the normal grade needle coke, has made significant improvements in the quality. And then, of course, on top of that, we had the huge breakthrough on super-premium needle coke. So, now that that facility can make all of the grades we require and we no longer have, starting next year, that mandated take-or-pay type contract, we have complete flexibility to maximize Seadrift’s operating rate, the profitability, et cetera.

So, time will tell where that goes and I’ll share with you. Last month, we made some electrodes with the normal premium needle coke that Seadrift’s been making for 30 years. With all the improvements that we’ve done under our ownership, it’s the finest normal premium they’ve ever made and we’ve made electrodes with it, and I’ll tell you, the electrodes coming out of our electrode plants are the finest electrodes we’ve ever made.

So, obviously, we see this as a strategic competitive advantage on quality, better service for our customers, we have assured supply. And so over time – time will tell where we go, how much we use of it, but I think your big takeaway should be we’ve had a major constraint here. We had three years of take-or-pay type contract that were triggered and mandated by the Department of Justice under that P66, the old Conoco contract.

So, for instance last year, we had to buy about 80,000 tons from Conoco, huge numbers. So, lack of flexibility. We have to take it. It’s a kind of a take-or-pay type situation. So, my point is when you put our ability to make super premium needle coke, you look at what we’ve done with the normal premium and the quality that that team has delivered for us, just outstanding. And then you match that up with the flexibility we have go forward, our low cost platform, I think, just got better position, more flexible, better to generate EBITDA and quite frankly more competitive.

Arun Viswanathan – Longbow Research

Okay, thanks. And then on the volume side, you said you’re seeing slightly better volumes in 2013. So, how does that kind of play out your utilization rates? Were you in the low to mid-60s in 2012 and you see that going up in 2013 in electrodes and what about needle coke as well?

Craig Shular

Yes, the way we see the book going, I’ll start with the graphite electrodes first. We’ll run about 70% in Q1. If you go back to Q4, the exact number was 64%. So, we’ve stepped up from 64% to 70% in Q1. And what I would expect the way the book is coming together and like I said before, almost every geography is a little bit better. And then we don’t have that big hole in Q1 and Q2 that we had last year due to the huge carryover inventories our customers had.

So, what I see looking forward in op level we’ll do about 70% in Q1 and I would expect over the course of the year it will be higher every quarter. Q1 should be our lowest operating rate and we’ll build on the 70% and depending how the book comes together, how the economy shape up, we could be, we could exit in the low 80s.

And so volume is coming up, there’s new EAF furnaces and so I would expect that second half of the year will be our better half for sure. We would have worked off the old high cost Conoco coke that we had to buy.

That should be gone pretty much in the first half, so costs will be better. Operating rates will be higher the second half. Our ES business continues to put nice points on the board. They will have a solid second half, like we said. Margins – op margin 13% to 15% and we should exit the year if the economies continue the trajectory we see and steel’s up at 3% that world steel is looking for. We should exit the year probably with a 80% plus, 82%, could be 83% operating rate.

Arun Viswanathan – Longbow Research

Okay. Thanks. And I guess, another longer term question then, if things are going to get better in the second half, how do you see longer term kind of pricing playing out in electrodes and needle coke? I mean, you used to enjoy a little bit better situation. Obviously, things are a little tougher in 2013 with new competition. I mean, is that a structural headwind that you won’t be able to overcome in future years or how does that relate to the future as you see it?

Craig Shular

Yes. You’re right. It’s an overhang in capacity. Picture in 2011 and 2012, the graphite electrode industry already had excess capacity and then the new capacity coming out over the next couple of years that we highlighted just exacerbates that, so I see it’s a timing item. It’s going to be structural here for a while.

I really like our position in that kind of situation. We have a very solid track record, performing well when our industry gets tough. I like what our model’s done, how we built that out back integrating. I like the needle coke quality. I like the ES diversification. So, I think we’re very well-positioned. So, there’s going to be a little bit of a market conflict out there. You’ve got some guys that have put in new capacity and whatnot. But when I look at what we have versus the other guys, I like that match up. And I’d tell you, our plan is we’ll come out of this bigger, better, and faster than we went into it.

Arun Viswanathan – Longbow Research

Yes. Sorry, this is a clarification though. I mean, historically, there were times when you could get 15% to 20% needle coke pricing and the structure there hasn’t necessarily changed so much so that would preclude that, would it? And I understand there’s more capacity in electrodes, but can we see the pricing, the type of pricing improvements that we’ve seen in the prior year?

Craig Shular

Yes. Good point. I was speaking about graphite electrodes. If we change it over to needle coke, I would expect now that we are out of this take-or-pay large volume, our volume drops down significantly this year versus what we had to buy last year. So, our flexibility, already this year, is picking up. The volume’s cascaded down, so this year I think we have to buy about 56,000 tons.

So, what I see in needle coke is we should run full out. Seadrift needle coke is going to run full out between our demand and the market. So, if I look at needle coke, I see that sector getting tighter sooner than graphite electrodes. It’s not as much capacity overhang versus what we have in graphite electrodes. So, your point is spot on. Needle coke should get better before electrodes. That’s generally been the trend in the last 30 years. It’ll get tighter first and so, needle coke really doesn’t have a large structural issue right now in front of it.

Arun Viswanathan – Longbow Research

Okay, thanks.

Craig Shular

Thank you.

Operator

Our next question comes from the line of Sal Tharani from Goldman Sachs.

Craig Shular

Good morning, Sal. How are you today?

Sal Tharani – Goldman Sachs

Fine, Craig. How are you?

Craig Shular

Great, thanks.

Sal Tharani – Goldman Sachs

So going back to this take or pay contract you have, does that contract is impacting your Seadrift that you are not running it full out because you can’t sell the rest of – versus what you will be getting in the future internally?

Craig Shular

This year Seadrift will run full out, just to be clear. In the last two years, it’s been a constraint that we’ve had to manage around because we had to buy so much and then obviously, we want to run Seadrift as full as we can. So, think of it as a significant constraint that our operation has had that this year is much smaller and next year goes away.

And so we’ve managed through it the last three years, hasn’t been easy. We’ve had to manage through that when the global economies were in very tough shape, EU went into a massive recession, and last year, like I said, we had to take 80,000 tons, manage through EU recession, huge slowdown in a lot of our markets, 30% of our sales are in the EU. But, Sal, my point would be that that’s behind us.

Sal Tharani – Goldman Sachs

The electrode versus needle coke, which one do you have to run at high utilization rate to sort of dissipate or reduce the fixed costs?

Craig Shular

Well, both enjoy reduced fixed costs per unit as they run higher. So, think of Seadrift will run full out this year. So, they will have a very nice cost structure. They’re making outstanding quality, as I said earlier. So, they will benefit from higher operating rate – they will run higher. Last year was not low for them. They were in the high 80s for much of last year.

Remember last year, we had to interrupt the Seadrift machine to do many trials. We were perfecting and trying different formulations for the super-premium needle coke. So, we had lot of interruptions.

During the turnaround last year, you’ll recall we made modifications to the machine using some of our technology, et cetera. So this year, we don’t have any of that. So this year, Seadrift will run at a high op level, without any of those types of interruption, making spectacular needle coke so it will enjoy nice fixed cost absorption.

And then electrodes, over the course of this year, op level should come up. First half, as I said earlier, we should finish with the higher cost third party needle coke we had to buy. And so second half, we’ll have higher fixed cost absorption per unit and lower costs because the higher cost coke will be worked off.

Sal Tharani – Goldman Sachs

Okay. And last thing, beyond 2013, how should we look at the tax rate and your SG&A? Any guidance you can give or at least an idea? Should we go back to 20%, 24% or do you think it will remain in the 30s, the tax rate?

Craig Shular

Well, as you see on the overhead, we’ve done a lot of work there. We did a lot of work last year, a lot of heavy lifting, a lot of reductions in teammates and cuts in discretionary. But if I profile SG&A for you first, kind of 12 to 23, last year, we – if I pull out R&D, call R&D for us is about $13 million. We don’t want to cut R&D. It’s our future in electrodes and Engineered Solutions and needle coke. And you see the benefits. You see what we did with our R&D with needle coke. You see the double-digit growth in Engineered Solutions, so our graphite material science work in R&D, we don’t want to slow down. So last year was about $13 million. This year will be about $13 million. So we want to protect that.

On SG&A, last year I think it was about $142 million, and this year, I think if you look at our guidance, it should come in around $127 million, so it’s down about $15 million. So we’ve got virtually all of that off the payroll already. We’ve already moved. We moved Q4, December, January, February, on all of that, so overhead this year, $127 million. So for SG&A and total about $140 million, so if I look at those two totals, $155 million to $140 million, that’s the way I’d look at SG&A, so we’re trying to be very, very tight there but not sacrifice R&D and our service to the customer.

On tax rate, as you see, we have a complex tax picture because we sell in so many countries and we produce in so many countries, and we have the widest network of graphite electrode plants around the planet. So well positioned to service the customers, but it generates a complex tax book.

And you’ve seen in the last several years, we’ve been very good at getting very low tax rates in their low 20s. This year, because of some of the jurisdictional profitability, some of that kind of moved some of our tax credits, you see our tax rate is going to come up. How long that’s going to last, I don’t know. Could it last into 2014, yes, it could. Some is going to depend on profitability where the industry goes, but can we get back to those 20s, absolutely.

So, for planning purposes, if you wanted to use this year and I don’t know, maybe next year at a higher tax rate, but I would not do it in any long-term plan for us. We will get back to those low 20s. It’s the model we’ve built here.

Sal Tharani – Goldman Sachs

Okay. Thank you very much.

Craig Shular

Thank you, sir.

Operator

Our next question comes from the line of Luke Folta from Jefferies.

Craig Shular

Hey, Luke, how are you?

Luke Folta – Jefferies

Hey, guys, can you hear me?

Craig Shular

Yes, sir. How are you today?

Luke Folta – Jefferies

Not bad, Craig, how about yourself?

Craig Shular

Oh, outstanding, thanks.

Luke Folta – Jefferies

Good. A couple of just a quick follow-ups, firstly just on the tax rate, like you said, there has been a bit of a shift in jurisdictional profitability. Can you talk about which regions have changed and what’s kind of driving that change in the tax rate?

Craig Shular

Yes, absolutely. Let me toss it over to Lindon, he’ll give you some color on our tax book.

Lindon Robertson

I would just highlight that as our business is a global – business operating in a global market, we rely on manufacturing locations that you can see described in our public filings. And as we structure this tax book, it’s based on our operations. And so, when we structure it as most companies would, it would put it – you bring those profits to those manufacturing sites as they’re contracted to provide manufacturing to your global equation.

And then your global fulfillment equation provides you the incremental opportunity to fulfill and in a higher margin equation, that’s where those higher margins will flow as the global entity makes the sale.

And so our structure does become more optimal at a higher profit level. And so this year as we’re guiding a little lower profit, you can see that there’s pressure on that tax rate.

Now, a second aspect of this is the ES business has – Engineered Solutions business has accelerated and increasing some profitability as well. Most of that business equation is still based in the U.S. and in that regard, that’s driven off of the U.S. jurisdictional profit. That’s a smaller element of it but that’s not something that we’re – that we certainly regret. It’s the mix of the entire graphite electrode market though and lower margins that you can anticipate with the pressure on price that is really driving the change in our tax structure.

Luke Folta – Jefferies

Okay. It seems like that’s kind of fairly complex. I guess, could you simplify it by saying that you’re making more in the U.S. and less in some of your other regions. Is that what it really boils down at the end of the day?

Lindon Robertson

Well, it’s not quite that simple. It’s the profit margins, again, come back to those manufacturing locations that we contract inside our structure, and so we manufacture, yes, in the U.S. but we also manufacture in Mexico, Brazil, France, Spain, South Africa.

And so much of these are under the contract that I described. And I would just probably hesitate to go further. As you said, it is complex. And I think I run the risk of creating more confusion than helping to clarify. But when you get into a lower profit equation, the very first people who get – the first plants and locations that get paid on this is those contracted manufacturers. And so the incremental margin opportunity and our global structure is what puts pressure on the tax rate.

Luke Folta – Jefferies

All right. Thanks for that. And also, you – there’s a lot more discussion about China this quarter than there ever has been. Understand the capacity issue. Can you talk about what’s happening from a quality perspective there? Because it seems like based on what you’re saying and also just in some of our channel work done over the past year that their presence in some of the major markets is increasing. I’m curious to know is it’s – if you think it’s more a function of their quality is slowly getting up the curve or was it just that there was a meaningful price differential between the – kind of Chinese and non-Chinese producers that kind of allowed them in and now they’re there? Any color on what’s happening there would be a help.

Craig Shular

Yes. Luke, we haven’t seen a dramatic improvement in their quality. They continue to march up the curve. So every year, they get a little bit better. And as I’ve said before, we’re not standing still, obviously. And so the needle coke improvements, electrode improvements, we continue to raise the bar.

So they get better every year, but we haven’t said anything dramatic in the last two years. What they have done in the last year is they just keep adding more capacity. In China, capital is almost free, they go to their little regional government, they build a new plant, and like I said, the local market in China is just in devastation. It’s the lowest prices we’ve ever seen in China in 15 years for graphite electrodes. So, it’s a lot of losses accumulating there and I think for the local producers, obviously, they look offshore and maybe they can make a little bit of money. So, yes, they’re a factor in many countries, they tend to be at the lower end, and they’ve got a lot of excess capacity.

If I take it to a longer-view look, obviously, we’ve been looking very hard in the last 10 years at opportunities in China, and we’ve looked at, at least 10 producers, the ones we would consider the best 10, and we’ve looked very hard to look at an acquisition and we just the price expectations they have, have been way too high, especially when you look at it in today’s P&L that they have today, I’m delighted we didn’t drop $150 million, $200 million in there two or three years ago. It would be completely underwater today, written-off and bleeding.

So, looking longer term, what I see is – there’ll be a consolidation there. There’s going to be a rationalization. Even in the Chinese environment, they can’t continue forever with these large losses and so, there’s going to be consolidation, there’s going to be an opportunity, I think, for us, and like we did in our four last acquisitions, we’ll find the right one for us, we won’t overpay, and we’ll get a deal that’s good for us and that can generate income literally the first year, like the four that we picked up.

And so, that time is coming. Is it one, two, three years from now? I think it’s somewhere in that time zone. And just like I said at the outset, these tough times, our track record is – we’re very good at managing through these cycles. We’ve been doing this for 14 years and the 2009 cycle, we managed very well through that. Picked up four acquisitions then and we’ll do the same thing here.

So, you could see us emerge about two, three years from now. And we’ve got a profitable Chinese operation that we paid the right amount for.

Luke Folta – Jefferies

And one last one. When you look at your growth strategy in China, is there – or just in general, is there any strategic reason why it’s better to own Chinese electrode capacity than anywhere else in the world? Do they have any sort of strategic benefit there? And I guess as a second on to that, the new capacity that’s coming into the market that they’re constructing, is that capacity differentiated from – is that some of the highest quality stuff now, the newest capacity or is that just kind of more of the same?

Craig Shular

Well, the new capacity is a little bit better than some of the old stuff. They have some very old facilities, 40, 50, 60 years old and that have not been maintained well. So, it’s not like a plant in the U.S. that’s 40 years old. It’s really worn down. But some of the new ones are better. They’re more consistent product. And like I said earlier, they’re coming up the curve.

As far as an advantage in China, I’ll tell you, call it ten that we’ve looked hard at. Call it five that we’ve done detailed due diligence. And none of them have had a better cost structure than our facilities. So, this is something that when we’ve come back and looked at them, we looked at the price that they’re asking for, to your point, hey, is there an inherent strategic advantage? Well not in that scenario, right? So, I don’t mind competing against them. They’re not advantaged on the cost structure. What we’ve got to find is a right priced one where the price is realistic and one that we can improve and make profitable, like I said, in the first year of operations.

Luke Folta – Jefferies

So what would be the point of going, I guess, owning assets there to begin with? Just you having a presence on the ground and being able to service that market better.

Craig Shular

Well, here. You would do it looking a little bit longer term and this is what I see longer term. Scrap generation is growing dramatically in China. From almost nothing to – gee, every now and then, they even export scrap and so if I look out the next 10 years, China is going to generate a lot of scrap. EAF will grow in China and if any of you have been to China recently, the pollution is so bad. I mean, a month ago, they had to keep everybody indoor in Beijing and close the airport because of the pollution.

So, EAF, environmentally friendly, small carbon footprint, the growth of the scrap reservoir and generation in China is going to make it a very good market and it’s a market under the right conditions and price, as I said, we’d like to be in. So, I just don’t want us to miss that big growth. So, I think this consolidation will come. The losses can’t continue. They’re huge in China right now in the GE industry and we’ve just got to be nimble and have the ability to play offense to seize the right opportunity.

Luke Folta – Jefferies

All right. Thanks a lot, guys, and good luck.

Craig Shular

Thanks, Luke. Have a good day.

Operator

Our next question comes from the line of Michael Gambardella from JP Morgan.

Craig Shular

Good morning, Mike. How are you today?

Michael Gambardella – JP Morgan

Good, Craig. How are you?

Craig Shular

Excellent. Thanks.

Michael Gambardella – JP Morgan

Good. Could you give us a rough ballpark number for the EBITDA penalty that you estimated you had in 2012 and what you think you’re going to have in 2013 from this onerous needle coke contract, the take-or-pay contract.

Craig Shular

Well, let me start with some items and let me think if we want to put a dollar on it. The items, obviously, it’s caused us to carry a higher inventory. We’ve had to take that and so, it’s given us less tools to manage our working capital. So, I say big picture going forward, we’re going to be able to streamline our inventories without that mandate buy to a much greater extent. So there’s a carrying cost to that.

If you look at this year, just coming to your dollar question now, obviously needle coke prices have come down on the third party buy. And so, the higher priced needle coke that we bought last year is still in our system and that will run for the next six months. So, could that be approximately $20 million? Yeah, it could be approximately $20 million penalty. Obviously, I’d much rather be producing at my Seadrift cost versus buying from a third party with a markup. And so, very, very rough like you asked, Mike, I’d say, is it a $20 million penalty in a year? Yes.

Michael Gambardella – JP Morgan

And how much higher of a penalty was it in 2012?

Craig Shular

Well, in 2012, I would say most of it was carrying costs. Remember, we did not have the drop in needle coke prices in 2012. In fact, they went up. So, one was carrying cost.

Two was, we could not optimize Seadrift as much as we could have without that mandated buy, right? We had to get the 80 or pay for it, right? So, one is the higher inventory we had to carry. There’s a carrying cost to that.

And another one would be Seadrift did not run – max-out all last year. This year, it’s going to run full out because the mandated buys come down. So, there’s an element of Seadrift, I haven’t priced that out, but it’s an important part. Is that another 10 or 20? Could be. Could be, yes.

So, my point is we’ve been highlighting this, as you know, ever since we did the deal. That, hey guys, big picture. Super premium needle coke has been so important. Because without that, I still have to go to the third party and buy because they force you to buy some normal premium to get their super premium. Because before we had the breakthrough, there’s only two producers of super-premium needle coke. So, now we’re the third, we’re self-sufficient, and then next year, I don’t have that mandated take-or-pay type contract.

So, we really get flexibility and can run Seadrift, service all our needs, take great care of our customers. And I think over time, like we’ve talked big picture, we’re putting the R&D into the needle coke, right? It’s all graphite material science. And you’re going to see continued improvements in our quality. The normal premium that Seadrift makes is the best they’ve made in 30 years. And that will translate into better electrodes and a sustainable competitive advantage, not only in the quality, but obviously on the cost structure we enjoy versus the competition.

Michael Gambardella – JP Morgan

But did I hear you say earlier that you thought that the penalty on EBITDA was higher in 2012 than 2013?

Craig Shular

No, not necessarily. Remember, some of the penalty coming into this year is price has come down, right? But what I’m saying is we haven’t priced it out. You asked for a big picture number, right? Last year, we would have carried more inventory because of the 80,000 buy and we would have run Seadrift at a little bit lower operating rate than what it could have run. And so, I didn’t price that out, but obviously that’s EBITDA for us, right?

Michael Gambardella – JP Morgan

Right. And then, so your guidance on 2013 and what you’re looking at 2013, you’re looking at higher volumes and it sounds like you’re also looking for lower non-needle coke costs in 2013 versus 2012. Is that correct?

Craig Shular

Well we said lower needle coke cost in the second half of 2013 because we’ve worked off the high cost inventory.

Michael Gambardella – JP Morgan

Right, but you have higher volumes, so – and you’ve made some comments about your SG&A...

Craig Shular

Correct. So SG&A down 15, op level should increase over the course of the year for both of our businesses and for GE and needle coke, so fixed cost absorption should be better especially the second half. So, you’re spot on on that, Mike.

Michael Gambardella – JP Morgan

But so the delta change in EBITDA year-over-year is just a bigger cost drop on GE versus the cost drop on needle coke?

Craig Shular

Well in price, you know. We said price is down in GE...

Michael Gambardella – JP Morgan

Right.

Craig Shular

Price is...

Michael Gambardella – JP Morgan

I’m....

Craig Shular

Price is the big item.

Michael Gambardella – JP Morgan

I meant to say, bigger price drop in GE...

Craig Shular

Yes.

Michael Gambardella – JP Morgan

Than the cost drop on...

Craig Shular

Correct. So – but you add all those up, price is, it’s a huge item. Price down in GE, 8% to 12%, price down on needle coke, 8% to 10%, that’s the big item is, year-over-year that’s the big change in EBITDA.

Michael Gambardella – JP Morgan

Okay. Thanks, Craig.

Craig Shular

Thank you, sir.

Operator

Our next question comes from the line of Mark Parr from KeyBanc.

Craig Shular

Good morning, Mark. How are you today?

Mark Parr – KeyBanc

Hey, Craig, doing well. Hope you’re doing well.

Craig Shular

Yes, doing outstanding. Thank you, sir.

Mark Parr – KeyBanc

You always are. Hey, I had a couple of questions. We have – in your release, you had indicated you thought that customers would be restocking in 2013, and I’d like to get some color around that because we were just seeing so little interest on the part of people in the supply chain to build inventory at this point.

Craig Shular

Yes, Mark. What we were referring to is if you go back a year ago, there were some of the largest carryover inventories we’ve seen other than the crash of 2009, right? And so if you go back a year ago, Q1 a year ago and Q2 a year ago, a lot of customers were burning electrodes that they had bought a year before. So coming into this year, there is some carryover electrodes, but it’s not near what we had last year. So our point is we don’t have Q1 and Q2 so affected by large carryover compared to last year. So that’s a better picture for us.

And then as I said, almost every geography is coming in a little bit better. EU looks a little bit better, I mean, not great. China is better. Middle East is better. Brazil is better. South Africa is better. U.S. is a little bit better. So most geographies are a little bit better than what we saw in 2012. So those two items combined is what’s picking up our volume.

Mark Parr – KeyBanc

Do you see electric arc furnace production gaining share in 2013 compared to 2012?

Craig Shular

Well, it might. We had that collapse in the iron ore prices you recall last year, and it dropped depending on where you were in your starting point, 40%. And the electric – or the iron ore guys have got most of that already back. So, yes I think if iron ore stays up high, EAF will continue to be in a very nice position this year.

Mark Parr – KeyBanc

Okay. If I could ask one follow up...

Craig Shular

Please, please.

Mark Parr – KeyBanc

I was just reading recently about a material, I believe – correct me – I may not be pronouncing this right but I think it sounds like graphene?

Craig Shular

Right.

Mark Parr – KeyBanc

And it’s – apparently it’s a liquid graphite – it’s a liquid carbon product that has the ability to hold a lot of energy. And I was wondering and they were talking about using this potentially for batteries in cell phones and other small electronic devices. I was wondering if you knew anything about this or if this is something that the ES division has working on commercializing.

Craig Shular

Mark, a great question. Graphene is front and center, a part of graphite materials science. And our PhDs here would work with grapheme, which, if I give you the simple answer, is a single layer of graphite. So, it’s the thinnest, most basic layer of graphite you can make. And – so it’s very, very light and it has unbelievable heat and electrical properties.

And so in the world of graphite materials science, many people are looking at this graphene because it has such unique properties – strength. And down the road, graphene will have some great applications in what you were talking about, in batteries, in thermal management, in strengthening certain areas and applications that need to be very strong but lightweight. Graphene is at the front end of product development.

So, the Nobel Prize was recently – a couple of years ago awarded for, so we’re in the front end of it and graphene is just one of the many examples of graphite materials science and we’re one of the leaders in the world with patents and PhDs, et cetera. And so, over time, you’ll see graphene, which is right in the middle of our Engineered Solutions business. You will see it propel growth in Engineered Solutions in some unique applications down the road.

Mark Parr – KeyBanc

Okay. Thanks. And good luck on the first quarter.

Craig Shular

Thank you, sir.

Operator

Our next question comes from the line of Rob Pohly from Samlyn Capital.

Craig Shular

Good morning, Rob. How are you today?

Rob Pohly – Samlyn Capital

Good, Craig. Just a quick question just getting back to the Chinese comments. I was wondering if you could maybe just put a little bit firmer numbers on – in 2012 how much capacity, the UHP capacity in particular, was exported from China into obviously non-Chinese markets?

Craig Shular

Yes. Let me start with kind of the additions. We said there’s about 100,000 metric tons of additions and about 65...

Rob Pohly – Samlyn Capital

Is that all UHP, that 100,000?

Craig Shular

Yes. That’s all pretty much UHP.

Rob Pohly – Samlyn Capital

So, what do you think the total capacity is of UHP in China today?

Craig Shular

I would say to you, China is around 300,000 metric tons of UHP. Now, not all UHP is created equal, as we know. Some will burn off very quick on a furnace and some will last an eight-hour shift. So, UHP – if I look at the range of what China calls UHP, there’s a lot of variation.

Rob Pohly – Samlyn Capital

And how much was actually exported in 2000 – last year?

Craig Shular

Yes. In total...

Rob Pohly – Samlyn Capital

Bought by customers.

Craig Shular

Yes. They would export worldwide a little over 200,000 metric tons around the world.

Rob Pohly – Samlyn Capital

Okay.

Craig Shular

And in that 200,000, you have a lot of UHP, but you also have some lower grades that our industry would call HP and RP and these might end up in simple, easier smelting applications.

Rob Pohly – Samlyn Capital

What about just the higher end, how much of that was exported?

Craig Shular

I’d say probably less than 25% of the total exports are UHP.

Rob Pohly – Samlyn Capital

Great, thank you.

Craig Shular

So, of that 200, 220 total that’s exported, less than 25% is UHP. So it’s a factor. It goes to a lot of different countries. It’s always low, low price and in some applications, it can work, right? Or you have a steel industry that’s losing hundreds of millions of dollars every quarter, boy, you look at everything, right? You’re just trying to stay alive. I mean, you saw so many steel companies issue equity, new debt just trying to stay afloat, so they’re forced to look at almost anything.

So the Chinese are a factor. They have been for a number of years as we said, but they tend to be at that lower end, low price.

Rob Pohly – Samlyn Capital

And what’s the, roughly, the price difference between a UHP that you sell and a UHP that a Chinese manufacturer would sell?

Craig Shular

Oh, it can be $1,000.

Rob Pohly – Samlyn Capital

Okay.

Craig Shular

It can be $1,000 difference. Remember, if you sit in the Chinese producer’s shoes, he’s got a plant in China; I’d dare say lot of them, every sale they make in China is a loser and the payment terms, the ones we’ve looked at, done due diligence, they’re lucky to get a payment in six months. And some are carrying AR that’s a year-and-a-half, two years old and still carrying it as good. So, I’d say their domestic business is less than rewarding to them, and like I said, we’ve done due diligence on them.

Rob Pohly – Samlyn Capital

Have you ever – sorry, have you ever sold needle coke to a Chinese electrode producer?

Craig Shular

Oh, absolutely. Seadrift would sell in all of the major markets: Japan, Europe, China, Russia, so around the world.

Rob Pohly – Samlyn Capital

How much needle coke did you sell into China, to Chinese electrode producers?

Craig Shular

Well, we don’t give that out for competitive reasons, but let me say this, Seadrift’s quality, like I said, the normal premium and the super-premium is at a level it can sell anywhere. It’s in demand. We’ve got people demanding us the Seadrift coke. So, it depends on the market and so we have no trouble selling into China.

Rob Pohly – Samlyn Capital

Great. Thank you.

Craig Shular

Thank you.

Operator

Your next question comes from the line of Chris Haberlin from Davenport & Company.

Craig Shular

Good morning, Chris. How are you doing?

Chris Haberlin – Davenport & Company

I’m well. How are you?

Craig Shular

Excellent. Thank you.

Chris Haberlin – Davenport & Company

Thanks for taking my call. Can – just going back to kind of the supply, demand balance in GE, I mean it looks like between last year and what’s coming on this year and next year, you’re looking at maybe a 15% total capacity increase. Are you seeing higher cost producers being forced out of the market, starting to shut in capacity, or is the industry as a whole really taking it on the chin and kind of everybody is just operating at lower rates which is driving prices lower?

Craig Shular

Yes, I’d say it’s more of the latter. No one has really left the playing field. So, some new assets have come on. And as new assets like to do, they like to run them, right? They just made the capital investment. So, no one has left the playing field yet. But as I said, being the industry’s low-cost producer, back integrated, what we have on quality, some of the things we talked about, the flexibility we have to go forward without a mandated third-party needle coke buy, growth in our ES business, et cetera. I think we’re very well positioned for this challenge.

And so our team, I’ll tell you, we look forward to it because out of it, I think you’ll see us play offense. We’ll make some smart acquisitions. There will be, to your point, probably some consolidation. Some guys are going to leave the field, probably through consolidation. And we’ll come through this even stronger.

Chris Haberlin – Davenport & Company

And then in terms of customer buying, is what you’re seeing with – about half of your book done so far this year, is what you’re seeing, is that in line with expectations for growth in steel production or is it exceeding expectations for growth in steel production, saying that customers are restocking inventories in a down price year.

Craig Shular

I think it’s in line with the two factors we talked. Remember, they don’t have near the excess carryover electrode inventories this year that they had a year ago, right? That’s one.

And then two, in general, most geographies have some improvement this year over last year. So, I see the increase in our volumes is normal with what’s going on in the market and as I said a little bit earlier, the one little color we’ll give you.

We have a couple of markets where we have the graphite electrode facility, South America, South Africa, that got pretty hard hit last year. And so we felt that more than others because we have a large position there close to the customer, local CTS. So last year, I’d say we got it on the chin more in some of those markets.

Well, this year, some of those furnaces are coming back online and so we’re benefiting a little bit more than maybe the others are because of that. So we’re getting a little boost from that. You add all that up and that’s why our levels are coming up for us and the guidance we’ve given.

Chris Haberlin – Davenport & Company

And then just last question on that guidance. Can you just talk about what you would like to see in order to get to the top end of your guidance and maybe what type of environment would have to play out in order to be at the bottom end of your guidance?

Craig Shular

Well, I think most of that range is one, we’ve got to build the balance of the book. So there’s always risk on that. So there’s some noise in that in the range. And then how does steel run this year? If we have the increase, I mean World Steel Association is looking for what, about a 3% improvement. Last year was 1%, 1.2%. So, almost triple year-over-year. So, if we get that 3%, that will put us probably towards the upper end.

Last year also, I’ll tell you, working with a lot of EAF customers, I think a lot of them believe, total steel improved maybe 1.2%. But EAF didn’t improve near that much year-over-year. It was flat or maybe 0.5%. So, we may see EAF do a bit better this year than last year because of what we talked about on iron ore pricing.

Iron ore pricing last year collapsed 30%, 40% down and so, some of the cost advantage of EAF was mitigated by that. Well, iron ore prices are looking pretty good right now, probably up 30%, 40% from their bottom last year. That may skew some of our producers to run more EAF than the blast furnaces.

Chris Haberlin – Davenport & Company

All right. Thanks very much.

Craig Shular

Thank you, Chris. Have a good day.

Operator

Your next question comes from the line of Ray Rund from Shaker Investments.

Ray Rund – Shaker Investments

Thank you for taking my question, Craig.

Craig Shular

Good morning, Ray. How are you today, sir?

Ray Rund – Shaker Investments

Fine. Thank you. How are you?

Craig Shular

Excellent. Thanks.

Ray Rund – Shaker Investments

In looking at the guidance that you gave on EBITDA and on overhead costs, SG&A and R&D, it sounds like plugging them into the model I have and making some assumptions, which I think are not outlandish on your revenue levels, it sounds like your first profit margins in the first and second quarter are going to be down into the mid-teens and then start to recover towards the end of the year. Is that a misreading of the situation?

Craig Shular

No. I think you’re reading it right. I mean, we don’t guide to that item, so I won’t comment on a specific number. But I think your read of it is correct, yes. And that’s graphite electrode pricing. That pricing is such an important item in our industry. And so, directionally and your interpretation is spot on.

Ray Rund – Shaker Investments

Thank you.

Craig Shular

Well – I’m sorry, go ahead.

Ray Rund – Shaker Investments

Can I follow it up, just...?

Craig Shular

Please.

Ray Rund – Shaker Investments

A question. I mean, in the quarter just finished, you did $371 million total. Why would the demand drop so much in the first quarter?

Craig Shular

Well, remember, Q1 historically is a little softer for both of our segments, for ES and for IM. ES has come off the big year-end build and new products and all that.

Ray Rund – Shaker Investments

ES I understand, because of the consumer electronics content.

Craig Shular

In IM, steel, usually Q1, most years, is one of our weakest quarters. That’s our history. So, that’s not completely out of line. And then, remember we didn’t say they don’t have – the customers don’t have any carryover inventory. They do have some carryover into Q1 but nowhere near what they had a year ago, so there’s some carryover for sure, but it’s much less than – like I said, last year. The impact of carryover on Q1 and Q2 was the largest other than 2009 collapse.

Ray Rund – Shaker Investments

I see. Okay, thank you very much.

Craig Shular

Thank you, sir. Have a good day.

Ray Rund – Shaker Investments

You, too.

Operator

Our next question comes from the line of Zahid Siddique from Gabelli & Company.

Craig Shular

How are you, Zahid?

Zahid Siddique – Gabelli & Company

Good, how are you?

Craig Shular

Excellent, thank you.

Zahid Siddique – Gabelli & Company

Just another, I guess, follow-up on the EBITDA delta question, so I think you’re expecting the EBITDA to decline somewhere between $40 million and $70 million in 2013 over 2012? With the volume going up and the cost being reduced and customer inventory position better and your own inventory position better, so you’re suggesting that most of that is pricing?

Craig Shular

Absolutely, absolutely, price.

Zahid Siddique – Gabelli & Company

I wanted to find out what are you assuming in your models from a pricing perspective, is that 10% to 12% number or is that a higher number?

Craig Shular

What we would say across different geographies, the price in graphite electrodes is down 8% to 12%. So if you want to take the middle of that range, that’s probably not a bad assumption.

Zahid Siddique – Gabelli & Company

So if we took that and put that in our models and assumed some volume improvement will get an EBITDA decline of $40 million to $70 million?

Craig Shular

Yes, you should be somewhere in that direction depending on some of your other assumptions in your models. And then also remember, needle coke is down about 8% to 10% also.

Zahid Siddique – Gabelli & Company

Correct, right. Okay, and then just another question on the book building process, relative to the past book building processes, where are you? Are you – is it a slow process or is it in line or is it faster at this point in time?

Craig Shular

Yes. It’s faster than last year. We’re over 60% in the graphite electrodes so far. So, it’s rapidly heading to 70%, 75%. We have a lot of requests in hand right now, so I’m telling you what’s actually in the book is over 60%, between 60% and 65%. So I can see over the next few weeks, that number is going to ratchet up quite a bit just because of the bids we have requested in hand. So it’s faster than last year. Last year, you’ll recall, because of the huge carryover, inventories was very slow, in fact, went deep in the Q2 for some accounts.

Zahid Siddique – Gabelli & Company

Okay. And just a last question on valuation, given that small price improvements can adversely impact – or positively impact your EBITDA to such a degree, how should we be valuing GrafTech given that there’s so much volatility?

Craig Shular

Well, we’re going through a period here of some excess capacity, so that’s got to sort itself out. The things that – the way I would look at it, you’ve got to look at what are the times that team GrafTech can work on and how has it improved its business model the last several years. Our low cost – I think we’re industry-leading low cost position when you – especially when you throw in the needle coker, and our balance sheet, our ES growth, all of those items.

And so, as you play this out, who do you think outperforms and who is kind of the company that can play offense and maybe make some great acquisitions through this tough time in graphite electrodes? That’s the way I would look at it. We can’t control the capacity adds or what the others are doing, but boy, we can improve our model so it’s low cost, the quality is great, super-premium needle coke, and then be shrewd when we make a move.

Like I said, I’m so pleased we haven’t bought anything in China, I’d have probably 200 million written off, losing money, bleeding cash where our cost structure right now is better than any of the Chinese producers. And so the right time will come and we’ll be in that local market at the right time, at the right price. So, Zahid, I’d look at it that way if I stood back at it, it’s going to work itself out. We’ll continue adding EAF steel capacity around the world because it’s advantaged and we’ll be there to service it.

Zahid Siddique – Gabelli & Company

Thank you.

Craig Shular

Thank you, sir.

Operator

Our next question comes from the line of Charles Bradford from Bradford Research.

Craig Shular

Hi, Chuck. How are you today?

Chuck Bradford – Bradford Research

Good, good. How are you?

Craig Shular

Outstanding. Thank you, sir.

Chuck Bradford – Bradford Research

Terrific. There are as many as 20 million – or is – there is as much as 20 million tons of DRI capacity being planned in the U.S. over the next few years. I know the U.S. isn’t that big a market for you guys but some of these same trends might happen elsewhere. For example, the Chinese are claiming they have twice as much alternative gas supplies as we have or reserves as we have, which they’re only beginning to develop and that’s really the basis of why DRI makes sense.

So the question is, my understanding and I don’t want to comment frankly about whether these plants get built or not, but when you melt DRI, do you not use more electricity than if you melt scrap? And secondly, if you use more electricity, will that use up more electrode?

Craig Shular

Chuck, you’re spot on. We – let me say one thing in detail and then step back from the DRI equation. DRI is a melt that chews up a lot of electrodes. So, we love working with DRI. And so in general, yes. Does it use electrodes? Does it tend to be tough on electrodes? Yes, it can be. Point one.

Point two, if we stepped back from it, when you see DRI adds in capacity, for someone like us that services EAF, this is very, very good news. More scrap, more China scrap, more DRI and other scrap substitutes are just beneficial for the EAF industry. And this low-priced natural gas that we have in the U.S. and you see China trying to exploit some of it through shale is so powerful to the DRI equation that we agree with you.

We see more DRI coming, like Nucor is building and other customers, which is a big benefit for EAF steel, which means there’s going to be a lot more high-quality electrodes, large diameter electrodes required in the future. DRI usually is attached to the largest available EAF furnace, which requires the large high-quality electrode. So, this phenomena we are very supportive of, we like to see it and it’s very good for our business.

Chuck Bradford – Bradford Research

The next step would be that if a lot more DRI does come on-stream and it’s likely to come on in a lot of places, that would seem likely to drive down the price of scrap, even in places like Turkey, which have big electric furnace output and may not have access to the cheap gas, I’m not sure, but it may actually enhance electric furnace output in a lot of places?

Craig Shular

We agree with you. We agree with you and you know scrap is their biggest cost in an EAF furnace, so this is very beneficial for our customer base, very beneficial for GrafTech. That phenomena, DRI, natural gas in China, the things they’re talking about, plus just the scrap reservoir and sources coming up in China over the next 10, 15 years are so impressive and dramatic, it’s the other reason we want to find the right access and the right acquisition in China at the right time.

Chuck Bradford – Bradford Research

One of the questions I would have is would there be enough DR quality pellets available to supply a lot of additional DRI capacity and would this not cause iron ore prices to increase, just in general?

Craig Shular

Well, it – that’s a tough equation. As scrap grows, as DRI capabilities grow, as natural gas stays very, very affordable, I think you’re going to see EAF really enjoy that growth. And then, like I said earlier, if you travel to China, most of the cities, you can barely see across the street some days and this is downtown financial district, because the pollution is so bad.

So, if you’re on the ground like we are in China, China is getting very serious on pollution. They’ve got a long ways to go, but all of that is just another factor that plays into why EAF will have a good run and good growth in China.

Chuck Bradford – Bradford Research

I’ve been going to China since the 70s when most of the homes were heated with charcoal briquettes. You don’t see any of that anymore for exactly the reasons you say. The – and they do have a lot of electric furnace capacity, but they feed most of it from blast furnace hot metal.

Craig Shular

Yes.

Chuck Bradford – Bradford Research

Do you hear anything about developments of the natural gas in China? I mean, I’ve got a study showing that they’ve got twice as much as we have.

Craig Shular

Exactly. What we do see is a lot of talk and efforts around shale, natural gas type work in China. The big run up 30%, 40% up on iron ore makes those items even more viable. So, I think you’re going to see China who has to import, what, 65%, 70% of its iron ore needs, really try to change that equation if they can. So, if they can use natural gas to get DRI and supplement that with scrap reservoirs that 10 years, 15 years from now are going to be very sizable, I think you’ll see them do that. And then I think you’ll see less of what you’re talking about, using kind of a blast furnace to put some hot metal into an EAF because it won’t make economic sense.

Chuck Bradford – Bradford Research

Well, thank you very much.

Craig Shular

Thank you, sir. Have a good day, Chuck.

Operator

Our next question comes from the line of Thomas Horan from Acorn Capital.

Craig Shular

Good morning, Tom. How are you today?

Thomas Horan – Acorn Capital

Good. How you doing? Thanks for taking my question.

Craig Shular

Excellent. Thank you, sir, our pleasure.

Thomas Horan – Acorn Capital

I think you had a question on the last call, somebody had mentioned something about a CapEx spend depreciation being in excess of one. And I know you said that that was due to a lot of the acquisitions that you’ve made over the last few years and the position the market had been in. But I was just wondering, now, with the lower CapEx guidance due to the environment, if there was any sort of rough estimate of what you could use for modeling purposes as a long-term maintenance CapEx number?

Craig Shular

Yeah, Tom. Good question. As you see this year, we have guided to a lower CapEx. We’ve given you the breakout of maintenance and growth. And so the total is around $105 million and that splits $60 million to IM and $45 million to ES, the total numbers. We have brought down maintenance and growth capital. But if we look at the maintenance, IM, as we talked, is going to be about $55 million this year and ES, is going to be $10 million, so call that around $65 million of maintenance capital.

And I think as we’ve talked on prior calls. For planning purposes, there are years we can do this. We’ve cut way back. But typical maintenance, you should think closer to $90 million or maybe even $100 million for us.

And that the reason is this, the needle coker is going to celebrate its 30th year this year. Our newest graphite electrode plant is over 30 years old. We have some that are over 50 years old. So, what I would put to you, in a heavy manufacturing, high-temperature environment that’s very tough on the assets as graphite production is and needle coke production is, that for planning purposes, we’re going to be a little bit at the higher end of that little formula or it should be the same as depreciation.

So, we’ll be $90 million to $100 million, that’s our typical. Can we squeeze down some years, like we’re doing this year in this tough year? Yes. But it will need to come back up closer to $90 million at some point down the road.

And then, just to be clear on our D&A, we have $90 million, $92 million of D&A this year. And remember about $20 million of that is purchase price accounting. So, take $20 million out of that, so it’s $70 million, call it $70 million. But our typical maintenance to have great operations, reliable, productivity improvements through our lean program is probably closer to $90 million and maybe $100 million some years.

Thomas Horan – Acorn Capital

All right, thank you very much.

Craig Shular

Thanks, Tom. Have a good day.

Operator

We have a follow-up question from the line of Sal Tharani from Goldman Sachs.

Craig Shular

Hey, Sal. How are you doing?

Sal Tharani – Goldman Sachs

Hi, Craig. I wanted to ask you about the super-premium needle coke. Do you get a premium selling that or is it gives you a better market share?

Craig Shular

It’s – no, it’s higher priced. There’s ourselves and two other producers in the world. So, yes, it’s always been a higher price. So, it’s got a bit better margin. It definitely has a higher price and it’s used in the largest diameter, toughest applications. And that’s a space – building on all the dialogue we’ve had, the largest furnaces, DRI, some of those kinds of applications is where you would want a super-premium needle coke in your electrode.

Sal Tharani – Goldman Sachs

And your take-or-pay contract, is that mostly with super premium?

Craig Shular

No, it’s both. It’s both normal premium and super premium. What some of those players have done over the years, if you want super premium, you have to buy so much normal premium. And so, why we make a point that this breakthrough in super premium needle coke is important to us, it really frees us.

Sal Tharani – Goldman Sachs

Great. Thank you very much.

Craig Shular

Thank you, sir.

Operator

We have another follow-up question from the line of Mark Parr from KeyBanc.

Craig Shular

Hey, Mark. How is it going?

Mark Parr – KeyBanc

My question has been answered. Thanks, Craig. Thanks, guys.

Craig Shular

No problem. Thanks, Mark.

Operator

We have another follow-up question from the line of Arun Viswanathan from Longbow Research.

Craig Shular

Arun, how are you?

Arun Viswanathan – Longbow Research

Hi, guys. Good, thanks. Thanks for taking my follow-up here.

Craig Shular

No worries.

Arun Viswanathan – Longbow Research

Maybe can you just help me with a little bit of detail. Out of the IM segment revenue of $1 billion or so in 2012, how much was electrodes, how much was Seadrift and how much was the refractory portion?

Craig Shular

Arun, great question. It’s a breakdown we do not give because of strategic and competitive reasons. So, in that number there is electrode sales, there is needle coke sales and there’s our refractory sales and...

Arun Viswanathan – Longbow Research

Well, can you just help us out with the refractory then?

Craig Shular

What’s that?

Arun Viswanathan – Longbow Research

Can you help us out with an order of magnitude maybe for refractory?

Craig Shular

Yeah, what we’ve said historically, refractory is a very small number. So...

Arun Viswanathan – Longbow Research

Less than 10%?

Craig Shular

Needle coke and graphite electrodes are the big part of that and we don’t give that breakdown because, as you know, we’re the only back integrated graphite electrode producer that produces needle coke. So, it’s a competitive reason. We don’t share that.

Arun Viswanathan – Longbow Research

So, refractory is definitely less than 5% of the total profitability?

Craig Shular

Oh, yes. Yeah, it’s small.

Arun Viswanathan – Longbow Research

Okay.

Craig Shular

Yes, sir.

Arun Viswanathan – Longbow Research

Fair enough. Thanks.

Craig Shular

Thank you, sir. Have a good day.

Arun Viswanathan – Longbow Research

Yes.

Craig Shular

Jody, if that’s it. Any other questions?

Operator

No, sir.

Craig Shular

Okay, Jody and callers, thank you very much for your questions today. We look forward to talking to you at the end of Q1. Have a great day. Thank you.

Operator

Thank you. That concludes today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: GrafTech International's CEO Discusses Q4 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts