GrafTech International Limited Q1 2009 Earnings Call Transcript

May. 2.09 | About: Brookfield Asset (BAM)

GrafTech International Limited (GTI) Q1 2009 Earnings Call April 30, 2009 11:00 AM ET

Executives

Kelly Powell – Manager of Investor Relations

Craig S. Shular – President & Chief Executive Officer

Mark Widmar – Chief Financial Officer

Analysts

Ian Zaffino – Oppenheimer & Co.

Luke Folta – Longbow Research

Mark Parr – KeyBanc Capital Markets

Michael Gambardella – JPMorgan

Charles Murphy – Sidoti & Co.

Asad Abedi – Merrill Lynch

Yvonne Varano – Jefferies & Co.

Charles Bradford – Bradford Research

Raymond Rund – Shaker Investments

Philip Gibbs – KeyBanc Capital Markets

John Lancefield – Royal Capital Management

Operator

Good day, ladies and gentlemen, and welcome to today's GrafTech Q1 2009 results conference call. Please be aware that today's conference is being recorded. At this time I would like to turn the call over to Kelly Powell for opening remarks and introductions. Please go ahead ma'am.

Kelly Powell

Thank you, Tamika. Good morning and welcome to GrafTech International's first quarter 2009 conference call. On the call today is GrafTech's Chief Executive Officer, Craig Shular and our Chief Financial Officer, Mark Widmar.

We issued our earnings release this morning. If you did not receive a copy, please contact Jen Raedake at 216-676-2281 and she will 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 is 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.

At this time I would like to turn the call over to Craig.

Craig S. Shular

Good morning everyone. Thank you for joining our call. Today, we will take you through our first quarter and then open it up to questions. In the first quarter, net sales were $134 million primarily the result of lower volumes associated with significantly reduced demand in both our business segments. Gross profit was $32 million or approximately 24% of sales as a result of lower sales volume and unfavorable fixed cost absorption associated with reduced operating rates.

Our graphite electrode facilities ran at a 38% operating rate, which aligned with market demand. We believe this is the lowest ever operating rate for our facilities. Operating income was $8 million. Net income before specials was $5 million or $0.04 a share. Operating cash flow was $14 million, and net debt during the quarter, we are able to reduce by $2 million. As a result of our successful deleveraging initiatives over the last couple of years, our interest expenses dropped nicely in the quarter it was $2 million versus $8 million a year ago. And so to recap the first quarter, we are profitable in Q1; cash flow positive and we paid down debt, all of this in a very, very tough environment.

In our Industrial Materials segment, sales were $105 million, while operating income was $7 million. The reduction in operating income in the quarter was primarily due to lower sales volume for graphite electrodes related to the drop in global steel demand. The decrease in sales volume impact on operating income however was mitigated in part by an execution of previously announced cost reduction and productivity initiatives that we laid out in our last call. In our Engineered Solutions segment, sales were $30 million in the first quarter. Operating income for that segment was $2 million as a result again of lower sales volumes across multiple product lines, which event of course impacted by the very steep global economic slowdown.

Turning to the status of our graphite electrode book building process. As reviewed previously in our last call, the normal '09 book building process has been disrupted by the significant decline in demand. The process however is underway and bidding activity is incurring in all geographies. However, it remains too early in the process to speculate on settled contract prices at this point. We do expect higher graphite electrodes selling prices in '09, due to the significant cost increases for our key raw material, needle coke. As a result of a volatile global economy, we are also seeing a change in the time horizon of the contracts currently being booked. Given the limited visibility our customers have to demand, many have been more inclined to take shorter contracts quarter-to-quarter or even month-to-month. It's important to note that in the current environment, this is generally not treated as spot business and of course is not conducted as spot prices.

Finally, turning to outlook, very weak end market demand is expected to persist with a high degree of uncertainty surrounding the timing of any anticipated recovery. As a result, steel producers continue to operate at very low rates in order to reduce inventories, destock, and of course match with current market demand. The majority of our customer base has very limited or no visibility to third and fourth quarter '09 operating rates.

Given current global economic conditions, which continue to be extremely volatile and uncertain, our ability to project full-year guidance is very limited. We expect '09 to be very challenging for both our business segments. First quarter results came in better than expected and we generated a small profit. We believe second quarter results will be similar to those in the first quarter.

However, second quarter loss is possible given the variability in customer demand. Also important to note that historically, the third quarter is a weaker quarter, as many of our European customers schedule plant shutdowns during the summer holidays in Europe. Given the current economic conditions, it is possible that the planned customer shutdowns in Europe could be extended resulting in further reduced demand for our products in the third quarter of '09. While a high degree of uncertainty around forward-looking projections remains, we expect a marginal improvement in the second half of the year as our customers should have largely completed inventory destocking initiatives, and the anticipated benefit of higher graphite electrode selling prices should be realized, offset in part by higher raw material costs.

Finally, in '09, we are targeting capital expenditures to be approximately $50 million to $55 million, depreciation expense to be approximately $35 million; and our effective cash rate to run somewhere between 28% and 32%. That completes our fixed response here. Let's go ahead, Tamika, and open it up to questions please.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll go first to Ian Zaffino with Oppenheimer & Company.

Ian Zaffino – Oppenheimer & Co.

Hi, good morning.

Craig S. Shular

Good morning, Ian. How are you today?

Ian Zaffino – Oppenheimer & Co.

I just wanted to think about your operational break-even point. As you look at the second quarter, you're projecting a potential loss. Does that mean that operating rates need to fall below that 38%, or what are kind of the moving parts that we need to consider?

Craig S. Shular

Well, right now as we said in our guidance. We expect Q2 to look like Q1, so a small profit, that we did $0.04 in Q1. But as we highlighted, a loss is possible because what we find in our customer base, their order requirements are so volatile that many are moving orders around forward and back. And that at these profit levels, it's very easy to have a loss if some of that occurs in the second quarter or even towards the end of the second quarter. So operating rate 38% first quarter, what we will do go-forward, we will match that operating rate with what we see from our customers. And so it will line it up with demand. And if it goes lower in the customer demand, we'll lower it; if it has to remain the same we’ll do that. So right now, we expect Q2 to kind of look like Q1. That was $0.04 in the case of Q1.

Ian Zaffino – Oppenheimer & Co.

Okay. And how close to the end of the destocking do you think we are?

Craig S. Shular

Well, we've watched this very closely. And I think, in general, as you've seen from the steel producers and this is a generalization, of course, but I would say most of them, if you have talk to them in January and February their outlook was stronger than what it is when they finished the quarter. I think most of them have run slower in Q1 than what they anticipated in the front half of Q1. And you saw a number of them over the course of the quarter even downsize some of their outlook. So that of course results in delaying and slowing down some of the destocking process and extends some of that longer than what it might otherwise be. But having said that, we see a number of customers should be done in Q3 and then by Q4 from our advantage point pretty much most of the customer base worldwide is done with its destocking. So what we see is in Q3 some of the customer base is going to be on new electrodes. And probably by Q4, the vast majority of the customer base is going to be on new electrodes. And that's why we think there is going to be a marginal improvement in the second half of the year.

Ian Zaffino – Oppenheimer & Co.

Okay. And then one final question. There is a comment in the press release about the pricing being partially offset by needle coke. Does that effectively mean that you're able to raise prices beyond needle coke? If that's the case, what type of price increases are you seeing? And are you locked in on needle coke right now. Or, is that still very much spot purchases?

Craig S. Shular

No, needle coke, we have secured our pricing on needle coke on volume obviously, given the volatility in the marketplace. We have a lot of flexibility on volume. So, we will not be in a position where we have to take or will take excess needle coke. But the price of our needle coke is fixed; it is up as we’ve highlighted in the last several calls. And the goal will be to get graphite electrode price increases to offset and hopefully, more than offset the significant price increase that we're seeing in needle coke.

Ian Zaffino – Oppenheimer & Co.

Okay. And that price is locked in for the remainder of '09?

Craig S. Shular

That’s right, it secured for ’09. Volume, we'll take exactly what we need to meet market demand. We will not end up taking excess volume or being required to pay for excess volume. No, that's not what we have lined up. We will manage the working capital aggressively and line that exactly up with market demand.

Ian Zaffino – Oppenheimer & Co.

Okay. Great, thank you very much.

Craig S. Shular

Thank you. And have a good day.

Operator

We will go next to Luke Folta with Longbow Research.

Luke Folta – Longbow Research

Hi, good morning everybody.

Craig S. Shular

Good morning, Luke. How are you today?

Luke Folta – Longbow Research

I'm great. Yourself?

Craig S. Shular

Excellent. Thank you.

Luke Folta – Longbow Research

Okay. I just had a question first on your needle coke inventory position. Can you talk to the extent of how much you have in stock at last year's pricing and when do you think that you’re going to start chewing through the higher cost material?

Craig S. Shular

Luke, I won’t give you for a competitive reasons, obviously our exact position or picture, but in directional wise, we have got some coke inventory that will benefit us a little bit here in the first half lower cost. But the second half we will start seeing the impact of higher cost needle coke. And so, first half, a bit of a benefit; second half, it will begin to drag on us and that's why we are seeking price increases to offset that increased cost in the second half.

Luke Folta – Longbow Research

Okay. And you had mentioned that people are looking for shorter-term contracts now. How do we look at pricing if we get into, like, a quarterly contract situation? Is it still fixed pricing based on quarterly volumes or how does that work?

Craig S. Shular

Yes, Luke it is. And I guess why we highlighted was obviously, there is not an annual contract out there to be done and our customers’ line of sight is so limited that we’ve seen a few go month-to-month and we’ve seen a larger percentage go quarter-to-quarter just because they have no line of sight at all to Q3 or Q4. And so one we want to highlight that too, what we do in pricing, then if the customer comes and books let's say a quarter with us then that’s all fixed price for that quarter. And then that customer would come back to the market at the end of that quarter and then face the market again to secure their Graphite Electrodes. So that's what we are seeing right now. It's early in the process but I will say it's going orderly, going smoothly and the destocking at our customers is well underway, and its orderly and towards the second half of this year, the supply chain at our customers is going to be very, very lean and they will need new Electrodes.

Luke Folta – Longbow Research

Okay. And just one more if I may, can you kind of give us a break down of what the international versus domestic business was in the quarter and your expectations of where you expect to see a rebound - you expect to start building your book first?

Craig S. Shular

Luke, I will give you in general. In general our U.S. sales are somewhere around 25% of our total portfolio. And so we’ve got a very good geographic mix. We sell into 80 countries and so, U.S. 20% to 25% is where it usually bounces. What we're seeing is obviously, like everyone else and you listen to our customers calls, North America, Europe, no signs of a rebound yet. In China we are starting to see the first part of some positive indication. Obviously, China has a very large stimulus program. Its gotten underway maybe quicker than some other countries and money is being spent, and so in China we are starting to see the first positive signs of little steel production coming up, order activity, ordering some durable goods. And so I would expect China will be probably the first one that we see really start to turn.

Luke Folta – Longbow Research

Okay. Thanks a lot guys, and thanks for the color.

Craig S. Shular

Thanks, Luke. Have a great day.

Operator

We’ll take our next question from Mark Parr with KeyBanc Capital Markets.

Mark Parr – KeyBanc Capital Markets

Good morning.

Craig S. Shular

Good morning, Mark. How are you doing?

Mark Parr – KeyBanc Capital Markets

Good. Congregations on making money at 38% utilization?

Craig S. Shular

Thanks Mark. Our team has done an awful lot of heavy lifting the last several years and as I told them early this morning after we released. It's really a testament of what's been accomplished in the last several years to run at the lowest op level ever in our company's history to make money. Cash flow positive and still pay down some more debt, nice way to start out the year in a very, very tough environment.

Mark Parr – KeyBanc Capital Markets

Yeah, it's tough. If I was going to just try to sum up any potential changes that you’re making in your commentary today compared to the last time you made commentary. Would it be fair to say that you think perhaps a pick up is a bit more extended now than you did say 30 days ago?

Craig S. Shular

I would say Mark, probably the destocking is going to take longer.

Mark Parr – KeyBanc Capital Markets

Okay.

Craig S. Shular

Because in general the steel customers globally have run slower than what they anticipated in Q1. And you’ve seen that I think in the earnings and in some cases some of them had to, came out mid quarter to readjust their outlooks. So destocking is going to take a little bit longer. And I would say instead of some of those customers being completely destocked in Q3, that looks like right now it will roll over to Q4. But net-net, by Q4 the vast majority of the customer base will be running on new Electrodes, which I think obviously is good news for us and we will start to pick up the supply chain which at that stage will be very, very lean and need replenishment.

Mark Parr – KeyBanc Capital Markets

Have you had the opportunity to do any in regard to melt shop by melt shop analysis? Or I guess maybe another way if thinking about this is, what’s the capacity utilization assumptions you have in terms of, are you assuming any pickup in steel production utilization rates in the second and third quarter?

Craig S. Shular

Not in the second quarter, what we see the run rates right now and the feedback from our customers and just around the conference call they've had, we think there is no real pickup that this material in Q2. We don't see that and they aren't communicating that to us, a side from maybe a little bit in China, but recall China is 90% integrated and only 10% electric arc furnaces using electrodes. So, Q2 we have no uptick in their at all in our guidance for Q2.

Mark Parr – KeyBanc Capital Markets

Okay. All right. And in terms of your existing needle coke supply will you have some ’08 needle coke into the second half of the year or will all be consumed in the second quarter?

Craig S. Shular

I think the best way to look at it is that most of that will be behind us in the first half of the year.

Mark Parr – KeyBanc Capital Markets

Okay.

Craig S. Shular

As so, I wouldn't plan on a benefit in the second half of the year for that. So, we will see some benefit here in the first half and obviously it varies by grade, some grades are already on new coke, because you have different grades for different products and different applications.

Mark Parr – KeyBanc Capital Markets

Right.

Craig S. Shular

So, I think if you add it all up, I think the little benefit in the first half, but by second half, no; that benefit is not something you want to plan on.

Mark Parr – KeyBanc Capital Markets

Okay. Is there anything that you can say as far as the pricing on a quarter contract? Let's just say, let's use Q4 for an example, say somebody comes in and says, okay, I don't really know what my business is going to look like, but I will give you a contract for April, May, and June. Just pick a timeframe, 90-day timeframe. Is that – how do you – how do you look at that in terms of how you price it in the context of your current spot price? I mean is it the same kind of pricing that you would use for a 12-month contract or is it because you say your cost right now are perhaps a bit lower would that allow you to pull the pricing expectation in a little bit?

Craig S. Shular

Mark, the way it would tend to look, it would not look like a spot price. And generally these are larger accounts.

Mark Parr – KeyBanc Capital Markets

Okay.

Craig S. Shular

And so they have the volume and the volume commands a better price. So, the pricing would tend to look more like what you would associate with a contract price.

Mark Parr – KeyBanc Capital Markets

Okay, all right. So, that's interesting though that that change, it is working into the situation. I've got a couple, I don't want to tie this thing up, but I'll pass it on and get back in queue. But I do appreciate the exceptional performance that you guys put out in the first quarter that was really solid.

Craig S. Shular

Thank you, Mark. Much appreciated.

Operator

Next we'll go to Michael Gambardella from JPMorgan.

Michael Gambardella – JPMorgan

Yes, good morning.

Craig S. Shular

Good morning, Mike. How are you doing?

Michael Gambardella – JPMorgan

Good, good, good. So, it sounds to me what you're saying is that you haven't felt the needle coke cost increases in the first quarter and probably not in the second quarter? Is that correct?

Craig S. Shular

Yes. That's correct Mike and, because the volume and the op levels are so low, the older inventory is lasting a little bit longer.

Michael Gambardella – JPMorgan

Sure.

Craig S. Shular

And in general, that's the way I would look at it, but I do highlight like, obviously there is different grades of coke for different applications. And some grades we would already be on new coke price, but in general the way to look at it is yeah, in Q1 and probably to a good part in Q2, we should enjoy some benefit from the lower cost needle coke.

Michael Gambardella – JPMorgan

Now in Q1 what percent just a percentage of the book did you have a repricing on the sales prices of graphite electrodes that you had booked earlier in the year, before the debacle in the economy?

Craig S. Shular

Well, some of it obviously was booked before the downturn. And in some cases, depending on the customer and the size of the customer, some of those were much-improved prices.

Michael Gambardella – JPMorgan

Right. So, I'm just trying to get an idea, like I know, you can tell us the price, but just the percentage of your volumes in the first quarter, how many what percent got a higher price from those contracts that were signed early last year?

Craig S. Shular

Well, maybe the way to look at it is, let's go to those accounts that tend to book Q1-to-Q1. Okay. And so those accounts that booked Q1-to-Q1 they had let's say the old prices in that.

Michael Gambardella – JPMorgan

Right.

Craig S. Shular

Right? And so, in general, I'll give you just generality, in general that Q1-to-Q1 in the first quarter might be 20% of our sales in Q1. So, that group of course they were already booked. They had an annual contract before the market downturn and they had the old price. The balance of the book would start looking at newer prices.

Michael Gambardella – JPMorgan

So, in the first quarter, are you saying I don't understand you are saying that 20% got new prices, higher prices?

Craig S. Shular

No, the 20% would be the carryover of annual contracts for accounts that go Q1-to-Q1. So, those are all.

Michael Gambardella – JPMorgan

Okay. So, end of Q1.

Craig S. Shular

That's right. We've got every year there is a group of customers, that's just our budget cycle. So...

Michael Gambardella – JPMorgan

So, then 80% would be starting calendar year, so January 1?

Craig S. Shular

Yeah, more like 70% to 80% would start being newer business now. The thing that clouds it a little bit is this Mike and that's the general, all right?

Michael Gambardella – JPMorgan

Right.

Craig S. Shular

So, generally, we got 20% in Q1 is carryover.

Michael Gambardella – JPMorgan

Right.

Craig S. Shular

The thing that files it is, this year is so different remember we had customers in Q4 they didn't want to take the products. Right.

Michael Gambardella – JPMorgan

Right.

Craig S. Shular

And so some of that slipped into Q1 and so that 20% that would normally be at old price, all right you got to also add those that slipped Q4 to Q1. And so, you had some of that in Q1, but as far as giving exact percentages, that's not what we do here.

Michael Gambardella – JPMorgan

But I mean you also I thought you had said like, after the summer, you stopped booking new prices, because people didn't have any visibility in the marketplace, right?

Craig S. Shular

Well, no, the book building process stopped. They just stopped asking for bids, yes.

Michael Gambardella – JPMorgan

So, all I'm trying to get a feel for like before the book building stopped?

Craig S. Shular

Right.

Michael Gambardella – JPMorgan

What percent of your business got the price increase that was effective January 1?

Craig S. Shular

I don't have a percent of my business, because I'm not giving you the total business for the year. Right, everybody that was booked before the downturn, everything that was put in the book before the bidding season was spot by the customers had a price increase everybody.

Michael Gambardella – JPMorgan

Right, sure. No, I understand it, but I am just to get a feel, how much was that percentage wise?

Craig S. Shular

Well, again that's something we don't guide to. Right, all I'm trying to tell you is the general themes right? So, every Q1 you got about 20% that carries over, those accounts that are Q1-to-Q1, right. And then all the new business we booked before the bid season was suspended by the customer base all had increases across the board every geography.

Michael Gambardella – JPMorgan

But there were some percentage of the 70% to 80%?

Mark Widmar

Hey, Mike, this is Mark. Let me try to help out here a little bit as well. When you think of Craig's reference to the 20%, the 20% would have been at normal historical volumes. Okay, so, we normally are somewhere around, call it 50,000 – 55,000 tons a quarter. The 20% would have been relative to that normal historical volume. So, we rolled that into Q1 and similar to what happened in Q4 most of our customers that were on the '08 contracts would have taken the full annual commitment that they had on those fiscal years, okay?

Michael Gambardella – JPMorgan

Right.

Mark Widmar

So, then what happened with the new contracts, when you look at what we provided in terms of our operating rate, you can kind of get a gauge that we're probably down 60% year-on-year. Okay.

Michael Gambardella – JPMorgan

Yeah.

Mark Widmar

Most of that drop in volume year-on-year would have been those new contracts, the new annual contracts that would have been sent January 1. So, I think what Craig was trying to give you an indication of 20% the normal roll, using a normal run rate you can calculate kind of what percentage of tonnage that would get you. And then there was some amount of additional carryover, as Craig said, from '08 annual contract contracts that we allowed to carryover. So, that gives you a very small percentage still of new contracts with '09 pricing that would happened in Q1.

Michael Gambardella – JPMorgan

All right, but you have some price increases in Q1, is that right?

Craig S. Shular

Yeah, there was some.

Michael Gambardella – JPMorgan

And you have no cost increases on needle coke?

Craig S. Shular

I would not say no. Primarily, most of it was carryover coke, but we do have some grades Mike that we run out of, we've got to replenish.

Michael Gambardella – JPMorgan

All right. So, very little I guess my point is, is the third quarter the critical quarter where you're probably not going to book any higher prices yet in the third quarter because it's still going to be a weak quarter, you got GM down for the whole summer basically. You got a lot of OEMs probably taking extra vacation to soak up some inventories as well, but you guys will have the kind of hurdle of getting the higher needle coke costs flowing through in the third quarter without the benefit of higher pricing yet?

Craig S. Shular

I would say Mike in Q3, as we said earlier, some of our customers would have completed their destocking. So, some customers absolutely will be burning brand new electrodes purchased this year at a higher price in Q3. The offset to that is the European summer holiday phenomena, that usually Q3 is a slower quarter for us and what we highlighted was, when those European steel plants go out, do some of them extend that that outage. But we will have some business in Q3 for those customers that have completed their destocking that will be at newly priced electrodes.

Michael Gambardella – JPMorgan

Have you booked though much business with the new higher pricing since the economy fell off a cliff?

Craig S. Shular

That's been ongoing, yes. There is every week now, there's new prices being put in the book for Q3 and Q4.

Michael Gambardella – JPMorgan

That are high enough to offset the needle coke?

Craig S. Shular

Well as I said in the release it's too early to tell other than we expect them to be higher to offset and the goal is to offset, but yes, price is up.

Michael Gambardella – JPMorgan

Okay. I won't take any more time. Sorry.

Craig S. Shular

Thanks Mike.

Operator

We'll go next to Chuck Murphy with Sidoti & Company.

Charles Murphy – Sidoti & Co.

Good morning guys.

Craig S. Shular

Hey how are you doing?

Charles Murphy – Sidoti & Co.

Doing okay, just kind of wanted to follow-up on that last question. Just to be clear, you were trying to say that like 80% of your customer base is on a calendar year contract right?

Craig S. Shular

That's right.

Charles Murphy – Sidoti & Co.

You weren't saying that 80% of the volume in the first quarter was at 2009 pricing level is that right?

Craig S. Shular

That's right. That's correct. 80% is calendar and then about 20% go Q1-to-Q1 that's where they’ve been for decades.

Charles Murphy – Sidoti & Co.

Okay, that's what I thought, okay. My first question was that Tokai came out a few weeks ago saying that they wanted the $7,000 prices from their domestic customers. I was wondering if you're seeing similar type pricing from other competitors?

Craig S. Shular

Well, I think it's too early really to tell. The book building process is underway. Obviously, there is pressure on the cost side and I'm sure that's probably what's driven some of our competitors to try and get higher prices also, because of the needle coke we have talk to, but Chuck, it's really too early to talk about the book building process until we get it completed and behind us. And so it's kind of quarter-by-quarter this year, really because of the lack of visibility our customers have. And I think our customers would be the first to tell you, they have little or no line of slight to Q3 or Q4 and we're kind of part of that supply chain, so we're in the same position.

Charles Murphy – Sidoti & Co.

Okay. And in terms of what you said before, that you expected the electrode prices to offset the needle coke prices. When you say offset do you mean if needle coke is up 80% you expect the electrode prices to be up 80% or is there something I'm missing?

Craig S. Shular

Well no, you'll recall the needle coke is 40% – 45% of our cost structure. So, that's what we've got to offset.

Charles Murphy – Sidoti & Co.

Okay.

Craig S. Shular

It's not dollar-for-dollar, but the goal will be to get enough price increase to offset significant increase in that key raw material.

Charles Murphy – Sidoti & Co.

Okay, okay. And my final question was just kind of, can you give us a little sense of what's going on with Engineered Solutions markets? Will that business be flat or up in the second quarter I know Brush Engineered is kind of feeling that way?

Craig S. Shular

What we see is we expect Engineered Solutions in the second quarter to look like the first quarter. So, we do not see an upturn in any of the geographies or businesses at ES services. So, you add all that up, IM and ES we expect Q2 to look like Q1.

Charles Murphy – Sidoti & Co.

Okay. And what was the particular markets that were weak for that segment?

Craig S. Shular

Well, it's across the board. So, it's everything, solar is down, transportation is down, consumer electronics is down quite significantly. And you saw that in Q1 in ES' results. And I would expect a kind of similar kind of profile for ES in Q2. There is no turnout there just yet.

Charles Murphy – Sidoti & Co.

Okay. Thank you.

Craig S. Shular

Thanks Chuck. Have a good day.

Charles Murphy – Sidoti & Co.

Me to.

Operator

We'll go next to Asad Abedi with Merrill Lynch.

Craig S. Shular

Hello Asad.

Asad Abedi – Merrill Lynch

Good morning guys.

Craig S. Shular

How are you today?

Asad Abedi – Merrill Lynch

Much thank yourself.

Craig S. Shular

Excellent thank you.

Asad Abedi – Merrill Lynch

A couple of questions for you. You talked about a risk that customers that extend their Q3 normal shutdown in Europe. Would that be to maintain stock levels at the current levels they want to maintain them at or would that be part of if they say were restocking?

Craig S. Shular

Asad the reason we highlighted, one to just to re-highlight and remind everyone that Q3 is generally slower because of the European holiday. But also to remind that, if we go back in time to other downturns there have been occasions where European customers, once they shut down a facility for the summer holidays, they extend it. It's very easy to extend those once you've got everybody out on holiday. And given the current economic environment it's very possible that some of our customers may extend it. So, it would be, Asad not so much in response to destocking as I said earlier a lot of that destocking is going to be behind marketplace. It will be more related to demand. What is ultimate steel demand like, what's auto production like in Europe, where are durable goods in Europe at that time, and if the European steel producers have everybody out for three or four weeks for the natural holiday, do some of them decide to keep people out longer. It's been a phenomenon that we've seen sometimes in other prior downturns.

Asad Abedi – Merrill Lynch

Okay. And how about the amount of production, you've actually shutdown, say for in your graphite electrodes business. Can you give us a feel for how much that amounts to out of total production ability?

Craig S. Shular

Well we haven't shut anything down per se. What we've done is significant reductions in headcount, hours worked and we have the operating rate down to 38%, but none of our facilities have been fully shutdown. But obviously their capability has been curtailed and obviously, a lot of cost has been driven out.

Asad Abedi – Merrill Lynch

Okay, that's great. Thank you.

Craig S. Shular

Thanks Asad. Have a good day.

Operator

We'll go next to Yvonne Varano with Jefferies & Company.

Yvonne Varano – Jefferies & Co.

Thanks. I just wanted to make sure I was clear on that whole pricing discussion, it seems like its safe to assume that your 2Q pricing could be up directionally just a little and more so in 3Q?

Craig S. Shular

Yeah, Yvonne in general, I think that's a good way to look at it, there will be some more new electrodes in Q2. In Q3, as I said a lot of our customers will finish their destocking and then by Q4, the vast majority of customers will be done with their destocking. So, Q2, a few more new electrodes; Q3, I think a bigger number. And then Q4 pretty much most of the customer base will be on new electrodes.

Yvonne Varano – Jefferies & Co.

Okay. So, hopefully seeing the prices trend up in Q2?

Craig S. Shular

That's correct. So, you may see a little bit of juice from that in Q2; increasingly more in Q3 and likewise I would expect increasingly more in Q4, with the one caveat that we talked about Q3, Q3 the volume could be impacted from that European phenomena we talked about.

Yvonne Varano – Jefferies & Co.

Right. So, then I guess translating that into gross margin and taking into account the comments on the needle coke were probably flat in 2Q could see some pressure in 3Q as that higher cost comes in but hopefully leveling back off in 4Q as we get pricing up?

Craig S. Shular

Yeah I think that's a good way to look at it, in general terms. However, as we said, we are still building the book, so we do not have line of sight to the volume. We do not have the final picture on the price. And so as we've said our customers have such little line of sight to Q3 or Q4 and that just backs up into our line of sight. And some of them right now, as I said are booking month-to-month, quarter-to-quarter. So, in general terms I think you're correct, but there is such little visibility right now.

Yvonne Varano – Jefferies & Co.

Okay. Did you sell anything on spot in 1Q, or you've just gone to be shorter contracts?

Craig S. Shular

Yeah, I'd say there is very little spot business out there right now. I mean right now the general theme is destocking, customers are working off and reducing working capital. So, there is just not the phenomenon of spot business out there.

Yvonne Varano – Jefferies & Co.

Okay. And then lastly I know you've talked about the book is there anyway to look at it on a percentage basis is maybe where like 35% through it or 40% through it?

Craig S. Shular

Yvonne, that's just not a guidance we can give at this stage. And in part its line of sight, what's the total book, so there is so limited line of sight in Q3 and Q4 that we're just not in a position to say. I think we've got to contact this year quarter-by-quarter. And in fact I think that's the way most of our customers are kind of taking it, quarter-by-quarter. And so Q2 we expect to look like Q1, Q3, Q4, we expect the marginal improvement for the reasons, we've talk Q3 could be weaker volume depending on what the customers do especially in Europe. And we are just going to take it quarter-by-quarter.

Yvonne Varano – Jefferies & Co.

But I think the feeling is that Europe is going to take a little longer to come back than the U.S.?

Craig S. Shular

I don't know now, obviously none of our customers have announced formally and they've not communicated to us, but what I am relating to is kind of our experience. If I go back the last two or three or four major downturns, when they've gotten to the European summer holiday, some of the customers have decided instead of taking three or four weeks well let's leave everybody out for six weeks, so let's leave everybody out for seven weeks, because demand is slow. And so we are just highlighting that attention. That could be in Q3 and so that would obviously impact our Q3 more than normal. Our Q3 is usually a weaker quarter and this could make it an even a weaker quarter than what it has been historically.

Yvonne Varano – Jefferies & Co.

And then, lastly the customers that you've negotiated with, would you say they're mostly your larger customers or your smaller customers?

Craig S. Shular

It's across the board. It's completely across the board a lot of the smaller customers have come in. Some of the smaller customers have tended to take maybe longer contracts. And some of them have taken, for the balance of the year. And in general the larger customers maybe have gone a little bit shorter. They've gone quarter-to-quarter, some even they're just looking month-to-month. They just don't know their book yet. They just don't have line of sight to Q3 or Q4.

Yvonne Varano – Jefferies & Co.

And then just on Seadrift, any comments that you could give us in regard to what's going on there?

Craig S. Shular

Yeah. As we reported Seadrift made money in the first quarter. Obviously, being a key raw material to the graphic electrode industry and you see us running at a 38% op level, you see us working off needle coke. So, the way I think you should look at Seadrift is they've probably got very limited sales opportunities right now. People are working off their needle coke like we're, and so Seadrift the way I would look at them, running at a very low op level. And I would not factor into earnings in any kind of significant contribution. I think '09 for Seadrift will be a low operating rate and really, we've got to look to 2010 and 2011 as stimulus starts to give traction before we really start to think about Seadrift making a contribution. So, I would not plan on them making any kind of significant contribution to us this year. We're their type of customer, and as, we are not buying much in the first half.

Yvonne Varano – Jefferies & Co.

Right, but then we could probably see that tick down maybe a little in that minority interest line?

Craig S. Shular

Yes, I would plan very little to nothing out of that for this year, I think is just prudent.

Yvonne Varano – Jefferies & Co.

Perfect. Thanks so much for your comments.

Craig S. Shular

Thank you. Have a good day.

Operator

We'll go next to Charles Bradford from Bradford Research.

Charles Bradford – Bradford Research

Hi, good morning.

Craig S. Shular

Good morning, Chuck. How are you today?

Charles Bradford – Bradford Research

Good, good. Question for you, other income was most of your income for the quarter with the re-measurement of intercompany loans the item that you highlighted, how did that come about, since it was intercompany, and what can we look forward to?

Mark Widmar

Chuck, it's Mark. The intercompany loans is obviously how we are managing cash flows between various jurisdictions. And those intercompany loans have been in place for a number of years. They do have volatile mark-to-mark impacts; could be a gain one quarter, could be a loss another quarter. So, as I think we may have referenced before we will exclude those as we look at non-recurring items. So, the EPS that's included in the lease of $0.04 does not include the impact of the mark-to-mark, there was a gain associated with it this quarter as you can look last year we had a $21 million loss in other income most of that was losses on the mark-to-mark. So, the way we think it's – the right way to look at the business operation is to exclude those impact. The biggest exposure we have is to euro. So, anyone guess in terms of what direction that may go. So, we may see movement next quarter it could go against us, it could result in additional gains, its just really too difficult to project and that's why we try to exclude it from how we talk about the business and the EPS that we provide in the release.

Charles Bradford – Bradford Research

So, will the $0.04 does not include the 6 million?

Mark Widmar

No, the $0.04 does not include the 6 million.

Charles Bradford – Bradford Research

Another areas where I would have thought relatively soon your customers would start seeing some business from the so called shovel-ready infrastructure projects, but it sounds like it's not happening. And this is an around the world phenomenon, everybody seems to have a stimulus package. So it's just not happening yet?

Craig S. Shular

Chuck, I think we talked a bit about this on the last call too. The way we would look at government spending and remember we've had many highway bills in this country. And so we have some experience with it. And when highway bills or major government spending comes, we usually find it's at least 9 months to 12 months before the impact of those are felt by our steel customers. And so the way I would look at stimulus is I wouldn't plan on a lot of impact in our business in '09. Stimulus I think traction will begin in 2010 and 2011. The one little change you see to that worldwide is China. China has a large program, it's 14% of their GDP program. So, it's the highest percentage of GDP of any of the other stimulus programs announced. It has a lot of major projects that are very steel intensive. So, we've started to see that uptick and I think if you look at some of the China numbers you're starting to see it, they're often running in spending money. In Europe and the U.S., the government spending programs really we haven't seen – seen anything yet, and I think if you talk to a lot of industries here the same kind of thing, because they're lag. In fact there was a great article in the Wall Street Journal today on Caterpillar. And Caterpillar started to get some orders from China as a result of the China government stimulus program. So, it looks like China is going to lead this give us the first positive data points, but probably 2010 for U.S. and European stimulus to really move the dial at all.

Charles Bradford – Bradford Research

Well thank you.

Craig S. Shular

Thanks Chuck. Have a good day.

Operator

And moving on we will take our next question from Ray Rund with Shaker Investments.

Craig S. Shular

Good morning Ray. How are you today?

Raymond Rund – Shaker Investments

Fine. Thank you. I was going to ask a question on the other income line, but that's already been answered. So I think I’ll go into the queue. Thank you.

Craig S. Shular

Thanks, Ray. Have a good day.

Operator

(Operator Instructions). We’ll go next to Mark Parr with KeyBanc Capital Markets.

Mark Parr – KeyBanc Capital Markets

Thanks a lot. One thing, Mark, I was wondering if you could comment or Craig if you could comment on supply discipline or what you’re seeing. I realize there is not a lot of business and the year book is still in a preliminary phase, but, and I know your goal is to get pricing. Can you give us some color on how discipline the environment is from a pricing perspective right now?

Craig S. Shular

Mark, it's really too early in the process to comment much other than what we have said thus far. The bidding process is underway. Most geographies are bidding. Most customers are getting lined up for needs that they’re going to have in Q3 or Q4, because their destocking is projected to be done then. So I think it's really too early to comment. Obviously the goal is to get prices up, I believe prices will be up across the Board, and mainly propelled by this deep raw material increase. The last thing you want to have happened is get behind these raw increase, because they'll just overrun you. So the goal is to prices up, offset the raw material increases and participate in an orderly book building process.

Mark Parr – KeyBanc Capital Markets

Okay. All right thanks. And then just to, and again, I hate to keep coming back to this first quarter scenario, we were kind of running some numbers and it appears as though, on a year-over-year basis price realizations for the electrode business was pretty flat compared to ’08. Is that correct based on, I mean, are we looking at that in a correct way?

Craig S. Shular

Well, again it’s not an item we guide to. I am going to have to leave it to your individual analysis on pricing. We tend to guide more to the bottom line rather than individual prices in one of our individual businesses. So I'm going to have to leave that really to you Mark and your analysis team to kind of tear apart. Obviously, as we said before, we’ve had some carryover business. We had the 20% normal that's Q1 to Q1 bid. And so obviously a fair amount of Q1 was last year’s type business.

Mark Parr – KeyBanc Capital Markets

Okay. Was there a constant mix or was there a greater mix of non-melter grade in the first quarter?

Craig S. Shular

No, that's run pretty steady. That mix is pretty steady. We haven't seen any real disruptions in the typical, kind of 70, 30-type mix.

Mark Parr – KeyBanc Capital Markets

Okay, I think Gibbs has got a question here, if you don't mind.

Craig S. Shular

Sure. Please. Go right ahead.

Philip Gibbs – KeyBanc Capital Markets

Just as far as overall inventory levels. How are you looking working capital to trend just on the inventory line from kind of an absolute basis here. Given the fact that you are seeing some upside in needle coke, but maybe some lower volumes.

Craig S. Shular

Yeah, Phil, very good question. The way I would look at our working capital account I would look in Q2 and then Q3, you should see a reduction in our working capital. So, we have a number of teams working on it, we have worked very hard on AR collections and keep them current. And we have a number of teams working on inventory reduction. So, the way I would look at is, Q2 you should see our inventories come down, Q3 probably some more reduction in total working capital. So, Q2 better, Q3 better than Q2 on working capital.

Philip Gibbs – KeyBanc Capital Markets

And just lastly on your CapEx, it looks like your budget there was relatively unchanged. What are you really working on there?

Craig S. Shular

Well, I think if you go back last year, $75 million in Q1. Our last guidance I think we said about $55 million or so. And we brought that down even a little bit another $5 million. So we've been continuing to work to squeeze down the capital requirement for this year. And over the course of Q1, we were able to find perhaps another $5 million to squeeze out of that.

Philip Gibbs– KeyBanc Capital Markets

Okay. I just meant on what type of projects?

Craig S. Shular

Well, let's look at about $30 million is a kind of maintenance capital. And then anything beyond that would be primarily productivity type capital, how to improve productivity; how to get costs out, there can be some quality items in there; how to improve the quality to our customers the consistency to our customers. So, a good $30 million of that is maintenance capital.

Philip Gibbs – KeyBanc Capital Markets

Okay. Thank you very much.

Craig S. Shular

Thanks, Phil and Mark. Have a good day.

Operator

(Operator Instructions). We'll go next to John Lancefield with Royal Capital.

John Lancefield – Royal Capital Management

Hey, guys. Good morning.

Craig S. Shular

Good morning John. How are you today?

John Lancefield – Royal Capital Management

Well, thanks. How are you Craig?

Craig S. Shular

Great, thanks.

John Lancefield – Royal Capital Management

Good. So I guess the last questioner had asked a question about the 70%, 30% mix that you alluded to before. As far as the 30% of your book, which sounds like it remained fairly stable in the first quarter, what impact are you seeing of the tariffs on that end of the market, has that had a meaningful impact as far as keeping prices up?

Craig S. Shular

Well, the tariffs that you're alluding to in the U.S., of course have taken place. And yeah, they've, I believe over the course of this year are going to result in the prices of those diameters that were covered under the tariffs, caused those prices to be firmer and up. But again, as we said on this call, it's really too early. We're early in this book building process. I think you've really got to let us get the book together. And given the limited line of sight our customers have I think it's just the right guidance to give you all. You've just got to be patient for us to get the books together over the course of the next several months. And really, the way I would look at it is kind of quarter-by-quarter in this environment.

John Lancefield – Royal Capital Management

Okay. As far as the tax rate guidance, what's driving that lower range?

Craig S. Shular

For the first quarter, John, we actually came in right around 30%. So the guidance is 2 points either north or south of the 30% that we came in for Q1. And again, as we said before, some of that is the jurisdictional mix of profitability. The other component of that is actually some tax planning initiatives that we're doing right now.

John Lancefield – Royal Capital Management

And then Craig I know you've talked before although has been, I think, a couple of years, you've talked about what sort of sustained pricing you would need to see in the industry that to actually have Greenfield electrode capacity added. I guess, taking that from the other side, what would need to happen as far as industry capacity utilization or contract pricing, or whatever other dynamics to actually see capacity among your competitors come out?

Craig S. Shular

Well, that's a tough one. You've got the overall economic environment bearing on that. I mean, what's the demand level? When we look at current demand, you can make a case that some capacity could come out. But what's 2010 going to look like? What's 2011 going to look like? What are these massive stimulus programs going to look like? So John, I think that's such a moving target, really, really difficult to comment on, because what's the underlying demand? And when will it return to kind of the '07, ’08 type level.

John Lancefield – Royal Capital Management

I mean, as you look around at the cost structures of your industry, there have to be people who aren't making money in this environment, I would think, meaningfully?

Craig S. Shular

Yeah. Maybe the way to look at it, we're not planning it in our forecast that any significant capacity is going to come out of our industry. So we're not planning for that. And I think, what many people would be looking for in our industry is obviously these massive government-spending programs should stimulate steel demand 2010, 2011. And so I don't expect a lot of people to be thinking about taking capacity out today in a permanent way, because looking at 2010, 2011, it could get quite interesting, as this large government spending starts to get traction.

John Lancefield – Royal Capital Management

Okay. Thanks.

Craig S. Shular

Thank you, John.

Operator

There are no further questions at this time. I will turn the conference back over to our speakers for any additional or closing remarks.

Craig S. Shular

Tamika, thank you very much. Ladies and gents, thanks very much for joining our call, and we look forward to talking to you at the end of our next quarter results. Thank you. Have a good day.

Operator

And that does conclude today's conference call. Thank you all for your participation.

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