Graftech International Q2 2009 Earnings Transcript

Graftech International Ltd. (GTI)

Q2 2009 Earnings Call

July 30, 2009 11:00 AM ET

Executives

Kelly Taylor - Manager, Investor Relations

Craig S. Shular - Chairman, President and Chief Executive Officer

Mark Widmar - Chief Financial Officer

Analysts

Luke Folta - Longbow Research

Mark Parr - KeyBanc Capital Markets

Chuck Bradford - Affiliated Research Group

John Evans - Wells Capital Management

Brett Levy - Jefferies & Company

Chuck Murphy - Sidoti & Company

Eric Prouty - Canaccord Adams

Presentation

Operator

Good morning and welcome to GrafTech International's Second Quarter 2009 Conference Call. Today's conference is being recorded. On the call today is GrafTech's Chief Executive Officer, Craig Shular; and our Chief Financial Officer, Mark Widmar.

At this time, I will turn the call over to Mrs. Kelly Taylor. Please go ahead ma'am.

Kelly Taylor

Thank you, Andrea. Good morning and welcome to GrafTech International's Second 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 didn't receive a copy, please contact Sami Noor 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 discussed 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'd like to turn the call over to Craig.

Craig S. Shular

Thank you, Kelly. Good morning everyone and thank you for joining our call today. Today, we'll take you to our second quarter highlights and then open it up to questions.

Net sales were a 158 million, an 18% improvement over the first quarter. Gross profit increased over 40% to $46 million. Gross profit margin increased more than five full percentage points to 29% of sales.

Operating income more than doubled to 19 million, net income before specials tripled to 15 million or $0.12 per share. Operating cash flow improved $32 million to 46 million in the quarter. Net debt was 48 million, a reduction of 29 million over our first quarter.

In the second quarter, we recorded a $45 million non-cash impairment charge net of tax against the valuation of our investment in Seadrift. The global economic recession has led to historic declines in global steel demand and record low capacity utilization.

Seadrift not like other, not unlike other needle coke producers has been impacted by the dramatic destocking that is incurred throughout this field supply chain. This together with the uncertainty regarding the timing of a global market recovery has required per GAAP, a reassessment of our balance sheet carrying value.

Additionally on July 2nd, we entered into an agreement with Seadrift to lend up to $18.5 million at a 10% interest rate. Seadrift currently has borrowed 6 million under this agreement in order to reduce its revolver.

Aggressive working capital management, successful productivity initiatives, cost reductions have enabled Seadrift to generate 13 million of free cash flow in the first five months of the year. Seadrift has reduced liabilities by 17 million from year end '08 to 25 million at the end of May '09, of which 20 million was outstanding debt. So Seadrift sits with solid assets, a good balance sheet and very few liabilities.

In our Industrial Materials segment, sales were 130 million, while operating income for the segment was 16 million versus 7 million in Q1. Obviously the severe drop in steel production rates has affected our business. However, execution of previously announced cost reduction and productivity initiatives have helped mitigate some of this impact of the very low demand.

In our Engineered Solutions segment sales were 28 million in the second quarter as compared to 30 million in Q1. Operating income was 3 million, up slightly from 2 million in Q1.

On July 20th, GrafTech was awarded the R&D 100 Award for our new product line GRAFIHX, a graphite solution uniquely tailored for radiant floor heating systems. The R&D 100 Award honors the 100 most significant new products commercialized over the past year. This award marks our sixth R&D 100 Award in the past seven years.

Turning to the status of book build as indicated last quarter, our '09 book building process has been disrupted by the severe global economic recession. The trend of shorter term contracts quarter-to-quarter has continued. We are beginning to see an uptick in the order process as destocking has reduced a number of our customers' inventory levels. Given the pick up in orders, we expect our second half results to be better than those in the first half.

Turning to outlook, we continued to expect '09 to be very challenging for both of our business segments. Second quarter results came in better than expected due to timing of shipments and a lower tax rate. Given the favorable timing of shipments experienced in Q2 and the usual seasonal lower demand in the third quarter, we believe Q3 results would be below the second quarter and closer to those in Q1.

As anticipated, third quarter graphite electrodes sales volume will be adversely impacted by the low European steel offering rates and the normal European August holiday season. While a high a degree of uncertainty around forward-looking projections remains, we expect an improvement in Q4 results, as customers should have largely completed inventory destocking initiatives.

The fourth quarter should represent, our strongest quarter of the year. Based on the first half year results and anticipation of a moderate improvement in the second half of '09, we are targeting operating income to be in the range of 60 to $70 million; CapEx to be approximately 50 to $55 million; depreciation expense to be approximately 35 million; and our effective tax rate to be in the range of 22 to 25%.

Andrea, with that let's open it up to Q&A.

Question-and-Answer Session

Operator

At this time, thank you very much. We will go to our question-and-answer session. (Operator Instructions). Our first question will come from Luke Folta with Longbow Research.

Luke Folta - Longbow Research

Hi. Good morning guys.

Craig Shular

Good morning, Luke. How are you today?

Luke Folta - Longbow Research

Not bad. Just a couple of questions right off the bets, regarding characterization, are you able to give us what you operated at in the second quarter?

Craig Shular

Yeah, in fact Luke we are even lower than the first quarter. So we sold up some inventory. And we were down all probably close to 35% or so in the second quarter. So we've continued to be very prudent on our operating rates and match operating rates with what we see in the marketplace.

Luke Folta - Longbow Research

You had to step down the utilization quarter-over-quarter. Is it that mean... are we likely to see a further step down from that in 3Q now?

Craig Shular

Well, I'd say, it's early to tell. We really got to see how the quarter rolls out. But I think what you can count on is we will line up our operating rates with what we see in the marketplace. And as we said all things being equal, we look for Q3 to be a little bit softer than Q2 and more like Q1 in numbers because of the European holiday slowdown.

Luke Folta - Longbow Research

Okay. And just taking into account, if my capacity utilization numbers are reasonably close, it would appear that you guys are guiding to fully pass through the higher needle coke cost we've seen. Is that an accurate statement?

Craig Shular

Yeah. I'd say, if I look at Q2 '08, prices in graphite electrodes versus Q2 '09, across our whole portfolio of graphite electrodes, I'd say and remember, we make many grades, many sizes. But average price between this Q2 to last year's Q2 is up over 12%. And so yeah, the goal would be to pass on higher price needle coke. Needle coke is going up significantly.

Obviously with steel running at low rates some of our inventories are lasting longer and so some of our lower priced inventories depends on the grade is lasting longer. So we've rolled all that into the annual guidance to 60 to 70 million of operating income. And I think that's the best way to look at it Luke.

Luke Folta - Longbow Research

Okay. And I just have one more and I'll turn it over.

Craig Shular

Yes sir.

Luke Folta - Longbow Research

Regarding the... a lot of your these contracts now you are putting together pretty late in the year. So the term of the contracts, should we think about in 2010 or to be kind of a renegotiation on calendar year basis or are these contracts a lot of them spilling into 2010, I mean how is the timing in works on those things?

Craig Shular

Now Luke, right now the contracts literally are of Q3 and Q4 or some customers are just Q3. So they are either quarterly or six months, we really haven't put anything into the 2010 book.

Luke Folta - Longbow Research

Okay, great. Thanks a lot guys.

Craig Shular

Thank you, sir.

Operator

Our next question will come from Mark Parr with KeyBanc Capital Markets.

Mark Parr - KeyBanc Capital Markets

Hey, good morning.

Craig Shular

Good morning, Mark. How are you today?

Mark Parr - KeyBanc Capital Markets

Good Craig. How are you?

Craig Shular

Superb. Thank you.

Mark Parr - KeyBanc Capital Markets

Nice quarter, congratulations.

Craig Shular

Thank you very much.

Mark Parr - KeyBanc Capital Markets

I've got a couple of questions. First, just from a house keeping standpoint, I think your release says that the credit line with Seadrift is 8.5 million and I think I've heard you say 18.5, I'm just trying to --

Craig Shular

No, no, you're right. If I did, I misspoke, I apologize. It's 8.5 million, of which they have taken 6 million.

Mark Parr - KeyBanc Capital Markets

Okay.

Craig Shular

Thank you. Thank you for the correction.

Mark Parr - KeyBanc Capital Markets

No, I just wanted to clarify that. Okay, so that's certainly helpful. Secondly, could you give us an update on your '08 priced needle coke supply and how long do you expect it to last at this point given that your production environment?

Craig Shular

Well, market is lasting a little bit longer. And so it is trending into Q3. Obviously, there is many grades, right. And so it kind of varies by grade, and then of course depends on the customer demand.

And many of our customers are in that process, where their destocking program is either at the end, just starting to get at the end or they are starting to have line of sight. So it really depends on who starts to send in what order. But let's think of it this way in totality. Our coke will last longer than probably prior years because of the slow operating rate and it will go into Q3. Maybe there is couple of grades that might even carry over to Q4 depending on the demand from our customers.

Mark Parr - KeyBanc Capital Markets

Okay. So some of that... so and the numbers that we've heard on needle coke for '09, I mean they originally were at one level that was dramatically above the '08 level. I think that the numbers that we're hearing more recently are still well above the '08 level but somewhat lower than what they had been initially talked about. Is that something you could confirm and do you have any sense along those lines in terms of what sort of pricing upside you might see in 2010?

Craig Shular

Yeah, a good point on the coke. There has been some relatively recent developments in coke price. And I know we've been talking about our 90% hype year-over-year increase and that's what the coke producers were out there, trying to get. And we've seen some reductions in those requests. And I'd say right now, it's more or like around 50% or say increase. So they have come off the big 90%. But as you rightfully point out, that's still a big number, 50%, so we still have pressure on the cost structure go-forward and then obviously it looks like needle coke prices will be up quite significantly in 2010. And we'll have to build the book with the goal of overcoming that along with continued work on the productivity and cost front.

Mark Parr - KeyBanc Capital Markets

Okay, terrific. I'll get back in queue but congratulations on the progress.

Craig Shular

Thanks Mark.

Operator

Our next question will come from Chuck Bradford with Affiliated Research Group.

Chuck Bradford - Affiliated Research Group

Hi. Could you explain a couple of items that are in some of your footnotes, what's the valuation allowance?

Craig Shular

Yeah Chuck. How are you today, I'll toss that over to Mark and Mark will help you out there a bit.

Mark Widmar

Chuck, as per GAAP we have to evaluate the likelihood that we'll be able to benefit from various deferred tax assets. And because there is movements in those deferred tax assets, every quarter we have to assess whether or not we need to re-establish valuation allowances again. So, and as you may remember to the end of 2005, 2006, I can't remember the exact year, we established the valuation allowance for our U.S. deferred tax assets. Do within the quarter we had valuation allowance associated with the movement of our deferred tax assets in the U.S. And that's what's showing up in the GAAP to the non-GAAP walk. So we had about a $4.8 million impact of that valuation allowance.

Chuck Bradford - Affiliated Research Group

And that shows up as part of the tax credit?

Mark Widmar

Well, actually it's an expense. So if you look at our GAAP it actual will show up as an expense booked in the quarter, it's in the overall tax expense line that we show. And we will back it out for the purposes of looking at our recurring operating income streams that we are generating.

Chuck Bradford - Affiliated Research Group

Okay. Because then there were two other items that you show in that same table, one of them is an adjustment to results for an uncertain tax positions.

Mark Widmar

Yes.

Chuck Bradford - Affiliated Research Group

And also restructuring and other income expense net, both I guess they were fed each other?

Mark Widmar

Yeah. We have obviously, certain positions that we take for our tax returns and we have to assess the likelihood that those deductions will be allowed upon audit. And so at certain times certain criterias are met, we will establish a reserve against those tax positions.

We had couple that have been through audit and have been passed and allowed. Therefore, we reversed that reserve. So again that was a credit acknowledged in the quarter and we pulled that out again as the non-recurring item.

The items that show up below in their restructuring/other income expense largely relates to the foreign currency re-measurement with the in the inter-company loans. We have that one pretty much every quarter. Again it's a non-cash inter-company loan re-measurement that will pull out for purposes of looking at our ongoing operational results.

Chuck Bradford - Affiliated Research Group

When it comes to needle coke, with needle Coke up as much as you describe say 50%, I would think that would be very helpful to Seadrift. And have I am having a little difficulty figuring why Seadrift would be revalued down if they are getting that kind of a price increase because obviously oil and calcium, coke and all those kind of things came down?

Craig Shular

Chuck, I think the way to look at it is, kind of today's situation and then what the future may look like. In today's situation because needle coke is at the front end of the supply chain and you just see in our case we're buying very little or no needle coke, the rest of the electrode industries is in the same place. So Seadrift is running at a very, very low operating rate. And they have done a great job taking out costs. In fact they have closed the facility at different times and just ship out of inventory.

So, they... it's the very low op rate right now that Seadrift is facing, not unlike all the other coke producers. So it's not the case that the other competitors of Seadrift aren't facing exactly the same thing.

Many of the other competitors, they are not running or they have taken extended maintenance turnarounds or they are even making alternative products. Some of the other cokers can make an upgrade. So, that entire coke industry is at a very, very low operating rate. So that's where it sits today.

Now looking ahead, if they are able to get those kinds of price increases, let's say in 2010, yeah I think that together with increased operating rate obviously in 2010, we're going to have to buy, a bunch of more coke like I think a lot of the other electrode producers are going to have to do and Seadrift should be positioned to benefit from that quite nicely.

Chuck Bradford - Affiliated Research Group

But once you've written it down, it's my understating you can't write it back up again, if business does turn upward?

Craig Shular

That's correct. And we're just being very prudent and following exactly GAAP here. And you are right. So when it does turn up, it will be on our books at the lower value with the lower monthly and quarterly amortization rate flowing through. You're spot on there.

Chuck Bradford - Affiliated Research Group

Okay. One of your competitors has told me that ConocoPhillips cut the price of needle coke between 3 and $400 a ton. Is that difference between the 50% and the 90% that you are talking about?

Craig Shular

Yeah, that's very much akin without getting into specific numbers with what we've talked about with the prior question. There is been a drop in the pricing that they have been seeking and it's kind of come from that 90% level down to a 50% increase type level. So time will tell where that finishes. Obviously oil, we'll move a lot of that. And if you look at this recession oil's held up pretty good. I mean it's say high 60, 70 bucks, it's held up pretty good just, compared to the historical levels.

Chuck Bradford - Affiliated Research Group

Better than 150.

Craig Shular

I'll say, I am with you, absolutely. So yeah, you are spot on. That's the coke picture. And I think, when we get into 2010 that will become clear as we'll go ahead. And as always work to lock up our 2010 requirements and price and then start building up.

Chuck Bradford - Affiliated Research Group

How many of your sales contracts require you to pass through that lower coke costs?

Craig Shular

Well, none of our contracts require us to pass through. As I said price of electrodes and again and I caution this is the entire portfolio of electrodes we make, the average price and we make many grades, we make low and medium, then the high grades for the melters many different diameters. But that price in Q2 this year versus Q2 last year is up over 12%. So yeah our goal and as we've done in the last several years successfully is to get a price that allows us to pass on raw material costs and parallel for that drive efficiencies and cost reductions in our own platform. And that will continue to be our goal and we have had a bit of a track record here, but that will be the goal throughout this year and into next year.

Chuck Bradford - Affiliated Research Group

Thank you very much.

Craig Shular

Thanks Chuck. Have great day.

Operator

Our next question will come form Ryan Duckworth with Wells Capital Management.

Craig Shular

Good morning, Ryan.

Unidentified Analyst

Hey. I'm sorry. This is John Evans at Wells. How are you?

Craig Shular

No problem. Hi, John how are you doing?

John Evans - Wells Capital Management

Good. I just had a couple of questions for you. Help us understand, if you look at your gross margin, I mean obviously your gross margin was really impressive sequentially. It went up on a percentage basis and you gained 14 million in operating profits when your utilization went down sequentially. So you didn't absorb those fixed cost obviously you sold more electrodes, but if we get to a point in the back half and how should we think about as you start to sell more and utilization tons, what that does to gross margins because it seems like it has some pretty positive ramifications, is that right?

Craig Shular

Yeah, that's right. John that's the model we've build. We've worked very hard over the last several years to build that model and get very lean and low cost and build the leverage that model depending on the marketplace. And so you're right directionally, you're right on to the impact, the positive impact on the model. All of that we have factored into our 60 to 70 million guidance that we've given for the year.

John Evans - Wells Capital Management

Yeah. And help me though to understand so if you were in the low 30s and is there way a to think just in bigger increments, so let's say you jump 10 points or every 10 points, you jump in utilization, what does that do to gross margins?

Craig Shular

Well, that's not a guidance that we give and obviously we sell in many geographies, many products.

John Evans - Wells Capital Management

Right.

Craig Shular

So that's never a perfect science, so --

John Evans - Wells Capital Management

Can you give us any kind of sense of the incrementals because it seems like that's what really got to value the stock on it because we're assuming that the business is going to turn.

Craig Shular

Yeah, I know everyone is anxious the catch going and buying that term. But again, I think the best way to look at it is, one the guidance we give in the 60 to 70 million. And then two obviously, our portfolio, cost structure, global footprint, very, very strong balance sheet, virtually no debt has us positioned to enjoy and participate, when things do turn.

John Evans - Wells Capital Management

Sure.

Craig Shular

And that's been the goal of the team where we've done a lot of productivity improvements. They are starting to flow through. We've done a lot of tough decisions. We've cut people unfortunately, we've had layoffs, we've closed facilities for a week to drive off some cost and then restarted them, we've cut salaries et cetera, et cetera. So, that's the power of the model, we've been working on over the several years. And that, you are right, we'll participate.

And I think the way to look at it, I mean there is very little stimulus money in a lot of the economies yet flowing through the steel other than let's say China. But in 2010 and 2011, the large U.S. program, European programs, I think you'll start to see those flow to our steel customers.

And we've talked in the past that that's usually about a 12 months lead time from the time that bill is announced until it starts to flow to our customers. So sometime in 2010 and then probably across 2011, we'll start to see some of that pick up.

John Evans - Wells Capital Management

Okay.

Craig Shular

And my team's goal is been get position for that, have the right balance sheet, have the right model. And we've viewed, what's going on in this global marketplace, it's been brutal, it's an opportunity. This opportunity to get it some paradigms, maybe we couldn't get at an opportunity to drive change faster than what you might do, if it wasn't so severe out there and an opportunity to get position for exactly, what you are talking about. So I think the way to look at it is, we've given our guidance for this year to 60 or 70 but this is a team that's working very hard to be positioned to participate and enjoy that upturn and capitalize on it.

John Evans - Wells Capital Management

Okay. I was just wondering --

Mark Widmar

Just one thing to highlight, I'd not use Q1 to Q2 as a proxy though because we did get very nice flow through with the incremental volume, good mix of product in there in the light.

John Evans - Wells Capital Management

You had a positive mix.

Mark Widmar

Yeah, so we think about the balance of the year and the slight volume benefit that we'll see, I'd not use Q1 to Q2 as a proxy

John Evans - Wells Capital Management

Okay.

Mark Widmar

It maybe more of a beneficial you look at prior years and what we would have seen is the pull through in those years.

John Evans - Wells Capital Management

That's helpful. Help me then understand just on the numbers questions to R&D. So was some of the, was the charge that went through there, was it in Seadrift in R&D and then can you just help me think about R&D dollars sequentially, why they went up so much in the same thing with S&A?

Mark Widmar

Yeah, there was no charge to Seadrift at all that went through R&D. The Seadrift charge would have gone through the equity income.

John Evans - Wells Capital Management

Right. It's all below the line, right?

Mark Widmar

Well, it shows up a little pre-tax that's below operating income group.

John Evans - Wells Capital Management

Yeah.

Mark Widmar

Right.

John Evans - Wells Capital Management

Okay. So, if we look at S&A and I look at R&D, they grew sequentially. And I know you did a great job, on the top-line a great job. But you've got these costs cutting in place, so why did they grow sequentially and help us think about that because I would have expected it be flatter down?

Mark Widmar

I mean clearly in R&D. I mean, one of the things that we're trying to stay focused on as we go through this cycle is trying to make sure that we aren't going to compromise any investments in R&D.

I mean, Craig has already mentioned one of the R&D 100 Awards that we just won, six out of the last seven years that we pointed R&D 100 Award and those awards contributed meaningful revenue and profits over last few years. So one of the priorities we have through this current cycle is to make sure that we invest in R&D and there is some compelling programs that are underway that in the quarter, that the timing of when the spend occurs is little bit heavy than it would have been in prior quarters. But think of it as the commitment that we have to continue and invest in R&D for the future of the company.

John Evans - Wells Capital Management

Is this a new level though Craig, because if you look at it even where you're doing historic blow out numbers in 2008 that the biggest you had on R&D was kind of 2.5 million run rate, this is three one. And I guess what I'm just trying to understand is this three one going to three five to four or how should we think about it?

Craig Shular

No John. I don't look for a step change there. I think its more continuation of our investments in R&D as you've seen in the last couple of years.

John Evans - Wells Capital Management

Okay.

Mark Widmar

Everything is done is more of timing, if you want to consider, use that year-to-date number --

John Evans - Wells Capital Management

Got it.

Mark Widmar

Be more indicative. And then your question on SG&A?

John Evans - Wells Capital Management

Yeah, it was 21.6 in Q1. So then you were 23 and some change here. So just help us think about that. Is that the incremental that's driven by the sequential sales increase because what I'm really trying to focus on is the incremental leverage, if I think sales are going back to 250 or whatever?

Craig Shular

Yeah, John. Some of it is driven by sales where we have some jurisdictions where we sell through agents and they get a sales commission. So, some of that is driven in there.

And then some of it is, we've got some internal targets around cash flow and what not. And obviously we had a very solid Q2 year-to-date cash flow, operating cash flow is 60 million. And so that triggers some accruals on some of our incentive compensation as well as catching up in the first quarter. So, some of that is in Q2.

Unidentified Analyst

Perfect. And then lastly, you did a great job on the free cash flow. How do we think about debt, you're just kind of call up when it comes due next year and take that piece out?

Craig Shular

Well, we have saw so much flexibility here, assessment of what's been done over the last several years. But yeah, there is step down in the call, in February one possibility as we wait till then its only 20 million we can do it anytime. Another one is we could call early. So all of the above is available to us. Our balance sheet lets us do that. We don't guide the cash flow, but obviously we had a very solid first half 60 million. And if that continues I mean we could be at a place where we have zero net debt. So we may call early, we may wake to the step down in the call.

The good news is all of those alternatives are available to us. If you went back in our history obviously we had very few alternatives. And I'd say here we have complete flexibility financially and we're also very position to grow. There is really no growth opportunity. We can't look at cant afford, can't digest. So we are really I think well positioned from a balance sheet standpoint and the remaining 20 million of senior notes could go at any time or could wait till February.

Unidentified Analyst

Okay. The last question that is a great segway. So you probably will exit this year or early next year debt free, obviously totally different from where you've been in the past. How do you start to use your free cash flow to enhance shareholder value here over time? Do you start to buyback stock, do you make acquisitions, what do you do to take that free cash flow power that you really have and make shareholder rich?

Craig Shular

All of the above. We have a buyback program that we have done activity last year. So that's an alternative. Obviously, growth alternative in our industry would be very interesting to us. We have a solid balance sheet and growth as we've said in prior calls on either business segment. Industrial Materials or Engineered Solutions would be very attractive to us.

Growth in Engineered Solutions of course increases the diversification we have. Today we're about 85% Industrial Materials, 85% steel. As we've said on prior calls we would like to grow that Engineered Solutions side. We think it provides one some diversification, and two there is a number of segments in there, solar being one we've highlighted in the past. That's very interesting to us. They have nice double-digit growth rates. We think there is a lot of years of good future in some of those segments. And so we would look very favorably in some of those.

So, John all of the above, we will look at to enhance shareholder value; from share buyback to the acquisition front, to internal growth, to grow our business.

John Evans - Wells Capital Management

Hey, thanks so much.

Craig Shular

Thank you, sir.

Operator

Our next question will come from Ray Rub with Cedar Investments (ph).

Unidentified Analyst

Thank you.

Craig Shular

Hey Ray. How are you today?

Mark Widmar

Good morning Ray.

Unidentified Analyst

Fine, thank you. How are you?

Craig Shular

Great, thank you.

Unidentified Analyst

I was wondering if you could give me some idea of the trajectory of your SG&A and your R&D expenses for the remainder of the year. Do you expect them to come down slightly or you expect them to remain constant? I mean, you've talked about maintaining the R&D investments, but how about the SG&A inside of the income statement?

Craig Shular

As we said here, I think if you look at the year-to-date, the first six months, I don't hear any material change. They could be up a little down a little bit. We are not looking for any material change there.

On the SG&A front, we've taken a lot on that out over the last five years. And of course, you never done, but I would look for a major increase in either of those. Do recall that as sales go up, we do have sales commission in certain countries where we have agents. And of course that will move with the sales increase. But Ray, don't plan on a material change from kind of the year-to-date plus or minus nothing material.

Unidentified Analyst

Okay. Thank you very much.

Craig Shular

Thank you, sir.

Operator

Our next question will come from Brett Levy with Jefferies & Company.

Craig Shular

Good morning, Brett. How are you today?

Brett Levy - Jefferies & Company

Hey Craig. One question for you that hasn't been asked yet. Can you talk about what's been done to constrain supply globally on the graphite electrodes? I know that's some in other calls but just some senses to kind of whether or not there is any threat of new capacity or what's been constrained?

Craig Shular

Well, right now, I think most producers have excess capacity. And they have cut back, not unlike the steel industry to try and manage working capital, take down inventories and meet market demand. So, I think most of have come right down to kind of take care of customers and the current market demand which is very, very low.

And I've seen that across the entire steel cycle. I think some of that exacerbated given the current global financial markets. It's very painful to blot to those financial markets. So, you're going to cover or carry excess inventory, excess working capital it is very painful. And if your balance sheet doesn't let you do that, will I know it gets extremely painful as we've seen many players along the steel supply chain.

Unidentified Analyst

So, the response is been very orderly, how about from Asia?

Craig Shular

Globally, I guess pretty much the same picture. I haven't seen much difference throughout the world, pretty much the same thing. I think our entire supply chain right through the steel has worked very hard not to get excess inventory and destocking or carrying a big pile of inventory that doesn't match up with customer demand.

Unidentified Analyst

All right. That was my one remaining question. Thanks guys.

Craig Shular

Thanks Brett. Have a good day.

Operator

Our next question is coming from Mark Parr with KeyBanc Capital Markets.

Mark Parr - KeyBanc Capital Markets

Hey thanks. Just had a couple of housekeepings. In your full year guidance, Mark can you give us a sense of a how the foreign currency assumptions have you either added to that or detracting from it?

Mark Widmar

Well, we're setting that right now is balance here we're assuming euros stability around the 140 range. And then the other currencies kind of holding, again we have exposures to rand, reais and the paso. So those currencies kind of holding at their current levels right now.

We did receive some benefit in the first half of the year from the currency standpoint. I wouldn't expect that benefit to change dramatically in the second half partly because the second half will have higher revenues than the first half with that. And we're long the euros of the strengthening of the euro from they were was at first half of the year to provide a little bit of benefit to get the other currencies going against that. So I would say net, net second half benefit should be very close to the first half.

Mark Parr - KeyBanc Capital Markets

Okay. And did you quantify what the magnitude of the first half benefit is?

Mark Widmar

It will be in the queue and it's around $7 million pre-tax. So, after-tax I think it is 4 million or 4.5.

Mark Parr - KeyBanc Capital Markets

All right. That's currency. And I had one other question, I think you may have touched on this and I apologize if it you to repeat. But, did you share what the volume in the second quarter was relative to the first quarter around a year-over-year basis, could you give us any volume information?

Craig Shular

We did not Mark. And that's one we don't guide to.

Mark Parr - KeyBanc Capital Markets

I'm not looking guidance, I was looking for number here Craig?

Craig Shular

I understand completely.

Mark Parr - KeyBanc Capital Markets

Okay. Alright, well you see that's actually so that would be something I think that would be really hopeful. And it would encourage you to think about sharing some numbers. Just is there any anecdotal color you can give us? Things of volumes were up in the second quarter from the first quarter, is that fair?

Craig Shular

Yeah. The volumes were up and so directionally absolutely correct, fair to say. And we'll take your input under consideration.

Mark Parr - KeyBanc Capital Markets

Any sort of order of magnitude that you'd like to share?

Craig Shular

Like I said, they were up.

Brett Levy - Jefferies & Company

Okay.

Craig Shular

Thanks.

Mark Parr - KeyBanc Capital Markets

All right, guys. Thanks.

Craig Shular

Thanks. Have a great day.

Operator:} Going next to next to Chuck Murphy with Sidoti & Company.

Chuck Murphy - Sidoti & Company

Good morning guys.

Craig Shular

Yes sir.

Chuck Murphy - Sidoti & Company

Just wanted to dig in a little bit more on the margins? Comparing the first quarter to the second quarter, was there any change in the average price of your electrodes, the average price of your raw materials sequentially again?

Craig Shular

The only numbers we've given out there, we kind of gave Q2 '09 versus Q2 '08 and that when we filed a Q and they were up over 12% graphite electrodes, average price across all the electrodes we make many grades, many sizes, low-end, high end et cetera.

Chuck Murphy - Sidoti & Company

And what about needle coke for that time period?

Craig Shular

Well, needle coke... our inventory, lower cost inventory has been lasting longer because of the slow steel operating rates. So there is still a lot of lower costs inventory in there. But there are some grades where we are starting to get the higher cost because we just run out of that grade. So, it's kind of a blend right now, but most of it is still the lower costs that we are working down.

Chuck Murphy - Sidoti & Company

Okay. I guess then could you say like qualitatively, the sequential increase in the gross margin was that just the usual operating leverage or was that something a disconnect between what you are selling and what you are buying?

Craig Shular

No, no I'd say it's the sum price. Graphite electrodes prices went up. Remember in Q1, we have historically some contracts that some customers bid in organize their own bill budget cycle which go Q1-to-Q1. So, we have some older contracts rolling off, some lower price stock. And in Q1, so Q1-to-Q2, graphite electrodes prices went up and I've already quantified the year-over-year increase.

So, price was up, volume was up. And then a lot of our productivity initiatives are starting to gain traction. And so you had some of them take hold from salary cuts to head count to productivity initiatives and our plants and in our offices. So some of that starting to flow through, so that's really Q2.

Chuck Murphy - Sidoti & Company

Okay. So the electrode prices may have increased sequentially, but it doesn't sound like the raw materials change much sequentially, is that fair to say?

Craig Shular

Yeah. I wouldn't say they moved a lot, but remember there are some grades of raw materials of coke and various raw materials that were on the new price. We've just run out. And so some we just run out our inventory of that grade. And so like I said it's a blend but its majorarly lower cost or older inventory.

Chuck Murphy - Sidoti & Company

Okay. All right. That's all I had. Thank you.

Craig Shular

Thanks Chuck. Have a good day.

Operator

Our next question will come from Chirag Trustwala with MK.

Unidentified Analyst

Hello?

Craig Shular

Good Morning, Chirag. How are you today sir?

Unidentified Analyst

I am fine. How are you, sir.

Craig Shular

Great, thank you.

Unidentified Analyst

Just a few questions. How have been your realization in second quarter as compared to first quarter?

Craig Shular

Could you just say that I didn't quite catch your question sir?

Unidentified Analyst

How have been your realization for graphite electrodes in second quarter as compared to your first quarter. Is there been a upward movement?

Craig Shular

You're not coming through so clear, maybe just the one more time slowly for me sir.

Unidentified Analyst

How have your been realizations for graphite electrode moving in second quarter as compared to first quarter CY '09?

Craig Shular

Are you meaning capacity utilization rate?

Unidentified Analyst

No, selling prices of graphite electrodes?

Craig Shular

Oh, selling price. Okay. We've talked about this a little bit earlier with a couple of questions. Selling price in Q2 of this year as compared to Q2 '08 is up over 12% and that's our average increase across the entire portfolio of graphite electrodes we make. So, when there are some very low price, low end electrodes from late old to flatten applications, titanium dioxide, all the way to the meter grade. So that's up over 12%. And then Q1 is here sir, to Q2 we haven't given any specific numbers that are going to say it's up over to Q1 of this year.

Unidentified Analyst

Okay. And sir, are we still using the needle coke, which have been purchased in CY '08 at a lower price? Are we still using the same needle coke right now or we have started buying new coke at higher prices?

Craig Shular

In most of our application sir, majorily we are still using old coke and old raw materials. But we have some grades of coke, grades of electrodes, where we have to use new coke because we are out of that grade or maybe some new raw materials, other raw materials non-coke raw materials that we've had to purchase because we've just run out. So it's kind of a blend, but it's majorily still older low cost raw materials that flow through in Q2, sir.

Unidentified Analyst

How long you expect to continue using the similar low cost needle coke?

Craig Shular

It's going to go into third quarter. And there'll be more new in Q3 than Q2. And then again maybe in Q4 even less right as we wind down some of those inventories. So, I think you should think of it in decreasing fashion Q3 we're going to have probably some less old material in raw. And then Q4 even less, as we start to produce more electrodes.

Unidentified Analyst

Okay. Previously you said that Seadrift is operating at a very low capacity utilization. So, is this operating rate even lower than what graphite industry has being operating?

Craig Shular

I don't know the rate, but yeah we've made it at a very low rate matching up with the marketplace and our customers demand. And in Q2, we're approximately 35% operating rate.

Unidentified Analyst

And even Seadrift is operating at a very lower rate, right?

Craig Shular

Yes, still.

Unidentified Analyst

So that operating rate is even lower than what graphite industry is operating?

Craig Shular

I don't know the rate. But, I can tell you, yeah, we're at a rate to match our customers' demand. And as our customers start to demand more we will pick it up. We have seen it increase in the order rate. So more customers, there is much more order activity here. And so, as that increases we will pickup our capacity utilization rate sir.

Unidentified Analyst

And then you have taken an impairment cost of $53 million against Seadrift, so do I expect any further impairment in second half?

Craig Shular

Well, it's going to depend on the marketplace. We follow GAAP very, very prudently and GAAP required us to do that in the second quarter. And we're just going have to... each quarter we reevaluate where is the marketplace et cetera. Seadrift been running at a very, very low operating rate. But, as we said that couple earlier questions, as the inventories of electrodes get worked off it to steel customers, we are going to have to get more coke. So in 2010, for sure, we're going to be buying more coke. And then I think then Seadrift's operating rate will start come up.

So, it's too early to tell if there is going to be another impairment charge that's really driven by GAAP is non-cash. Having said that, Seadrift's got great assets and I would much rather Seadrift focus on cash i.e. not run and overproduce inventory. So, I think they are doing the right things. They have slowed down and in some cases they shut, they completely stopped operations, save cash, layoff team members. And I think that's the right approach rather than building a pile of inventory. So, I'm pleased with what they've done. There is been cash flow positive year-to-date May.

Unidentified Analyst

Okay. And sir, needle coke prices have increased around 50%. So, I just wanted to ask sir what is the main reason behind that? See if feel crude oil prices have come down sharply from as high as of $140 to as low as to currently on $50 per tons. Despite that the prices have increased by 50%. Any reason for that?

Craig Shular

If I don't know that I've got your question. I believe it this, that why has needle coke going up 50%?

Unidentified Analyst

Yeah.

Craig Shular

Okay. Well, yeah, oil is all over the place. Remember, you call it 140 oil and that was the peak. But oil at 70 bucks, I'm sure impact their cost structure. And they are demanding a price increase. So, time will tell if they can get it. They went out initially for 90% increase. And now that's slipped off a bit. And now it's around to 50% increase. So, time will tell what they finally get. I don't know. We haven't booked any coke for 2010.

Unidentified Analyst

Okay. Thank you, sir.

Craig Shular

Thank you very much. Have a good day.

Operator

Our next question will come from Eric Prouty with Canaccord.

Eric Prouty - Canaccord Adams

Great. Thanks a lot. Just couple of quick follow-ups on Seadrift. One, with your own to the company is there an option there to increase your ownerships stake or is it just straight debt to the company?

Craig Shular

Yeah. It's just straight debt, there is no option to increase our 18.9%.

Eric Prouty - Canaccord Adams

Okay. And then I think you've exceeded the second largest needle coke producer. Are you their largest customer and can you quantify what percent of their revenue you make up?

Craig Shular

Eric, we don't give any supplier content or size. We're in relationship that any of our suppliers. Historically, we've not been a big buyer of Seadrift. We bought from some or the other suppliers that we have long-term arrangements with the others which we still have a very solid long-term relationship excellent relationship with Conoco. So we've not been a big customer of those.

Eric Prouty - Canaccord Adams

Okay, great. That's all from me. Thank you.

Craig Shular

Thanks Eric.

Operator

(Operator Instructions). Our next question is coming from Chuck Bradford with Affiliated Research Group.

Chuck Bradford - Affiliated Research Group

Hi. I've got another question with regard to capacity expansions. I understand that there are six plants in China that make ultra high power electrodes which are expanding by 50,000 tons. Do you know first of all, anything about the Chinese electrodes quality wise and weather or not these expansions are still happening?

Craig Shular

Chuck, yeah, there is probably six producers up significant in China. And they have been working very hard the last 10 years plus the come up quality curve. Their qualities improved like ours. I haven't really seen real expansions there yet. I'm sure there might be some projects, maybe they got curtailed, some are maybe announced, but not a lot of activity. So, I've not seen a lot of impact from any real expansions there.

But, having said that they are coming up the quality curve, obviously we are standing still on quality. We are making a better electrode, better performing, larger diameter et cetera. But they are good competitors and we watch them very closely. And to-date through the first six months really I haven't seen a material impact from them yet.

Chuck Bradford - Affiliated Research Group

And what about the electrodes coming out of India because I believe there are four plants there that are also planning to expand? What's their quality like I know they ship some product to the U.S. and some of the big minimal? They are also partly planning to expand, is that happening?

Craig Shular

There is two producers in India very good producers. They make a much higher quality than the Chinese. And they have done a couple of expansions over the last four years. And I think the majority of all their expansions have already been completed. There maybe a little tail of a little bit of one left, but most of their work has been done over the last three fours years. And they have articulated a very clearly in the public domain over the last four years. So, I haven't seen a major impact there or something brand new and out.

Chuck Bradford - Affiliated Research Group

Thank you.

Craig Shular

Thanks Chuck.

Operator

And with that there are no further questions. I'd like to turn the call back over to our speakers for any final or additional closing remarks.

Craig Shular

Andrea, thank you very much. Everyone thank you for joining our call and look forward to talking to you in Q3. Have a great day.

Operator

Again this does conclude today's call. And thank you for your participation.

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