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GrafTech International Ltd. (NYSE:GTI)

Q4 2009 Earnings Call Transcript

February 23, 2010 11:00 am ET

Executives

Kelly Taylor – Manager, IR

Craig Shular – Chairman, President and CEO

Mark Widmar – CFO

Analysts

Bob Richard – Southridge Investment

Luke Folta – Longbow Research

Brett Levy – Jefferies and Company

Brian [ph] – Oppenheimer & Co. Inc.

Chuck Murphy – Sidoti

Yvonne Varano – Jefferies

Eric Glover – Canaccord Adams

Charles Bradford – Affiliated Research

Mark Parr – Keybanc Capital Markets

Dan Hoshwood [ph] – Citadel Investment Group

Ray Rund – Shaker Investments

Tim Hayes – Davenport

Phil Gibbs – KeyBanc Capital

Tim Rothery – Goldman Sachs

Martin Pollack – NWQ

Operator

Good morning. My name is Kacey and I’ll be your conference operator today. At this time I would like to welcome everyone to the GrafTech fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.

(Operator Instructions) Thank you. Ms. Kelly Taylor, you may begin your conference.

Kelly Taylor

Thanks, Kacey. Good morning and welcome to GrafTech International’s fourth quarter and year end 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 have not received a copy, please contact Marie Noor [ph] at 216-676-2160 and she will be happy to fax or email a copy to you.

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

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

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

Craig Shular

Thank you, Kelly. Good morning, everyone and thank you for joining our call today. Today we’ll take you through our fourth quarter and full year highlights and then open it up to questions.

Net sales were 202 million in the fourth quarter, a 23% improvement over the third quarter and our strongest quarter of the year. Gross profit was 67 million or 33% of sales, an increase of $20 million over the third quarter.

Operating income excluding special items increased 68% to 42 million, representing the highest quarterly operating income of the year. Net income before specials increased more than 70% to 31 million or $0.26 per share.

Recapping the full year, sales were down 45% to 659 million versus '08, largely as a result of lower volumes associated with significantly reduced demand driven by the global economic recession.

Full year gross profit declined to $191 million or 29% of sales, largely as a result of unfavorable fixed cost absorption associated with lower sales volume. '09 operating income excluding special items declined to $95 million, net income before special items were $69 million or $0.57 per share. '09 was an exceptionally difficult operating environment, however, our team was able to achieve productivity and cost control initiatives allowing us to be profitable and cash flow positive. We proactively managed areas within our control, which included reducing operating rates out of production facilities.

We operated an average rate of 40% in '09 across our graphite electrode platform. We right-sized the organization placing several facilities on shortened work weeks or furloughs and sharply reducing headcount hours worked and overtime. A 10% pay reduction for officers [ph] of the company was implemented. We also implemented higher increases and suspension of salary merit increases. CapEx were also reduced by $16 million year-over-year, and finally we reduced discretionary expenses by 20% to 25% year-over-year.

As a result, we completed the year virtually debt free, and with the strongest balance sheet in our company’s history, closing the year with 50 million in cash and an undrawn 215 million revolver. Standard & Poor’s recognize the improvements made to the balance sheet by raising our corporate credit rating to double B plus and increasing the rating on a revolving credit facility to triple B or investment grade. Our solid balance sheet has the company well positioned for growth.

Turning to segment results, in our industrial material segment, sales increased to $167 million in the fourth quarter, a 22% increase over Q3 as a result of higher graphite electrode sales volume. This compares to Q4 ‘08 net sales of $219 million.

Operating income for the segment was $42 million as compared to $59 million in Q4 ‘08. The year-over-year decline was largely a result of lower graphite electrode sales volume and unfavorable currency movements offset in part by higher graphite electrode selling prices.

During the fourth quarter of 2009, we began to replenish our needle coke raw material inventory at the 2009 purchase price, which was approximately 45% higher than the ‘08 purchase price. As of December 31’09, essentially all of this higher cost material was still an inventory. And therefore, our 2009 cost-to-goods sold does not reflect the impact of the 45% increase in needle coke.

For 2010 needle coke purchases, we have completed the negotiations with our largest supplier and a 2010 cost per metric ton is essentially flat with a 2009 cost per metric ton. As we start our production in 2010, we will begin to use the higher cost needle coke purchased in the fourth quarter of ‘09 and we will have to replenish the needle coke raw material inventory at the 2010 purchase price. The inventory flow through of the higher cost raw material will significantly increase our cost-to-good sold in 2010 as compared to ‘09. Our ability to pass this increased to cost to customers depends on a large extent on the strength of the global economic recovery.

In our Engineered Solution segment, sales were 35 million in the fourth quarter, an increase of $7 million versus Q3. This compares to sales of $46 million in the fourth quarter of 2008. Operating income was $4 million as compared to $11 million in Q4 ‘08. The year-over-year decline was primarily the result of lower sales volume across multiple product lines and on unfavorable product mix.

Turning to outlook, based on the current International Monetary Fund projections and other global economic forecast, world output is projected to rise in 2010. IMF notes at the recovery in advanced economies is anticipated to be weak by past standards, while emerging economies are poised for a quicker and stronger recovery, given the robust internal demand.

While recovery has begun in certain regions, electric arc furnace steel end-market demand is anticipated to be below pre-crisis levels. As a result, graphite electrode industry recovery is anticipated to be slow, as operating rates remain subdued compared to historical standards. Weak end-market demand remains a risk to price realization as we work to complete our 2010 graphite electrodes order book.

We expect 2010 results to benefit from improved volumes in our graphite electrodes business, however this impact will be partially offset due to significantly higher raw material cost that we discussed earlier.

Given the fragile state of economy recovery, limited customer visibility and the resultant shift in customer order patterns to shorter term contracts, our ability to project full year detailed guidance is limited. We expect the first quarter will be our weakest quarter of the year with operating income targeted to be in the range of $30 million to $34 million. A marginal improvement turn is anticipated in subsequent quarters driven by a slight increase in industrial material volumes and the expectation that our engineered solution segment will begin to recover in the second half of 2010.

In 2010, we are targeting overhead expense to be in the range of $105 million to $110 million, CapEx to be in the range of $70 million to $75 million, depreciation expense to be approximately $35 million, and the effective tax rate to be in the range of 24% to 27%.

Given our strong solid balance sheet and our commitment to grow our company, we expect an increase in overhead expense and capital expenditures in 2010 to position our company for future growth. We increased our R&D spending 13% year-over-year on ‘09 and successfully leveraged State and Federal funding to invest in new technologies. Most recently we were rewarded a $410,000 Third Frontier Grant from the State Ohio to continue work on lithium-ion battery technology.

The increase in overhead expense in 2010 will also focus on investing in organic growth by increasing our sales and marketing coverage, supporting our lean initiatives and funding new product development. These actions will position our company for future growth providing long-term diet for our shareholders.

With that Kacey, let’s open it up for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from Bob Richard with Southridge Investment.

Bob Richard – Southridge Investment

Thanks very much for taking my call. Craig, in my last conference call we discussed electrode de-stocking. Is it fair to assume that it’s probably complete here in North America and probably a little more sluggish over in Europe and some of that activities ongoing?

Craig Shular

Yes, Bob, I think that’s pretty accurate. US, North America pretty much behind us. Europe maybe a little bit behind that, but in total as I look at the supply chain for graphite electrodes around the world, I see a very lean supply chain. So, very pleased the way that process has gone and as I look forward I see a tight supply chain. I don’t see large pockets of excess graphite electrode inventories. So I think as we move forward in 2010, the supply chain is in very, very good shape.

Bob Richard – Southridge Investment

Understood, thank you. And last, we have discussed last call needle coke at maybe 45% to 50% next year, I think you may have given that number in your discretionary, did you or that's still a good number?

Craig Shular

That's a good number, and yes that's the exact range we’ve been talking about previously, and that's where it’s come in 45%, 50% up.

Bob Richard – Southridge Investment

And my last question on these increased overhead cost, I appreciate all the detail and what you are trying to do, and I appreciate that. None of that’s capitalizable or is – any chance of re-class of that going along or do you think that's all going to be straight expense?

Mark Widmar

No, that’s truly admin, and selling and marketing, R&D type efforts that would be expense. The CapEx as we call, there would be incremental CapEx as well as clearly that would be capitalized and then amortized but the selling and marketing and R&D will be expense in P&L.

Bob Richard – Southridge Investment

Okay. The R&D will be expense. Okay, thanks for your time guys and thanks.

Craig Shular

Thanks, Bob, have a good day.

Operator

And your next question comes from the line of Luke Folta with Longbow Research.

Luke Folta – Longbow Research

Hi, good morning guys.

Craig Shular

Good morning, Luke, how is it going?

Luke Folta – Longbow Research

Fine. Couple of quick question for you, just firstly, just on the order book. Can you give us a feel for how much of the full year order book you’ve secured at this point?

Mark Widmar

Luke, the way I’d color it is that, looking at Q1 we’re probably 90% plus booked for Q1, the balance of the year really too early to talk about. What we have found is the majority of the customers are pretty much booking quarter-to-quarter, there is a few out there that done six months but it's quarter-to-quarter, and that's why we can give guidance on Q1 but the balance of the year, I think we’re just going to have the let the year play out and let us get the book together.

Luke Folta – Longbow Research

Can you give us a feel on what’s – just looking at the buyers, it seems like we have seen some price declines, and maybe you can comment on that whether you’re seeing that or not but, it seems like kind of prices are starting to weaken at least a little bit here, and no one wants to secure contracts, but at the same time you are saying that the inventory levels are very lean at the channel, but I am just trying to understand how you think this is all going to play out?

Craig Shular

Well, it’s early to count, but you’re right. Prices are going in below our targeted levels. The supply chain is lean; I think we are very well positioned to seize all the opportunities that are out there. And as the global economies recover, and let’s make a point over there, they are recovering, it’s slow, it’s still fragile. I think a lot of customers are optimistic, but they are very, very cautious because of what everyone has been through in ’09, but I think what we have tried to do is get ourselves very well positioned to seize those opportunities.

Obviously, ‘09 has been a solid year for us. We’ve worked on productivity improvements, cost reductions, cash flow, have no debt. And so, I think as we look forward in 2010 we will be positioned to seize those opportunities, but it’s going to be right now, I think from our custom base a quarter-to-quarter basis.

Luke Folta – Longbow Research

Okay, and just lastly, can you give us a feel for what the pricing percentage change has been just over -- either over ‘08 or over ‘09, that you are seeing in the first quarter?

Craig Shular

It’s too early to tell. What we have built into our guidance that operating income $30 million, $34 million. We’ve built in our pricing assumptions based what’s in the book and what we see. So, Luke, we are just going to have to let the quarter finish out. There is still more booking to go. And like I said, the customers are booking short, but the backdrop to that which I think is good news is the supply chain for electrodes is nice and tight, nice and lean.

Luke Folta – Longbow Research

Thanks, Craig.

Craig Shular

Thank you, Luke.

Operator

And your next question comes from the line of Brett Levy with Jefferies and Company.

Brett Levy – Jefferies and Company

Hi, Craig.

Craig Shular

Hey, Brett, how are you today?

Brett Levy – Jefferies and Company

Not bad at all. Just want to get the timing straight, needle coke from ‘08 to ‘09 was up what percent ‘09 to ‘10 is up 45% to 50%. What percentage of cost of goods sold for needle coke is going to be sort of pre-purchased in 2010, I am just trying to figure out sort of when the 2009 pricing one is out and what the exact increments between '08 and '09 and '10 were?

Mark Widmar

Let me lay it out this way, Brett, and thank you for the question, because this can be a little confusing, but think of – in '09 needle coke prices went up 45% to 50% versus '08. But in '09 we bought very little at the new price, and what we did buy was at the end of the year. And so it really wasn’t reflected in our cost for '09. So going into 2010, we will be buying at that 40% to 50% up, which because we bought virtually nothing in '09, is you really got to compare to '08. So the increase since '08 has been 45% to 50%. There is only one increase for us over that period because of our buying pattern.

Craig Shular

And there is not going to be any quarter in which you are going to have previous periods. It's going to spread out fairly evenly to assume from '08 levels up 45% to 50%, and flow all that through all quarters of 2010.

Mark Widmar

That’s right. So thank god we exhausted last year, the low cost coke, which would have been '08 price. And that in 2010 we are now on the new price, which came out in '09 and is 45% to 50% up, and in 2010 we will be using that coke throughout all the quarters, Q1 all the way through.

Brett Levy – Jefferies and Company

All right, and then, it is awesome to see toughing investment grade here. It does look as if even with higher raw material costs, you are going to be building up a significant portion of cash. Can you talk a little bit, I mean, it seems like needle coke supply has always been a concern of yours. Can you talk a little bit about what you might use the cash for, and then, sort of, by way of a comfort zone, where do you feel like leverage should be for this company on a long-term basis? Single B, double B, Triple B, where is your comfort zone?

Craig Shular

On the cash front, I think you are right our team has done a very solid job focusing on cash flow, productivity improvements, lean initiatives. So we have built a pretty good track record over the last several years on really generating cash flow and getting leaner. So, I would look for that to continue in 2010, and as far as usage of that, you see some of that we are growing our CapEx. So we are getting CapEx back to kind of the ‘08 level.

We are investing in overhead, which is really R&D and building our sales coverage model and our sales service model. So, we are hiring people. We are getting better coverage in Asia, more people, more training. R&D, as we said, was up 13% last year over ’08. So we didn’t cut a single dollar in that brutal 2009 and we will probably be up again here in 2010.

So I think firstly, Brett, we have a number of internal -- great internal project to invest in, there are productivity improvements, there are new product improvements. They are hiring new team members and then externally, really, we are open for business on the execution front. I think you have been with us many years and we really didn’t have the opportunity to really consider much of that, and obviously today with this balance sheet there is really not much on the acquisition growth front that we can’t look at very hard and execute today. So, that’s another big bucket.

Lastly, we always look at share buybacks and we always evaluate that against the former two and you have seen us in the past buy back shares. We have a share buyback program, and we have actually executed on it. So, that’s another area we always study in light of internal and external opportunities.

Brett Levy – Jefferies & Company

And then target leverage...

Craig Shular

I would say we don’t have a specific goal, Brett. Obviously, we've had some very nice improvement. I'm very happy where it is today. I think our company can carry 300 million or so debt very easily throughout the complete cycle with our size company and cash flow. So obviously we are underleveraged today. Our first priority will be to exhaust and look at internal and external growth opportunities. And down the road, I think as we execute on some of those, I think we'll get to a more normal debt level, which might be 300 million plus.

I think also as the economies continue to recover you’ll see our comfort zone to increase bad debt, the financial markets improve, you will see us with more comfort zone to increase there. I would hate to get ourselves in a position where there is a great internal or external opportunity and we can’t execute on it. And right now I don’t see because of this balance sheet us missing any of those opportunities. So, as the global economies continue to improve, I think we are so well positioned to see those opportunities.

Brett Levy – Jefferies & Company

Last question, and this is the one I usually ask is, you said you’re seeing supply coming on in the electrode business, where is it coming from and what makes you think that it’s either a threat or something that will be brought on rationally?

Craig Shular

Well, I see the Indian producers have announced a bit of capacity. I think none of it’s – when you look at the big picture and EAF growth, I don’t think any of it’s really material to the medium term, long-term, but there's been a little capacity announced, I think is around 6,000 metric tons by one of the Indian producers. I think he got that going in Q1. But other than that, I don’t see in high quality electrodes a lot of major new capacity coming on market versus what I see coming in EIF growth whether it’s new starts or higher operating rates as we move forward the next couple of years and the global economy improves.

Brett Levy – Jefferies and Company

Thanks very much.

Craig Shular

Thanks, Brett. Have a good day.

Operator

Your next question comes from the line of Ian Zaffino with Oppenheimer.

Brian – Oppenheimer & Co. Inc.

Hi, guys. This is Brian [ph] sitting in for Ian.

Craig Shular

Hey, Brian, how are you doing?

Brian – Oppenheimer & Co. Inc.

Good, good. Now you said that you are operating at a 40% rate within the fourth quarter or the average for the year?

Craig Shular

Brian, 40% was our average for the year. Our team, as you know, reacted very, very quickly and brought down the rate. In Q4, we were around 50%, 51% operating rate.

Brian – Oppenheimer & Co. Inc.

Okay. And how about now, where we are at?

Craig Shular

That’s not a point. The guidance we give, so I’ve got a point here to our operating income guidance that’s in our release and all of that’s embedded in that guidance we have given.

Brian – Oppenheimer & Co. Inc.

Okay. And as far as your appetite for acquisitions and talk about potentially levering up $300 million, what about the possibility of ultimately taking Seadrift the majority out there and wholly owning it, wouldn’t you want to keep your balance sheet available for that?

Craig Shular

You are spot on. Those are the types of external growth opportunities that maybe out there that we do want to keep our balance sheet very strong and open and ready for. So, I would not want us to be, let’s say levered up, and then have an opportunity like the one you mentioned or another comp and we can’t seize it. So, right now I am very pleased where we sit with cash on our balance sheet and virtually no debt. And if an opportunity like that came to the market, I want us at the table and ready and prepared to execute if the pricing and the overall offer was to our liking.

Brian – Oppenheimer & Co. Inc.

All right. Well, thanks a lot.

Craig Shular

Thanks, Brian. Have a good day.

Brian – Oppenheimer & Co. Inc.

You too.

Operator

And your next question comes from Chuck Murphy with Sidoti.

Chuck Murphy – Sidoti

Good morning guys.

Craig Shular

Good morning, Chuck. How are you today?

Chuck Murphy – Sidoti

Doing all right. Thank you. Just a few questions for you. First, what did you say was your average customer’s capacity utilization rate at the end of the fourth quarter, and what would you expect it to be by the end of 2010?

Craig Shular

I think a lot of them over the course of – I’m saying, Mr. average customer, over the course of the year they steadily increased, and in Q4 many of them got in kind of their 65% to 70% operating rate. So, very nice improvement versus where they were earlier in the year. So I've seen nice steady improvement, and Mr. average customer would be close to about a 70% operating rate.

Chuck Murphy – Sidoti

And what would you expect them to potentially get up to throughout 2010?

Craig Shular

I hate to mention a number for them but if I added them all up, I would see that most of them are cautiously optimistic. They don’t have good line of sight like we don’t, so they don’t have a long order book. But I think they are optimistic, and I think Mr. average EAF customer would expect over the course of the year to see that operating rate come up, and maybe with the second half being better than his first half in operating rate.

Chuck Murphy – Sidoti

Got you. Okay. And second question was given that electrode pricing has been a little bit late lately, I mean what are the chances that you might get some relief on the needle coke pricing?

Craig Shular

Well, I think, there is a couple of things at plays here. Obviously because orders are being booked short, like they are in the steel business, there is opportunities to look at graphite electrode prices increases over the course of a period because the book is open so that's a factor.

I think in needle coke, depending on operating rates that price may move around. Now, as we have said, we’ve already fixed majority of our coke, but if operating rates continue to, let’s say, remain horizontal I don’t know, there may be some opportunities there. Remember, needle coke moves often with the price of oil, it’s a by-product of oil and oil is kind of drifted up to kind of a high 70s, $80 type range. And so the other factor you’ve got to look at, Chuck, where is the oil market, what does that look like? Right now I am pleased, we’ve got it locked in, gives us nice cost stability, lets us work on the internal things we can control and productivity improvements, quality improvements et cetera.

Chuck Murphy – Sidoti & Co.

Got you. Okay. And again, with electrode pricing being so, so at least, are you seeing in the first quarter should your weakest, if electrode pricing is still in the like side, and volumes are not changing that much, how will we see the improvement in the bottom line throughout the year? Is it -- volumes may be little bit better than expected or there are engineered solutions?

Craig Shular

Here is what we expect, Chuck, as you articulate we expect Q1 to be our weakest quarter of the year. We expect, over the course of the year, our EAF customer base to continue to operate at a higher and higher operating rate. So I think there is some volume opportunities over the course of the year as their business improves. And then, ES, I would expect ES second half to be better than the first half. ES is, in Q4 as you saw, started to gain a bit of traction and ES type business is usually lags steel a little bit. So, usually you steel start to improve before ES. So I would expect ES to have a better second half and first half. And so, when you add all that up for us, that’s why I think our second half would be better than our first half, and why I believe Q1 will be our weakest quarter of the year.

Chuck Murphy – Sidoti

Got you. Okay. Thanks a lot.

Craig Shular

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

Chuck Murphy – Sidoti

You too.

Operator

And your next question comes from the line of Yvonne Varano with Jefferies & Co.

Yvonne Varano – Jefferies

Thanks.

Craig Shular

Morning Yvonne, how are you today?

Yvonne Varano – Jefferies

Good. How are you?

Craig Shular

Great. Thank you.

Yvonne Varano – Jefferies

I just wanted to clarify on the needle coke, I know you said that you didn’t buy very much, most of it what was at the end of the year. Did we see any of that cost going in 4Q but maybe in the last month?

Craig Shular

No, Yvonne, the way you should look at that is, that was bought at the end of the year and that really impacts Q1 this year, and that Q4 really not much impact at all. I think that’s the right way to look at it.

Yvonne Varano – Jefferies

Okay, and can you give us any idea of where you saw pricing or volumes relative to 3Q and 4Q?

Craig Shular

I can't really speak for Q1 this year, it's still on process as you know, and any of our assumptions in price or operating rate are embedded in our operating income guidance for the quarter that $30 million to $34 million.

Yvonne Varano – Jefferies

Okay. Can you tell us where it looked in 4Q relative to 3Q?

Craig Shular

Yes, in operating rate Q3 was kind of like a 40% operating rate, and then we came up in Q4 to about a 50%, 51% operating rate. So she started to pickup in Q4, a function of the destocking starting to be behind us in many customer locations, and some improvement in the economies. And I think Q1 most of the data points for our customer, although fragile, and you’ve listened, I am sure that most of their calls is starting to improve, it's a slow improvement, but at that point it looks like the worst is behind us back in ‘09.

Yvonne Varano – Jefferies

Great. And then, just on the needle coke, your recent comment seem to indicate that you have locked in a certain amount of volume and you might need to adjust that. Can you tell us how much is locked in?

Craig Shular

Yes, we’ve locked in probably 70% or so. It has been locked in. We’ve fixed the price. So, it gives us a target and we know where we need to be on cost, where we need to be on productivity improvements, where we need to be on graphite electrode pricing. The balance is open and that gets negotiated over the next few months. And so, needle coke, I don’t have many concerns on needle coke. I see that as pretty much well in hand for us and within what we were expecting, I don’t see any surprises there.

Yvonne Varano – Jefferies

Okay. So, your needle coke that you’ve locked is your entire amount for the whole year if needed?

Craig Shular

It’s about 70% of our requirement -- would be locked in and about 30% --

Yvonne Varano – Jefferies

And 70% requirement -- look kind of utilization rate?

Craig Shular

Well again, that’s not an annual guidance item that we can give it at this stage. I am going to have to keep it at quarter-to-quarter just because our customers have limited sight and they are booking quarter-to-quarter. So, we are going to have to let the year play out on that. But I think your takeaway should be, from our vantage point, on the cost side the needle coke, 70% of it was locked in, you know, part of ours is take some of that risk off the table. You have seen oil price jump all over the place here, and so I think the takeaway should be that needle coke cost we have in hand and the vast majority of that’s already been booked and I don’t see that as a material issue for us here in 2010.

Yvonne Varano – Jefferies

Great. How will Seadrift playing it all to your needs in 2010?

Craig Shular

Well, Seadrift will, I think continue to improve in 2010 as the global economies improve. But for planning purposes we own 18.9%, I would not put into year 2010 plans any material contribution at this stage, I think that’s premature also. And I would expect them to have a better year in 2010 as the economies continue to improve. But I think for planning purposes, from your vantage point I would really keep that to a very limited contribution to our numbers, and let’s let that play out, let's let that be something extra as that materializes.

Yvonne Varano – Jefferies

Great, we look forward to that. Thanks very much.

Craig Shular

Yvonne, thank you very much.

Operator

Your next question comes from the line of Eric Glover with Canaccord Adams

Eric Glover – Canaccord Adams

Hi, good morning.

Craig Shular

Good morning, Eric. How are you today?

Eric Glover – Canaccord Adams

Fine, thanks. Just wondering if you could talk a little more specifically about your CapEx plan for 2010, I think the number you gave was 70 million?

Craig Shular

Yes.

Eric Glover – Canaccord Adams

Compared to effect the depreciation of about half of that, so I'm sort of wondering exactly where is this money being spent?

Craig Shular

Well, there is a number of buckets on the CapEx side as you said, we are bringing it back up to the '08. Obviously we’ve got the balance sheet and wherewithal to do that. There is going to be a continued focus on incremental high ROIC internal projects. We continue to fair it out a number of those with our lean initiatives, and they are in the area of productivity improvements and cost reductions.

I think some other areas might be even in, as we develop some of the R&D new products, there is an opportunity to make some capital expenditures to prepare for some new product launches, especially in the area of ES. So I think you’ll see of this capital and a good portion of the increase go into some ES opportunities we have where they participate for instance in the solar industry that has started to pick back up quite nicely.

Eric Glover – Canaccord Adams

Okay. Thanks very much.

Craig Shular

Thank you, sir and have a good day.

Operator

And your next question comes from the line of Charles Bradford with Affiliated Research.

Charles Bradford – Affiliated Research

Good morning.

Craig Shular

Good morning, Chuck, how are you today?

Charles Bradford – Affiliated Research

Very good. Thank you. But in January, world steel production was up 25.5%. We’re trying to pulling down the average in there obviously light on electrodes. This, I would presume, should set up for a pretty strong recovery especially since your customer base is very seasonal and much stronger in the second quarter then the first. Are you seeing those kind of numbers?

Craig Shular

Chuck, things are improving and as we talked earlier about kind of give the picture of the average EIF customer. So things are improving, line of sight is limited. So, most of our customers I think they are cautiously optimistic. I think most of our customers believe the worst is behind them, and let’s face it, the BRIC countries are doing well in a number of areas and then even the developed economies. The US, starting to pick up as you articulated. Europe is starting to come back in some sectors. So, things are improving, but it’s relatively slow and I got to say it’s cautious. So, our customers have booked by quarter, so that’s kind of our line of sight, but I, we all watch the same numbers you are looking at and I am encouraged by them. But it’s still too early in the year I think, I think we need to get Q1 and deeper into the year, and get more data points and more continuously positive data points and then 2010 could shape out to be a pretty decent year, I think, on EIF steel. But it’s early for that.

Charles Bradford – Affiliated Research

Your customers are buying scrap to beat the band for second quarter delivery?

Craig Shular

Yes, so, many of them are starting to feel better. I mean if I kind of gauge a customer visit 30 days ago was more somber than a customer visit last week, this week. So they’re starting to feel better in a number of geographies, some product segments, that non-residential construction of course is still very, very tough shape, but some product segments are starting to come along nicely. So a number of customers are encouraged. But here we are very early in the year.

Charles Bradford – Affiliated Research

Have you restored the management pay scales?

Craig Shular

What we did is, the officers all gave 10% last year, the next level of management gave 8%, and then the next level gave 6%, and then we set up kind of a unique situation where if certain targets were achieved, and these were stretch targets, then we would pay back the reduced salaries for everyone except the officers. And the officers, 10% that was cut would go into the pool for the global team. And last year, our team exceeded those targets so all of the team got back their salary reduction except the officers, the officers' 10% was put in the pool and paid out pro rata to all the other global team members.

So that program went very, very well for us. This year we have restored everyone's salary back to the old level but we had no salary increase. So no salary increase last year, so far this year no salary increase, we will revisit that kind of the middle of this year as we look at the economy.

Charles Bradford – Affiliated Research

So the increase in overhead takes into account that restoration?

Craig Shular

Yes sir, that's correct.

Charles Bradford – Affiliated Research

Okay, and one other item. On the CapEx, can you identify for us what you are going to spend money on other than maintenance?

Craig Shular

Well, there is a number of – I won't get into specific new product development launches, but we have a number of product opportunities in engineered solutions and money -- capital money is being spent there. R&D money was spent over the last couple of years there. And now, some of those projects are at a stage where we are ready to scale up.

So some of those are in ES, some nice -- I think good, good growth opportunities for us. Some are in electrodes; we continue to find great lean opportunities to improve our productivity, reduce costs and we continue to generate some very nice high ROIC internal projects in industrial materials, and so some of the capital is going in there. And you’ve seen some that over the last couple of years as we continue to do well and challenge ourselves on the cost front.

Charles Bradford – Affiliated Research

Thank you very much.

Craig Shular

Thanks, Chuck. Have a great day.

Operator

And your next question comes from the line of Mark Parr with Keybanc Capital Markets.

Mark Parr – Keybanc Capital Markets

Thanks very much. Can you hear me okay, Craig?

Craig Shular

Morning, Mark, comes through loud and clear, thanks.

Mark Parr – Keybanc Capital Markets

Okay, terrific. I had a just a couple of kind of follow-up questions. I guess, pricing continues to be, I think, a major concern for a lot of people and I know that vantage [ph] had asked to kind of specifically if you would be willing to talk about the momentum in pricing in the fourth quarter, kind of looking backwards, is that something that you have a sense you might be willing to do at some point as to give us some sort of historical pricing momentum as these quarters unfold?

Craig Shular

Well, let’s let the year play out and we’ll take that into consideration. I understand everybody’s strong interest in that area. And of course, from our advantage point we still have got another six weeks or so to go in the quarter. Customers are booking on a very short basis. So, but we will take that under consideration, and as I said earlier right now, as everyone, I think is aware, pricing has come in below our targeted levels, so that’s very, very fair point there, and we've got to kind of let the quarter come together.

And on our next call when we go through Q1, we’ll take a look at the bookings in Q2. And if we start to get comfortable with line of sight and the overall economies, maybe we’ll give some color there or maybe even some broader guidance for the year. Once we get line of sight beyond the quarter we will – like we’ve done sometimes in the past, we’ll articulate a year number.

Mark Parr – Keybanc Capital Markets

All right, I think that would, to the extent of future comp flow with that, and doesn’t get in the way of your competitive situation or in the way of your ongoing marketing efforts, I think that would be really hopeful. I had one other question related to the CapEx, and I know you’ve got some new product development and you have maintenance, can you articulate the approximate level of CapEx just in total dollars in '09 and 2010 combined that are directly related to productivity initiatives and not new product or not maintenance?

Mark Widmar

Well, I don’t know that we’ll give the guidance and the breakdown, that detail, but I think the way to look at the total CapEx is to think about 35 million to 40 million is kind of the maintenance capital, and then everything beyond that is productivity improvements, new products that are starting to scale up, and we might be taking into a larger production arena adding equipment.

Mark Parr – Keybanc Capital Markets

Okay.

Mark Widmar

And so I would look at the buckets that way. So take 35 million to 40 million of our number, that’s kind of our maintenance number to keep our facilities running well and productive, and everything beyond that is very beneficial projects to growth and to productivity/cost improvements.

Mark Parr – Keybanc Capital Markets

Okay, all right. And is there -- when you talk about a high return productivity project, does that mean you are looking at like 30% return or you are looking at a 50% return, how do you define high-return projects? I mean can you throw a number on that?

Mark Widmar

20% plus.

Mark Parr – Keybanc Capital Markets

Okay, terrific. And I want to add one last question here, now I can’t remember what it is. Anyway I’d get -- I will get you offline anyway --

Craig Shular

No problem.

Mark Parr – Keybanc Capital Markets

Congratulations on the quarter. We look forward to some further commentary on the pricing side as the year unfolds upwards.

Craig Shular

Thank you, sir. Have a good day.

Mark Parr – Keybanc Capital Markets

All right.

Operator

And your next question comes from the line of Dan Hoshwood [ph], Citadel Investment Group.

Dan Hoshwood – Citadel Investment Group

Hey, guys. Kelly pressed “star one” a little late so most of my questions have been answered, but can you just help us understand and provide a little more color on why you think that you are seeing some weakness at the margin on pricing here given that directionally, most of the variables in the entire ferrous supply chain are looking up. And, you guys did pretty well on pricing in a tough year last year, can you just help us understand what’s really changed in the last couple of months?

Craig Shular

Well, what we are saying is we are not getting our targeted pricing and I think -- like anything the price is decided in the market place and there are so many variables to price. I don’t know that I can really isolate one or two that I would say are the major item, but prices is coming in the lower target level. We will have to finish up Q1 and then I think we will have little look back there and see where it’s come. But what we have embedded say in our guidance that 30 million or 34 million has our price assumption in there, what's in the book, 90% or more is booked already, and what we see kind of in the marketplace.

Dan Hoshwood – Citadel Investment Group

All right, thanks.

Craig Shular

Thank you, sir.

Operator

And your next question comes from the line of Ray Rund with Shaker Investments.

Craig Shular

Good morning, Ray. How are you today?

Ray Rund – Shaker Investments

Fine, thank you, and thank you for taking my question. I really have two questions. The first has to do with, how do you see yourselves in relationship to competition versus your needle coke cost? I'm just wondering whether your prices or rather your costs are higher or lower or about par with, and if there is any reason to be believe that your competitors who are supplying electrodes have any sort of a cost advantage over you?

Craig Shular

Ray, we are one of the largest buyers of needle coke, so I would say because of our large buy we have some leverage as a result of that, and that allows us to get the normal large volume price leverage and a better price than someone that buys much less than we do or someone that goes in for spot.

Ray Rund – Shaker Investments

Right.

Craig Shular

Not much different than what you see in the steel industry.

Ray Rund – Shaker Investments

Okay. That’s as I believe. So I mean, in terms of the pricing leverage that you have on your electrodes that you are selling, it would seem like it would be difficult for others to undercut you. I mean you should be able to match the prices that others are offering, and in fact you might actually have a better cost position than they do.

Craig Shular

Yes, price the marketplace determines, of course Ray, as you know. Cost, that’s our job, and when we attack that on every front, one is leveraging our large buy for all of our raw materials, and then other one, of course, is inside the gates of our facilities and with our team. And so, the cost, I think our teams has done a good job so far and I think there is many more opportunities in 2010.

I think we used ‘09, which was brutal environment and got the plants down as we set an average operating rate of 40% over the course of the year. We used that time and the balance sheet and the cash we have, to work very well in productivity improvements, in cost reductions and add to the team. So, on the cost side, coke is one of those items, leverage our large buy, try to get the best coke price, price that sets, the global market, it’s a huge market. It’s very competitive. There is a lot of producers and so there is many variable that set that.

Ray Rund – Shaker Investments

Okay. But second question I had, had to do with guidance you gave on your operating expenses. The increase that you have -- that you are guiding through are fairly significant and I guess my question is, is this as a result of restoring salaries or is this resulting from restoring salaries plus doing in some investing in R&D and marketing and sales to kind of expand your coverage, to give you perhaps more coverage and perhaps better coverage in places where you didn’t have it before.

Craig Shular

Ray, it's not as a result of restoring salaries. Recall, we set up kind of a unique program where the team could get their salary reduction back if they hit some stretched targets.

Ray Rund – Shaker Investments

Right, I heard your explanation, but I just wasn’t sure if I understood it properly, and what you are saying is the way I understood, it was the proper way, so.

Craig Shular

Yes, we paid that out at the end of the year. So that was in the '09 numbers and so '09 has those numbers in the overhead because they earned back and then some, because they blew right through the stretch target, and we ended with no debt, et cetera, et cetera.

So that's not the case, it's the latter you mentioned. So it's R&D, investing in R&D, adding new scientists, expanding our coverage model. We have added some sales team members to our Asian team, and it's in those areas, so its growth areas, productivity improvement, servicing customers better, adding the customer tech service team. So, the increase you see is all in lining up to propel growth, better serve our customers, have a better global footprint. As these economies improve I want us position to seize the opportunities out there and take better care of our customers than anyone.

Ray Rund – Shaker Investments

I see. And I guess it would be reasonable then to expect that if for any reason the productivity and sales improvements that you are expecting to come from this does not develop then you have the ability to cut some of these expenses or not incur them.

Craig Shular

We always have that ability, we are very nimble. Let me say that, you see our track record. But let me also say this. From what I see coming over the next few years in electric arc furnace growth and in EAF opportunities. I don’t see that as being a scenario. I see steady a bit slowly, global improvement in the economies, gaining traction second half of this year better, I see 2011 all things being equal, being better than 2010.

And I see a number of emerging areas, solar just to mention one, that's on a very nice growth path, double digit. And so I think for us, I want to make sure we are not left short-changed as those markets grow. So you have got solar growing all double-digit, it’s coming back very nicely. 2010 was, kind of, slow year for that sector, but it’s coming back very nicely.

So I need team members in the field, I need the right scientist, the right new products to seize those. So, that’s always a possibility what you mentioned, what if your sales [ph] fall down, but I tell you right now I don’t see that. I don’t see that in solar, I don’t see it in ES. All I see is, it’s going to be a slower steady, we should be prudent, but as I look medium term, two to three years, I see good growth across that platform.

Ray Rund – Shaker Investments

Okay. Thank you very much.

Craig Shular

Thank you, sir. Have a good day.

Ray Rund – Shaker Investments

You too.

Operator

And you next question comes from line of Tim Hayes with Davenport

Tim Hayes – Davenport

Hi, good morning.

Craig Shular

Morning Tim, how are you today?

Tim Hayes – Davenport

Fine, thank you. Two questions, in terms of the de-stocking that -- the supply chain is very tight at this point, is there any geographies where you are actually starting to see a hint of re-stocking?

Craig Shular

Well, I think, Tim in many sectors in Q1, people are burning new electrodes. So these are newly purchased electrodes. These aren’t – let’s call it old inventory that was in a big pile. So, I think as we start this year, many people have had to buy new electrodes. So, if you look at our first quarter virtually kind of we talked earlier about -- tell me about the average EAF customer. The average EAF customer is burning new electrodes. So these are newly acquired electrodes, if not bought be in Q4 or early Q1, and he is burning those because destocking is behind him.

Tim Hayes – Davenport

Right, okay. And then, specific to Q4 you had the sales year-over-year were down and this is in the IM segment, sales down year-over-year by 52 million. Of that amount how much was attributable just to the volume line, do you have that handy?

Craig Shular

Well, the Engineered Solutions business is a little bit different. It's not really a volume. There’s so many different products size and shape. So it's not like IM.

Tim Hayes – Davenport

Actually my question was just to the IM segment.

Craig Shular

I beg your pardon. On the volume side, I think you are going to have to wait for the K to come out, and within the K we give color around that. So the big picture, volume down dramatically in '09, and most of it attributed to two items, of course, big destocking. Everybody had too many electrodes, and our customers not only had too many electrodes, too many of all the raw materials, and then so they stop buying, and then when they did start buying at a much lower operating rate in a lower level, so significant reduction in volume '09 versus '08. 2010 volume starting to come back up as customers reorder, new electrodes, newly produced electrodes and start to burn those on their furnaces.

Tim Hayes – Davenport

Sure, sure, I just was trying to get a little bit more detail on the impacts within the Q4 there. The CapEx for the quarter you mentioned averaged 51% for Q4, where did it end the quarter at?

Craig Shular

Operating rate was 51% in Q4, so.

Tim Hayes – Davenport

That matters for the quarter. I am presuming that was turned in higher during the quarter?

Craig Shular

Yeah, so the year average was 40% operating rate for graphite electrodes. Q4 was the highest quarter, and it was about 51%. So yeah, Q4 was trending up, and as things improve and as customers had finished their destocking and had to order new electrodes.

Tim Hayes – Davenport

All right, and then final question on Seadrift, just to help reconcile pretax and after-tax numbers. There was a -- where you sort a pre-tax was a loss of 1.1 million, but after tax was $6 million. I was kind of curious what’s happening there?

Mark Widmar

This is Mark, Tim. There was some movement in the quarter that created a little bit of confusion on the Seadrift law [ph] as we recognized in our results in the quarter. We had some inter-company loans, which we were able to recap or collapse [ph] as result of paying down the senior notes, and that had some residual impact on how we were showing the income tax affected impact of Seadrift.

So, the better way to think of it is about $5 million that probably should be reclassified down into the other line, and only by the million of the operational results for Seadrift would have an adverse effect on our results during the quarter. So we should have only added back a million for Seadrift and the balance would have been related to the inter-company loan collapse, which we probably should have called out a separate line.

Tim Hayes – Davenport

Okay. And that separate from the re-measurement issue that you mentioned?

Mark Widmar

Yes, Seadrift probably has been included in that line versus included in Seadrift one.

Tim Hayes – Davenport

Okay. That’s all my questions. Thank you.

Craig Shular

Thank you, Tim. Have a good day.

Operator

And your next question comes from the line of Phil Gibbs with KeyBanc Capital.

Phil Gibbs – KeyBanc Capital

Guys, I appreciate it. I think all my questions have been answered. I appreciate it.

Craig Shular

Thanks, Phil. Have a good day.

Operator

And your next question comes from Tim Rothery with Goldman Sachs.

Tim Rothery – Goldman Sachs

Good afternoon, gentleman. It’s Tim Rothery here from Goldman Sachs.

Craig Shular

Good morning, Tim. How are you today?

Tim Rothery – Goldman Sachs

I am very well. Thank you. Firstly on raw materials, could you just remind the share of revenues within the industrial materials and needle coke is, just back to the envelope would suggest that with the 45% increase this is going to hit you by about $20 million in the first quarter, is that the right sort of magnitude?

Craig Shular

Yes, the coke cost that we will be seeing throughout 2010 is up about 45% to 50%, and that goes into our graphite electrode business, as you know of course so. That we will feel as we said earlier in the call throughout the year. And in last year, as we said, we used virtually all '08 purchase coke, so lower cost coke. So we'll start seeing that in Q1, it's in our guidance, and so it’s been factored in there.

Tim Rothery – Goldman Sachs

Okay. And you’ve not commented on the sort of the magnitude?

Craig Shular

Yes, that’s correct. That’s a color, it’s a color we just don’t give – I think we got to let the quarter play out, and any of our assumptions are built into that operating income guidance.

Tim Rothery – Goldman Sachs

Okay. And then sorry to labor a point here with regards to pricing. You’ve mentioned repeatedly that price is below your targeted level. I was just wondering if you could confirm that sequentially pricing is down in the first quarter versus the fourth quarter in terms of what you are transacting at. And in particular, given that inventory and the churn is down, demand is up, again, just sort of scratching my head here a little bit as to what's driving the softness in prices versus what looked like much worse the home [ph] conditions that are in the year or earlier in 2010?

Craig Shular

Tim, I appreciate the question, but we are still finishing up the Q1 books, some of its not all booked, and so I think it’s premature to really comment on Q1 pricing or what it looked like versus Q4. And again I’ve just got to point you to our guidance there on operating income. So what’s in the book and our expectation for the balance to come in to the book for Q1 is in that operating income guidance.

Tim Rothery – Goldman Sachs

Okay. Sorry to just label this but --

Craig Shular

It’s okay.

Tim Rothery – Goldman Sachs

…targeted pricing for the first quarter, is your targeted pricing up?

Craig Shular

Well, when we say targeted, we came out with an effort to get prices up and we had last announced the price increase back in Q3 ‘09 and our announced increase was 7795 and we are not getting that. So that’s when I say we are not getting our targeted pricing. Q1 -- what’s in the book and what we had estimated yet is to come is factored in that guidance we gave for operating income.

Tim Rothery – Goldman Sachs

Okay. Thanks very much.

Craig Shular

Thank you, sir. Have a good day.

Operator

And your next question comes from the line of Martin Pollack with NWQ.

Martin Pollack – NWQ

Just kind of looking at the whole commentary about pricing if one just steps away and sort of looks at what’s going on in the steel market, we know cost-push pressures are essentially creating an environment right now where our prices are going up for just about those products really on the flat growth side, maybe in the long side it’s a little bit more questionable.

But, I am wondering if when we are talking about cost-push pressures on your customers for raising prices and then you have your cost push-pressure from needle coke, is there any reason why we should not assume that assuming prices continue to trend up maybe hot rolled prices hitting 700 or some number like that, is there any reason why there isn’t going to be an ability for you to price with that? I am just sort of in a sense of looking at the overall dynamic of your customers as well as yourself?

Craig Shular

Marty, let me frame it this way. Because the customers are booking quarter-to-quarter, obviously much of the year's book is open, so given that, there is an opportunity for price, absolutely. Yes absolutely, an annual contract is fixed, so there is that opportunity. Whether that materialize or where they run or whether that can be achieved, we've got to let that play out. It’s way too early to really comment with any kind of specifics on that.

Martin Pollack – NWQ

There should be some ability for everyone in that supply chain to essentially respond to the cost pressures. You, of course, already have build them in – you’ve got to built in already in 2010, but presumably this could help you and those quarterly pricing mechanisms to just essentially capture that cost, I mean again why we think that that should be an opportunity?

Craig Shular

Marty, again, this is too early to tell. We have got that six weeks to go on a quarter and it’s just premature to tell how that will play out. Many, many variables there come to play. What I can say is because the book is going quarter-to-quarter right now for the customers' requirements, there is that opportunity but we got to let it play out.

Martin Pollack – NWQ

All right. Thank you.

Craig Shular

Thank you, sir.

Operator

Your next question comes from Mark Parr with Keybanc Capital Markets.

Mark Parr – Keybanc Capital Markets

Thanks very much. This is just a follow-up on the cost side. Do you have any guidance you can share with us as far as electricity cost in 2010 versus '09?

Mark Widmar

Not specific ones but as far as the total picture, in the past we've given some pie charts of the breakdown of our key raw materials. Mark, I don’t see any material change in the shift between the components of cost.

Mark Parr – Keybanc Capital Markets

Okay, all right. Thanks very much.

Craig Shular

Thank you, sir.

Operator

And you next question comes from Luke Folta with Longbow Research.

Luke Folta – Longbow Research

Please (inaudible) just one quick follow-up. If somebody wanted to buy an electrode from you today on a three-month contract, would they have to pay more or less than if they wanted to buy on a full-year basis?

Craig Shular

That’s a tough one. Pretty much today the prices that we’ve been asked to give -- give me a price I am bidding Q1, we have very little activity on Q on the full year, and for us we haven’t given a pricing benefit or if you book for the whole year you get a better price, that’s not been our tactic. We’ve been, here is our price, do you want it? And the requirements always been give me your three-month price. So that’s the environment we are in, Luke, and we wouldn’t give a discount for an annual price.

Luke Folta – Longbow Research

All right, great. Thanks a lot.

Craig Shular

Thank you sir.

Operator

And there are no questions in queue at this time.

Craig Shular

Thank you very much for joining and I look forward to talking to you in our Q2 when we articulate Q1 results. Thank you very much for you support. Have a good day.

Operator

And this concludes today’s conference. You may now disconnect.

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Source: GrafTech International Ltd. Q4 2009 Earnings Call Transcript
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