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GrafTech International Ltd. (GTI)

Q2 2010 Earnings Call

July 29, 2010 11:00 AM EST

Executives

Kelly Taylor – Manager, IR

Craig Shular – CEO

Mark Widmar – CFO

Analysts

Luke Folta – Longbow Research

Brian Bitner – Oppenheimer

Eric Glover – Canaccord

Mark Parr – Keybanc Capital

Chuck Murphy – Sidoti & Company

Charles Bradford – Affiliated Research

Sutra Sankaran [ph] – Investor

Tim Hayes – Davenport & Company

Zahid Siddique – Gabelli

Ray Rund – Shaker Investments

Operator

Good morning. My name is Lee and I will be your conference operator today. At this time, I would like to welcome everyone to the GrafTech second 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. I’d now like to turn the call over to Ms. Taylor. Ms. Taylor, you may begin your conference.

Kelly Taylor

Thank you, Lee. Good morning and welcome to GrafTech International’s second quarter 2010 conference call. On the call today is GrafTech’s Chief Executive Officer, Craig Shular and our Chief Financial Officer, Mark Widmar.

We issued our earnings release this morning. If you did not receive a copy, please contact Marie Noor 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 Relations section.

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

Craig Shular

Thank you, Kelly, and good morning to everyone, and thank you for joining GrafTech’s conference call today. Today, we’ll talk you through our second quarter highlights and then open it up to questions.

Net sales were $255 million in the second quarter, a 62% improvement over the prior year. Gross profit improved 64% to $75 million or 29.3% of sales. Operating income more than doubled the $46 million, excluding $7 million in expenses associated with the announced acquisitions of Seadrift and C/G. Excluding acquisition expenses and currency gains, net income was $37 million or $0.31 per share, more than triple the net income in Q2 last year on the same basis.

In our Industrial Materials segment, sales increased to $209 million, a 61% increase over Q2 last year, as a result of higher graphite electrode sales volume, offset slightly by unfavorable currency movement, and a lower year-over-year average graphite electrode selling price. Excluding the impact of acquisition related expenses, operating income for this segment was $41 million or nearly 20% of sales. We experienced improved electrode sales volumes as a result of increased steel end market demand. Partially offsetting the favorable impact of higher volumes in the quarter were increased raw material cost, namely needle coke.

In our Engineered Solutions segment, sales were $46 million in the second quarter, an increase of $18 million as compared to Q2 ’09. Operating income was $5 million. As discussed in the first quarter call, our Engineered Solutions business began to recover in the second quarter with sales improving 65% year-over-year, driven by strong demand in solar, gas, and oil drilling, and electronics.

In June, we received a $1.2 million grant from the Department of Energy to support our research and development in the area of solar power. We continue to utilize our core competencies in graphite material science to commercialize products for rapidly growing industries such as solar.

Turning to our acquisitions, as discussed in April, we’re very pleased to announced our acquisitions of both Seadrift and C/G. We are in the process to responding to the previously announced second request for additional information concerning the acquisitions from an Antitrust Division of the US Department of Justice.

Completion of the acquisition is subject to compliance with applicable DoJ clearance procedures as well as other customary closing conditions. We expect both acquisitions to close in 2010. These acquisitions are components of our company’s growth strategy and will allow us to better serve our global steel customers.

The acquisition of Seadrift secures a large portion of our key raw material needle coke, which strategically positions GrafTech to participate in the broader graphite electrode value chain. On completion of the Seadrift acquisition, we are confident that our collective teams of scientists and engineers working together will propel the Seadrift operation into one of the most efficient and highest quality needle coke production facilities in the world.

The eventual joining together of C/G and GrafTech will provide our respective customers with several benefits, especially in the areas of quality, service and innovation. The combination of our technologies, process know-how, and production capabilities will allow us to achieve several cost, quality, and lead time improvements.

We are looking forward to welcoming the excellent Seadrift and C/G team members to the team GrafTech.

Turning to outlook. Based on International Monetary Fund Projections and other economic reports, the global economies began to recover in the first half of this year, modestly in advanced economies and to a stronger degree in emerging economies.

As previously discussed, the third quarter for us which has historically been a weaker quarter is expected to be lower than the second quarter, as graphite electrode sales volumes declined in response to weaker demand associated with the normal European holiday season.

In conclusion, excluding the impact of acquisitions and related costs, we are targeting full-year operating income to be in the range of a $170 million to a $180 million and operating cash flow to be in the range of $100 million to $110 million.

That concludes our prepared remarks. And, Lee, if you can open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Luke Folta, Longbow Research.

Luke Folta – Longbow Research

Hi, good morning, guys.

Craig Shular

Good morning, Luke. How you’re doing?

Luke Folta – Longbow Research

Not bad. First question, I guess, it’s my typical question on the quarter. But, can you give us a sense of what the change in pricing was year-over-year that you utilized in the second quarter? And then, also, some sense of what you are seeing as far as forward-looking trends.

Craig Shular

Yes, Luke. As we discussed in the last quarter call, we expect that graphite electrode’s selling price to drift downward slightly. And, year-over-year, it was down about 6.5%, for graphite electrode pricing. And, as we said in the last call, we saw softness in graphite electrode prices, which, kind of, carried from Q2, Q3, Q4, as we built out the book and we saw lesser slippage over the course of this year with what we believe the total slippage is going to be something single digit.

Luke Folta – Longbow Research

And, looking forward, do you – I mean do you think is, kind of, the bottom here and that we start to look up. There’s been some announcements in the recent months about some actual price increases.

Craig Shular

Well, that’s always hard to tell. I think it’s going to be driven by supply and demand in our industry. What I can speak to is what’s in our book and we saw it stabilize, kind of, in the back half of this year. So we saw this slippage in Q2 and then, kind of, Q3, Q4, still softness, but to a much lesser extent. So time will tell.

I think next year supply demand, the equation will really drive where prices go, how hard does steel run, what are the global economies look like. Those types of things will really drive where the pricing ends up as well as needle coke cost and other cost. How much cost inflation do we see for next year will be another key driver I think.

Luke Folta – Longbow Research

Okay. And, can you give us some sense of what the sequential currency impact might have been for the second quarter? Starting to see trends kind of reverse there and I’m just trying to get a sense of what that delta might be in the third quarter.

Craig Shular

Well, in the second quarter, I speak to. For us, currency on that selling price, the top line had about a 4% negative impact on our selling price top line. Lot of that was Euro weakness that we’ve all seen over the last few months. Looking forward, hard to tell. Historically, currency has not been a major or a material item for us one way or the other.

Luke Folta – Longbow Research

Just to verify, that 4%, was that a sequential impact or year-over-year?

Mark Widmar

Luke, this is Mark. That was actually year-on-year.

Luke Folta – Longbow Research

Okay.

Mark Widmar

Sequentially, it actually had an amount that was slightly lower than that.

Luke Folta – Longbow Research

Okay. All right, and then just one more, and I’ll get back in line. The utilization for the quarter, can you just give us some feel for what that was?

Craig Shular

Yes, I can, Luke. Well, we came in at about a 76% operating rate in Q2. And, if put that kind of in our profile where we’ve come from, you’ll recall that last year, full year was a about an average of 40% operating rate in our graphite electrode facilities. We exited the year at about 51%.

And then, you’ll recall last quarter, Q1, we did about 66%. So it’s kind of a steady improvement, 51% Q4 last year, 66% up level Q1, and then about a 76% in Q2. So we continue to see – as we’ve discussed in this recovery a slow progressive recovery, but we’re running right about 76% in Q2.

Luke Folta – Longbow Research

All right, great. Thanks guys.

Craig Shular

Thanks Luke. Have a good day.

Operator

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

Brian Bitner – Oppenheimer

Hi guys, it’s Brian Bitner sitting in for Ian. How you’re doing?

Craig Shular

Hi Brian, we’re doing great. How are you today?

Brian Bitner – Oppenheimer

Good, good. You just talked about a 76% operating rate in the second quarter. Where do you see that going in the second half?

Craig Shular

Well, it’s not an item we guide to, so I’ll direct you to look at our full-year operating income guidance. And around that full-year operating income guidance as we said last quarter, virtually all that book is built. So it’s in the book. I think our risk on whether it’d be operating rate or volume or sales is more global economy, how does steel run. The orders are in our book and we’ll run the plants as hard as we need to, to meet the customers’ orders.

Brian Bitner – Oppenheimer

Okay, thanks. And then, as far as the gross profit margin, as far as the – how it changed sequentially, it went from 36.3 to 32.0. And, excluding depreciation, it went from 36.3 to like 32.7. How much of that is attributable to the higher needle coke?

Craig Shular

Well, a good portion of it. I can’t give you exact percent. It’s not an item we guide to. But, as you know, needle coke cost are up about 45%. And, so far us, sales volume was up a nice positive, coke cost were up, so a negative weight on us. And, as we said, graphite electrode prices were down about 6.5%. So really the operating leverage and the higher volume along with productivity improvements helped us offset some of that coke cost increase.

Brian Bitner – Oppenheimer

Thanks. And the last question, it was really nice to see a big jump in the Engineered Solutions business. How much – with the trends there, how sustainable you think they are?

Craig Shular

Well, last quarter, we said that business generated lags of three months to six months of our Industrial Materials. And I think last quarter we mentioned you order rates were picking up. So yes, it had a pretty solid quarter. Sales jumped up nicely. Baked into our full-year guidance is what we see in the Engineered Solutions. So it’s starting to perform better and that is fully in our operating income guidance for the year.

Brian Bitner – Oppenheimer

All right, thanks guys. Great quarter.

Craig Shular

Thanks Brian. Have a good day.

Operator

Your next question comes from Eric Glover’s line of Canaccord.

Eric Glover – Canaccord

Hi, good morning.

Craig Shular

Good morning, Eric. How are you today?

Eric Glover – Canaccord

Fine, thanks. I’m just wondering if you could talk about whether your customers have fully completed their restocking of graphite electrodes. I know you talked about how volumes are going to be in the third quarter, but is there still restocking left to do and how much longer do you think that can continue?

Craig Shular

Well, I will look at it this way. Really it’s the other end and the other situation that is the supply chains had too many electrodes in it, because of the steep drop-off in the global economies. So as I look around the globe, I’d say virtually all that working off of excess electrodes is behind us.

So what they are ordering now is based on their utilization – their current utilization, so they’ve worked off the excess. And, now they’re running their shops very, very lean, very tight, and what they’re taking from us from what we see and what they’re ordering from us is exactly what they need to meet their demand today. Obviously, their operating rates have come up also as you’ve seen over the last year, year-and-a-half.

Eric Glover – Canaccord

Okay, great. And, you mentioned, obviously needle costs are up. But can you talk about the other primary components, cost components that’s going to graphite electrodes and where those prices are trending?

Craig Shular

Well, they’ve all been trending up; it’d be pitch, electricity, natural gas. So most of those, the trend has been upward as the economies begin to recover, so that’s the trend on our entire cost picture with needle coke being the big one in size and in rate of increase.

Eric Glover – Canaccord

Would you say that these cost increases have been within your expectations?

Craig Shular

Yes, we knew about the 45% needle coke and I’d say pretty much the others had been pretty much in our expectations for this year.

Eric Glover – Canaccord

Okay, great, thanks.

Craig Shular

Thanks Eric. Have a good day.

Operator

Your next question comes from Mark Parr’s line with Keybanc Capital.

Mark Parr – Keybanc Capital

Hi, good morning.

Craig Shular

Good morning, Mark. How are you today?

Mark Parr – Keybanc Capital

No too bad. Thanks for taking my call.

Craig Shular

Our pleasure.

Mark Parr – Keybanc Capital

A good quarter.

Craig Shular

Thank you, sir.

Mark Parr – Keybanc Capital

Couple of questions; 90 days ago, I think the world may have had a little bit different view of the world as far as the second half was concerned. And, I think, things maybe at least – we still aren’t sure what the reality is yet, but the view might be a little bit more subdued or maybe, kind of, more leveling off than we might have thought 90 days ago. And you have – congratulations on being able to maintain your EBIT guidance for the full year in the phase of that. I was wondering if you could give some color on perhaps how you’ve been able to do this, given that maybe the world isn’t quite as moving forward as much as we thought a little bit before.

Craig Shular

Mark, it’s been in a few areas. One, we put together an annual book. And, as you recall, it started out quarter-by-quarter was kind of the customer’s approach.

Mark Parr – Keybanc Capital

Right.

Craig Shular

And then, early in the second quarter, globally, virtually all of our customers came in and really wanted to fill out their full book. So that gave us a relatively good line of sight to our year. So in our guidance of a $170 million to a $180 million of operating income, we have a book behind that. We also had some expectations that the Engineered Solution business would pickup that it lagged Industrial Materials and then that’s borne out pretty good as you see in Q2. So, for us, thus far, the year’s played out pretty much the way we thought.

In addition to that, we worked very hard on productivity improvements and efficiencies. And so, we have a very well delineated lean program here at the company. And we’ve been deep into that program for the last three years plus and that’s contributing some nice productivity improvements and driving continuous improvements, so that together with building the book, managing our cost very, very tightly, improving the quality, that our quality is very, very good right now. Scrap rates are very, very low in our facilities. And when you add that up, it’s held to stay within our guidance range and deliver on our targets.

Mark Parr – Keybanc Capital

Okay, terrific. And thanks for just reminding us of that and I appreciate that comment. I had another question though related to the currency situation for the second quarter. And, you had indicated that it’s 4% on a year-over-year basis from a top line standpoint. I was wondering, Mark, do you have any – can you give us any sense of what the potential bottom-line impact might have been there from a reported EPS standpoint?

Mark Widmar

Yes, from the year-on-year standpoint Mark, it actually, it had an EPS impact around $0.05 to $0.06. And really what happened is – and historically as Craig has mentioned, normally we are – the currencies in which we have exposure to, it normally move into potentially the basket relative to the dollar.

Mark Parr – Keybanc Capital

Yes.

Mark Widmar

What we saw in the second quarter is the Euro weakened significantly, while the other currencies we had exposure to strengthened. And given our long position that we have in the Euro, it really had an adverse impact that we normally wouldn’t see in the quarter, right? So it’s about $0.05 to $0.06 negative effect around the currency moving that happened discreetly in the quarter. Normally, if they move in tandem to each other, a nominal effect, maybe we see $1 million to $2 million currency effect, assuming – let’s assume depreciation of all the currencies by 10%.

Mark Parr – Keybanc Capital

Right.

Mark Widmar

It probably could impact our results by about $2 million. But because of the direction of which the currencies moved in the Q2, again not moving in tandem as they historically have, we did have a larger effect in the quarter than we would have seen normally.

Mark Parr – Keybanc Capital

All right. So it’s fair to say that, if that, in addition, this is kind of a weaker macro unfolding for the second half. Now, you’ve been able to maintain EBIT guidance in addition to greater than expected currency effect for the second quarter. Is that fair?

Mark Widmar

Yes, I would agree with that.

Mark Parr – Keybanc Capital

Okay. And looking out into the second half, I mean, you’re seeing the dollar weaken, they’re – are returned to, I guess in a gradual trend weakening, and it’s not quite halfway back. But I think the last I looked, it was about $1.30 on the Euro. I mean is – based on what you’re seeing now, if that currency relationship is maintained through the third quarter, would you see any greater than expected or further degradation of earnings, reports, related to currency?

Mark Widmar

No, not in terms of our operating results, because we obviously have entered into some [inaudible] and hedges for the third quarter. So largely our currency exposure is locked into at this point in time. And I wouldn’t see any short-term effect of movement of the currency.

Mark Parr – Keybanc Capital

Okay. So you just had that kind of that one hit in the second quarter and then you pretty much mitigated it for the back half of the year?

Mark Widmar

Exactly.

Mark Parr – Keybanc Capital

Okay, all right. And – all right, I’ll get back in queue. But I really appreciate all that color. Thank you very much.

Craig Shular

Mark, our pleasure.

Operator

Your next question comes from the line of Chuck Murphy with Sidoti & Company.

Chuck Murphy – Sidoti & Company

Good morning, guys.

Craig Shular

Good morning, Chuck. How is it going?

Chuck Murphy – Sidoti & Company

Doing all right. Just a couple of quick questions. I know you mentioned your utilization rate was about 76. What would you guess your customers’ utilization rate was?

Craig Shular

Well, when we look at global steel, it’s a little bit above 80% globally. US customers, I think were a bit below that.

Chuck Murphy – Sidoti & Company

Okay. Yes, that’s what I was wondering.

Craig Shular

US, I think were around 70, 72, a little bit below the global number.

Chuck Murphy – Sidoti & Company

Okay, got you. And what are you hearing in terms of third and fourth quarter utilization rates?

Craig Shular

Well, pretty much paralleling what we’re saying for our Q3. Q3 will be a little bit softer. You’ve got the European holiday effect and that I think a number of them believe Q4 will come back and be a decent quarter. So softer in Q3 and then back up in Q4 is kind of the trend we hear.

Chuck Murphy – Sidoti & Company

Okay. And then, my other question was, just for 2011, do you think by then you will be back to mostly full-year contracts for your electrode pricing or we’re probably still going to have a lot of monthly and quarter lease?

Craig Shular

Hard to tell. Our customer base drives that. If I look at how they manage their electrode by this year, it started out quarter-by-quarter. And then, once they seemed to see that the global economies were picking up and they had some reliability and their own operating rates got above 70%, I saw a pretty good interest from them to book the balance of the year to requirements.

So it may workout that if we enter 2011 and things are still looking good or slowly, steady, progressive recovery, and their operating rates are kind of where they are at to date and maybe they’re going to go for annual contracts again. So I think that’s a pretty strong profitability, but time will tell. They’ve each got their own buying strategy and they drive it. We don’t drive it, they drive it completely.

Chuck Murphy – Sidoti & Company

Got you. Okay, thanks.

Craig Shular

Thanks Chuck. Have a great day.

Chuck Murphy – Sidoti & Company

You too.

Operator

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

Charles Bradford – Affiliated Research

Hi, good morning.

Craig Shular

Good morning, Chuck. How are you today?

Charles Bradford – Affiliated Research

Hi. Could we talk a bit about the Engineered Solutions? It’s pretty clear the administration has been putting a lot of money into things like solar, just a week or two ago, a couple of billion dollar projects. Are you seeing any impact – obviously what they did two weeks ago doesn’t matter – but are you seeing much in the way of new construction of solar production facilities?

Craig Shular

Yes, yes, we are Chuck, and it’s a very global business. So part of the improvement in Engineered Solutions in Q2 was directly related to solar. So we’re seeing new facilities, new furnished locations coming up. We’re seeing US Government and some other governments putting some money behind it. You saw, we got some R&D grant money to support our work in solar. So, yes, we’re seeing it. A lot of it is even in China. China has really embraced solar. And a lot of our new customers are Chinese production facilities.

Charles Bradford – Affiliated Research

And that was going to be my next question, because China seems to be moving ahead very, very fast.

Craig Shular

They’re moving –

Charles Bradford – Affiliated Research

How much of that have you been able to kickoff?

Craig Shular

We’re doing a good share of it. In fact, we just opened our Shanghai office. We now have three offices in China. Hong Kong, Beijing, and most recently now Shanghai. So we’ve adding to our team there, adding the commercial people, technical people. And so China solar business for us has been very good.

Charles Bradford – Affiliated Research

On the oil and gas exploration side, obviously, we hear a lot about cutbacks, suspensions, but that’s mostly US centric. What are you seeing outside the US as far as the exploration activities for oil and gas? And how are you participating in that?

Craig Shular

Yes, we are again like our solar business, very global is our reach. And outside the US, we are seeing increased business, across the board. Recall, our business there is oil and natural gas, and so the drilling of natural gas is also a good component of our product portfolio. So we’re seeing good business there. Trends, the trend right now has been up in the demand for diamond drill bits.

Charles Bradford – Affiliated Research

On the electrode side, we’re hearing a lot of strength in places like Brazil, but continued weakness in places like Europe. Are there any other markets that are really strong and leaving aside China for a minute?

Craig Shular

Russia’s been good. As you mentioned, Brazil’s been good with the Olympics. So, right now, I would say, yes, Europe is the one that’s lagging a little bit. They’re going to go into their summer holiday, so that’ going to be slower. But when I look across the world, I see there a supply chain of electrodes is very, very leaned out.

They buy just what they need and what they’re using, so – and I think that’s very good for the overall picture. And anyhow no one knows where the global economies are going. But if I add it all up, it’s just looks like it’s going to be a continued and slow progressive recovery and that looks like the most likely scenario here.

Charles Bradford – Affiliated Research

And pretty sure that you won’t or can’t tell us details of the second request from the Department of Justice. But can you give us some idea like how many questions did they ask? How large that document was? I’ve heard stories that it was a couple of hundred pages or how bad is it?

Craig Shular

Yes, what I can tell you is, we got what I think everyone would term a very normal second request. So nothing out of the ordinary, nothing exceptional like you had asked. We got a very normal Department of Justice second request. We’re completely cooperating on that. We’re ahead of schedule with them. And I think when it’s all done I think both acquisitions are going to be very good for our customer base.

I think in the case of C/G, we’re going to be able to improve quality of electrodes. I think we’re going to be able to improve cost structure. And, obviously, with that facility combining with our Monterey facility, we’re going to be able to improve lead times and service to our customers, so I think it’s going to be a huge win for our customers.

When you look at innovation, it’s been GrafTech the last few years that’s had all the innovation in electrodes, new electrodes, high-performing electrodes, the parallel electrodes. And I think we bring all that to the table on the electrode side. So I think that will play out that way and turn out to be good.

On the needle coke side, I think we bring tremendous things to the marketplace there. As we’ve talked on prior conference calls, all the other needle coke producers are a part of a very large refinery making unlighted gas or diesel oil. And for us, Seadrift’s sole purpose will be to make exceptional quality needle coke to make a great graphite electrode.

At the refineries, the needle coke is a couple of percent of the whole operation. It’s an upgrade of a byproduct. And I’ll tell you that’s about the attention it gets. It’s an upgrade of a byproduct. The attention is to make diesel and unleaded gas.

For us, this is our key raw material. So our intention is to make Seadrift the number one location in the world. We’re going to invest money, we’re going to improve the quality. And when required, when increase the size and the capacity, and so I think that’s going to benefit our customer base.

This will be the only needle coke facility on the planet whose sole purpose is to make a superb quality needle coke to make the best possible graphite electrode, which in the hands of our customer base makes them more productive, lower cost, et cetera. So we believe we’ll get through it. It’s probably sometime at the end of this year.

But, obviously, having said all that, there’s a risk. You never know how these are going to turnout. And so we are completing cooperating with the DoJ. And as I said, we’re ahead of schedule in filing what they’ve asked to put together.

Charles Bradford – Affiliated Research

Thank you very much.

Craig Shular

Thank you, Chuck. Have a great day.

Operator

The next question comes from the line of Sutra Sankaran [ph], Investor.

Sutra Sankaran – Investor

Yes, thank you. The first was on the guidance that you all reiterated. From Q1 clearly, it is backed up by a strong – not a strong, but it is strongly backed up by the order book. But orders do not translate into sales unless they are actually – the clients are actually coming back and exercising their rights, right, to take supply. So I was wondering what the sensitivity was that $170 million to $180 million, it must mean that you’re having somewhere haircut the order book and I just wondered if you can discuss at least qualitatively how you all had hair cut it?

Craig Shular

Yes. Sutra, firstly, thank you for your question. You’re absolutely right, an order book has to translate into sales. And if we were to see a significant downturn in the global economies, well, then, some customers wouldn’t take their full requirements. So there is definitely that risk.

As far as our guidance, the $170 million to $180 million of operating income, built into that, you’re right. There is some conservatism and a range of variation built into that. So we don’t price out in our earnings guidance the absolute full order book we have, because of that very risk that you mentioned. So we have some latitude within that.

And I would say we feel very good about our guidance and that the risk to our guidance would be a significant global deterioration that may cause steel producers to significantly drop operating rates. Other than that, I think our range is very good.

Sutra Sankaran – Investor

Okay. No, that’s actually really helpful. Then, the GrafTech electrode, I’m sorry – yes, the GrafTech electrode, the end markets that you all feed into, did the utilizations of steel moves that feed into those end markets, did that sort of reflect the 80% thereabout global steel rates, utilization rates that you mentioned earlier in the Q&A?

Craig Shular

Yes. Our customer base, if we kind of look over the last year-and-a-half or so, kind of the first half of ’09, global steel kind of ran between 61% and 65% operating rate. And in the second half of ’09, they moved up to kind of the 72%, 76% operating rate range. And then, of course, here in the first half of this year so far, they’re about 80% in total global steel. So they’ve been coming up nicely and that’s what triggered our operating rates also to follow. And as I said early, we’re up now to about 76% in Q2.

Sutra Sankaran – Investor

I just I was under the impression that many of your clients are more leveraged to the construction market than perhaps some industries, then I could be wrong about that, and I just wondered if that was the case, were those kind [inaudible] seeing similar rates if it’ll be overall?

Craig Shular

Yes, I think depending on the geography, what you say is correct. So some of our US customers are at a lower rate in the global number. Some would be kind of 70% to 75%, 76% versus maybe an 80%, 81% for the global rate, because of some of the construction impact that they’re feeling.

But I think trend wise, they have the same kind of trend that the global steel has, coming from the 60% to 70%. So they’ve had the same march off which our business has benefitted from and that’s what’s driven our volumes up in Q2 and that’s what’s built into our order book and our guidance for this year.

Sutra Sankaran – Investor

Great. May I just – my last question was just on the CapEx increase, so if you could just delineate where that extra money is going, it seems to be Engineered Materials. And if it is, then, some color on that.

Craig Shular

Yes, you’re right. It’s primarily into Engineered Solutions. We’ve seen an uptick in a number of other businesses. And as we look forward to next year, we believe solar and some of those alternative energy markets will continue to perform well, so that minor increase in our CapEx is really getting Engineered Solutions better positioned to service those markets as they continue to grow next.

Sutra Sankaran – Investor

Okay, great. Thank you so much and congratulations.

Craig Shular

Thank you, Sutra. Have a good day.

Sutra Sankaran – Investor

You too.

Operator

You have a follow-up question from Mark Parr with Keybanc Capital.

Mark Parr – Keybanc Capital

Hi, thanks very much. I had a couple of things; one – and looking at the second quarter the tax rate looked a bit lower than normal. Although, if you look at the six months rate, it’s – I guess it looks like it’s more in line with normal historical levels. Mark, could you give us an update on what your expectations are for the full-year tax rate?

Mark Widmar

We did Mark. We did lower our guidance. I think we’re now in the range of 23% to 25%. And so we did take it down a little bit. And we are seeing some benefit in terms of the jurisdiction – jurisdictional mix of income. So we took that into consideration and we lowered the guidance into the 23% to 25%. There was a one-off benefit within the current quarter that resulted in the rate being a little bit lower.

We did some restructuring of one of our jurisdictions and as a result of that we ended up benefiting from a tax rate adjustment that impacted our deferreds and then benefit float into the rates, so there’s a one-off discreet item that impacted the rate for the quarter. But, clearly, when you adjust with that, we’re pretty much in line with the 23% to 25% that we guided you for the full year.

Mark Parr – Keybanc Capital

Okay, all right. So I can do the math on that. One other thing, I’m just wondering if you have any additional color that you might be able to give us at this point as far as the full level of the noncash amortization charges associated with the acquisitions. Is there anything there you can share?

Mark Widmar

Well, there’s some information that we’ve had to put together Mark for the S4 filing that we did a few weeks ago I guess. And we have done some preliminary estimates of what the purchase price accounting would be the associated as step-up and [inaudible] on the intangible assets and then the amortization that would drive from that.

Right now, again, Mark, this is preliminary, we have not engaged a third party yet to complete the purchase price evaluation work. We’ll be doing that over the next coming quarters.

But, right now, it looks like it’s going to be in the range around $35 million. I think what we actually in S4 is slightly lower than that, but I would just use $35 million at this point in time. And as we get better information, we’ll know more about that actual number probably at the end of Q3, beginning of Q4.

Mark Parr – Keybanc Capital

Okay. So the underlying assumption there is – and again, I don’t have the math all here with me, but I think that’s about the number that we were looking at, which would result in about a – from an EPS standpoint about a neutral situation as far as a 2011 EPS was concerned based on the EBITDA guidance that you provided when you announced the acquisition, is that about right, am I in the right ball park there?

Mark Widmar

Yes, I think based off your model by never looking at it, that’s about what your estimate is. So we’re not too far off of that.

Mark Parr – Keybanc Capital

Okay, good. That’s – that’s actually good news. I had another question about the acquisitions, if I could. And if it’s preliminary, just, please – it’s fine. But I’m just wondering if you’ve had a chance to assess the cost of commissioning the existing de-soft [ph] capacity that is – or the de-soft equipment that is theoretically onsite and part of the acquisition. And also do you have any ballpark estimates about the capital cost of increasing the – doing the Brownfield expansion and moving the capacity up. I think you were talking about two different trenches of capacity upgrades. And do you have any idea what that would cost you?

Craig Shular

Mark, you’re right. It would be premature for us to go through that. But I can speak to the general phases of the capacity expansion and maybe the path. Our first investments will be to improve the quality. Obviously, it’s running at a low operating rate today, because of the global economy.

So we’re going to use that time to improve the quality, add some good, I think production process improvements to the facility. And the facility right now can do about a 150,000 metric tons. The most we can use is about a 100,000 metric tons. And so, we’ll sell 50,000 metric tons to the marketplace.

And as I think – as we improve the quality, I think those third-party sales will go very well and that will help support the first phase expansion, which will be 180,000 metric tons, 200,000 metric tons is kind of phase one. And then we would sell that out. Our intention is to run this facility at a very high operating rate. We’ve got a nice base load, but we’ve got to sell the balance to third parties. And then the second phase would be about 240,000 metric tons. So these have been laid out high level.

The Seadrift team has done a lot of work before our acquisition on this. And so I think a lot of the mechanics and how it has to happen and whatnot are pretty well thought out. But I think it’s premature to talk about any cost or CapEx. We’ve sized up the facility and it’s got plenty of land. One of the beauties of Seadrift is there’s a lot of land there for expansion, so we’ve sized up the footprint and all fits there, the infrastructure can be upgraded and increased.

So as I look forward, I think this can become really the premier needle coke facility in the world in quality and one of the largest on the planet. And the beauty of it for our customer base is we’ve got a base load and we can now contribute to the efficiencies of that facility. Today, we have no say or input into the efficiencies of our needle coke production. And as I said earlier, it’s like 2% of a refinery. It’s an after thought, it’s a refinery.

In big picture, when I look at the refineries and I look at what’s going on in the Gulf Coast, I kind of think their focus is not going to be on this little tiny needle coke operation. They’ve got a lot of other issues in the oil industry that’s going to drive a lot of their attention. So, us having a access to the needle coke and it being so key to us to upgrade and run it full, I think will be very, very good for our customer base.

So two phases; first one, 180,000 metric tons to 200,000 metric tons; second one, about 240,000 metric tons; near term, improve the quality; sell it out. So my team’s mission will be sell that thing out, sell it out in 2011, and that means about 90,000 metric tons to 100,000 metric tons that we use internally and another 50,000 metric tons or 60,000 metric tons to the external markets.

Mark Parr – Keybanc Capital

Okay, all right. And I just have one last question. I appreciate all that color, Craig. Thank you very much. One last question on the – you had some acquisition related cost here in the second quarter. I’m just wondering do you have any sense of what those cost might be over the back half of the year, the third and fourth quarter.

Craig Shular

Yes, we had about $7 million in the quarter, but I’d say that it’s early to give you that number. We’ll give it you in Q3. Obviously, we’re working very closely with the DoJ and that’s got expenses attached to it. In our Q3 release, we’ll give you – get the latest update on that.

Mark Widmar

And Mark, in the guidance you gave on operating income as well as operating cash flow, just make sure you caught it. We’re excluding the effect of those related cost.

Mark Parr – Keybanc Capital

Okay, all right. So there will be additional costs and then we’ll just know to exclude those from the operations then.

Mark Widmar

Exactly.

Mark Parr – Keybanc Capital

Okay, terrific. Thanks again and congratulations on a great quarter.

Craig Shular

Thanks Mark. Have a great day.

Operator

Your next question comes from the line of Tim Hayes with Davenport & Company.

Tim Hayes – Davenport & Company

Hi, good morning.

Craig Shular

Good morning, Tim. How you’re doing?

Tim Hayes – Davenport & Company

I’m fine. Actually my question on that the acquisition cost whether that was excluded from the guidance, that was already asked and answered. Thank you.

Craig Shular

Thanks Tim. Have a good day.

Operator

Your next question comes from the line Zahid Siddique with Gabelli.

Zahid Siddique – Gabelli

Hi, good morning.

Craig Shular

Good morning, Zahid. How are you today?

Zahid Siddique – Gabelli

Good. How are you?

Craig Shular

Excellent, thank you.

Zahid Siddique – Gabelli

A couple of questions, but first on your book for 2011, when you do start building that and what’s your take on that?

Craig Shular

Well, it’s early now, really very little to zero activity so far from our customer base. So I would expect some of that to startup here in the third quarter and probably October, November, December, we start to get a sense of that. And then that usually is finished off kind of February type period.

Zahid Siddique – Gabelli

Okay. And on the needle coke, has the price been going up more, and what is your expectation, let’s say, towards the end of the year, where do you feel the price would be?

Craig Shular

Well, as mentioned earlier, ours is going to be up about 45% from our prior purchases, I guess over a year-ago now plus. And we’ve had no more pricing activity in that area. We’re already booked for our needle coke requirements for this year. So that won’t come up until kind of later in Q3, Q4.

Zahid Siddique – Gabelli

And do you have an expectation what that may be in Q3 or Q4, the prices?

Craig Shular

No, too early to tell. I mean, obviously, we look at the global recovery, we look at oil prices, but Zahid too early to tell. I really don’t have a sense yet.

Zahid Siddique – Gabelli

Okay. That’s all I had. Thank you.

Craig Shular

Thanks Zahid. Have a good day.

Operator

(Operator Instructions). Your next question comes from the line of Ray Rund with Shaker Investments.

Ray Rund – Shaker Investments

Thank you for taking my question.

Craig Shular

Good morning, Ray. How are you today?

Ray Rund – Shaker Investments

Fine, thank you, and how are you?

Craig Shular

Great, thanks.

Ray Rund – Shaker Investments

On the Engineered Solutions side, I was just curious, your operating margins declined a bit, even though your revenue went up. Is there any particular – is this a normal operating margin to expect in the future or do you expect the operating margins in the Engineered Solutions to go up as volume and revenue goes up?

Craig Shular

Ray, let me get Mark just to jump in to give you some clarification, because I think we’ve got to look quarter-over-quarter versus year-over-year.

Mark Widmar

Yes, so one of the – Ray, one of the things we need to continue to remember is that the manufacturing cycle in Engineered Solutions tends to be much longer than our normal core business.

And one of the challenges that we had is we started to ramp down production for ES in the latter part of 2009. It did drive some unfavorable fixed cost absorption. And what that meant is that that product would still carry an inventory ultimately until we started to ship some of the revenue in the second quarter. So as the business volume started to ramp back up, we were getting a little bit of a headwind against the margins associated with that unfavorable absorption that was sitting in the inventory, so most of that has worked its way through in Q2.

As we progress in the second half of the year, we would expect the operating margins due to expand. Now we did see expansion from first quarter to second quarter. Again, we did see unfavorable year-on-year. But what I would say is that we would start to see a much more favorable margin realization for ES in the second half of the year as the result of that unfavorable absorption now largely being behind us.

Ray Rund – Shaker Investments

Do you have any sort of a targets for the operating margins in the Engineered Solutions segment?

Mark Widmar

Well, Ray, I mean in the business side, in 2008, it was performing at a level that was in the low-20s, right? So we had out margins that were in the 22%, 23%, 24%. And clearly when you look at the end markets in which we’re serving and the unique solutions that we’re providing to our customers, we would expect to start to reach those margins overtime. And whether we start to see that in the second half of the year, I would say it’s probably too early for that. But, clearly, we would see this business having the potential to have out margins in the – solidly in the 20% range.

Ray Rund – Shaker Investments

Okay, thank you very much.

Craig Shular

Thanks Ray. Have a good day.

Ray Rund – Shaker Investments

You too.

Operator

At this time, sir, we have no further questions.

Craig Shular

Lee, thank you very much. Everyone, thank you very much for joining our call, and we look forward to talking to you later in the year to review Q3. Take care. Have a good day.

Operator

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

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Source: GrafTech International Ltd. Q2 2010 Earnings Call Transcript
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