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Executives

Kelly Taylor – Director, IR

Craig Shular – Chairman, President & CEO

Mark Widmar – CFO

Analysts

Luke Folta – Longbow Research

Ian Zaffino – Oppenheimer & Co.

Eric Glover – Canaccord

Mark Parr – KeyBanc Capital

Ray Rund – Shaker Investments

Charles Bradford – Bradford Research

GrafTech International Inc. (GTI) Q4 2010 Earnings Conference Call February 24, 2011 11:00 AM ET

Operator

My name is Tia and I’ll be the conference operator today. At this time, I’d like to welcome everyone to the GrafTech Fourth-Quarter and Full-Year 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)

At this time I’d like to turn the conference over to Ms. Kelly Taylor. Ma’am, you may begin.

Kelly Taylor

Thank you, Tia. Good morning and welcome to GrafTech International’s Fourth-Quarter and Year-End 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 didn’t receive a copy please contact Marie Nor at 216-676-2160 and she’ll be happy to fax or e-mail a copy to you.

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

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

Finally, we’d like to thank those of you who joined our call on Tuesday to discuss accounting related to our recent acquisition. For your reference, a replay of that call is available on our Web site.

At this time, I’d 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 full-year and our fourth-quarter highlights, and then open it up to your questions.

2010 proved to be a historic year for our company. We successfully completed the strategic acquisitions of Seadrift and St. Marys. These are the first major acquisitions in GrafTech’s history and are important to generating sustainable long-term value for our shareholders and better serving our customer needs.

Following the completion of the acquisitions, we exited the year with a very solid balance sheet well-positioned to capitalize on opportunities for future growth, as the global economies continued to recover.

The integration process with Seadrift and St. Marys is well underway and progressing very nicely. We’ve inherited two great teams. The cultural fit of our companies is excellent. Our values around safety, ethics, team work, productivity, cost control and continuous improvement are well aligned.

Our current expectation is that Seadrift and St. Marys will contribute EBITDA after synergies of approximately $90 million in 2011. Our assessment of operational, tax and working capital synergies potential is consistent with our earlier expectations.

Recapping our results, excluding the contributions from the acquisitions and other special items, our 2010 sales increased 50% to $988 million. Operating income improved 85% to $174 million. Net income more than doubled year-over-year to $146 million or $1.20 per share.

Turning to Q4 results. Sales improved to $262 million. Operating income in the quarter was $39 million or approximately 15% of sales. Net income was $39 million or $0.32 per share. Net income was favorably impacted by a lower tax rate, resulting in a $0.06 benefit to the quarter for a normalized EPS of $0.26 per share. The improvement in the rate resulted from realization of a portion of the acquisition related tax synergies in the quarter.

In our Industrial Materials segment, sales increased 29% to $215 million in the fourth-quarter. Sales in the quarter increased primarily as a result of higher graphite electrode sales volume partially offset by lower prices. Operating income for the segment was $33 million.

In our Engineered Solutions segment, sales were $47 million in the quarter, an increase of 26%, as compared to Q4 ‘09. This was due to higher sales volume across multiple product lines including solar, oil and gas, transportation and electronics. Operating income was $6 million, as compared to $4 million in Q4 ‘09.

Our team has grown the Engineered Solutions business from essentially a breakeven business in ‘06 to a solid contributor today. The segment sales in 2010 came in at $173 million, our second best year ever.

On February 9th this year, we executed our first external growth initiative in Engineered Solutions. We acquired Micron Research Corporation, a privately held producer of super fine grain graphite for $6.5 million. Micron uses a unique technology to manufacture graphite materials suitable for applications in solar, electronics, EDM and the medical industries.

This addition fills a gap in our technology portfolio and is very complementary to our existing Engineered Solutions product portfolio. It will aid in continuing to propel this segment forward.

Turning to outlook, based on current IMF projections and other global economic forecast, world output is projected to expand at an average of 4.5% in 2011. IMF has stated that the degrees of growth will vary in both advanced and emerging economies and downside risk remains to the stability of the global recovery.

According to the World Steel Association’s published reports, total steel production levels are expected to improve in 2011. We expect our 2011 results to benefit from improved volumes in our Graphite Electrode business; however this impact will be partially offset due to lower electrode prices.

As a result, in 2011, we are targeting EBITDA to be in the range of $285 million to $315 million. This represents an increase of approximately 40% over 2011. We anticipate that our electrode operating rates in 2011 will continue to improve from the fourth-quarter utilization rate of 75% as we move throughout the year in response to the increased demand in an improving global economy.

We expect that the first quarter will be our weakest quarter of the year with EBITDA targeted in the range of $50 million to $55 million, which includes the impact of inventory step-up cost and intercompany profit in inventory on sales of needle coke.

Negatively impacting first quarter 2011 EBITDA will be approximately $11 million in intercompany profit in inventory elimination on sales of needle coke and $3 million in acquisition related inventory step up costs. The margin benefit of first quarter intercompany needle coke sales to our electrode facilities will not be recognized until electrodes are sold to third-parties.

In the second quarter of this year, we expect to incur an incremental $5 million in intercompany profit in inventory elimination, related to needle coke sales and $1 million in inventory step up cost, at which time the impact of these items will be largely behind us.

As a result of the above, we expect our second half of 2011 to be better than the first half. For the full-year 2011, we are targeting cash flow from operations to be in the range of $185 million to $215 million, an improvement of approximately 40%.

On the capital front, we are targeting expenditures of approximately $135 million to $150 million, as we fund internal Engineered Solutions growth initiatives, support Seadrift and St. Marys quality improvement plans and improve operational efficiencies across our global platform.

We are targeting overhead expense in the range of $145 million to $155 million. The year-over-year increase largely relates to $17 million amortization of acquisition related intangibles and $10 million higher admin expense due to the inclusion of the Seadrift and St. Marys teams.

We are targeting interest expense in the range of $18 million to $20 million. Of which, only $7 million to $8 million is cash interest expense. For depreciation and amortization expense, we expect approximately $85 million.

On the tax front, we are targeting an effective rate in the range of 22% to 24%. Our fully diluted share count will be approximately 146 million shares.

Finally, we are confident in the growth prospects of our company and will continue to invest both internally and externally to best position ourselves to capitalize on future growth, as the global economies continue to recover.

Tia, if we can open up for questions. That concludes our prepared remarks.

Question-and-Answer Session

Operator

(Operator instructions) The first question will come from Luke Folta with Longbow Research.

Luke Folta - Longbow Research

Good morning, guys.

Craig Shular

Good morning, Luke. How are you today?

Luke Folta - Longbow Research

Okay. Yourself?

Craig Shular

Superb. Thank you.

Luke Folta - Longbow Research

A couple of questions; firstly, are you able to tell us how full the order book is at this point for 2011?

Craig Shular

Yes, GE order book is running right now little above 80%, put together and I’d expect that to be kind of in the normal range, where we would be in this kind of economy so I see that on track.

Luke Folta - Longbow Research

And then including your EBITDA guidance for the year, can you give us a sense of the magnitude of pricing decline that you’re expecting?

Craig Shular

I think that’s too early to tell. What we usually do is kind of recap that post the conclusion of a quarter and you see that in our and Qs and Ks. So I think it’s early to really try to quantify that, obviously, electrode prices are softer. And as we’ve indicated and all of that, Luke, is baked into the EBITDA guidance we’ve given.

Luke Folta - Longbow Research

Okay. Recently there’s been an announcement of a price increase from a key competitor of yours. Can you just give us some thoughts on as we think about spot pricing now? I don’t know if it’s spots, right word to use, but do you think we’re at a bottom here in electrode pricing and do you expect that price increase or other price increases might be realized towards the latter half of this year?

Craig Shular

I’d say it’s hard to project marketplace of course determines the prices. And as I said earlier what we’ve usually done is complete a quarter and then we reflect back for everybody in the Qs and Ks what the pricing experience was.

Luke Folta - Longbow Research

Okay. And then just another one. Can you explain why you think prices have weakened, last year it was like an inventory situation, where there was still destocking. What are the key issues this year that have led to that price decline?

Craig Shular

If we take in a step back from the global market, I’d say probably reason number one, two and three are here we’ve gone through a very difficult 2.5 years of low operating rates amongst all of the electrode producers and I think, one, you just got some fatigue, so everyone has been running kind of at half speed and I think, that’s contributing to it, so that would be, I’d say number one, two and three. Number four would be the industry we serve the steel industry has had some very difficult results the last couple of years, losing hundreds and millions of dollars each quarter. So I think that’s also weighed on the market, as our customers have been in some very tough shape through this downturn.

Luke Folta - Longbow Research

I’ll ask one more and then I’ll get back in line, but can you just give us your thoughts on what needle coke pricing does for this year and if you expect anything different from Seadrift then you would be seeing on the electrode side of your business from external suppliers?

Craig Shular

I can’t comment specifically on the prices, but what I can comment on, let’s step back from Seadrift. We are very pleased the way that acquisition has come together, we are very pleased with the integration, we see no major issues on the integration and we are very pleased the way the Seadrift book has come together, that book has come together very, very nicely. And as you see in our $90 million EBITDA guidance on the acquisition that has come albeit at the lower end of the range, but it has come well within the range and is a very nice accretive transaction for us.

Luke Folta - Longbow Research

With the order books coming together nicely, can you just talk about what sort of utilization you expect out of Seadrift in 2011?

Craig Shular

Order book looks very good. Electrode demand, we see going up over the course of the year based on what we see in the global economies and what we see from our customers and what we see in our own book. Parallel to that I see Seadrift at a very solid high operating rate as a result of that.

Luke Folta - Longbow Research

But you don’t want to quantify at this point?

Craig Shular

No, sir.

Luke Folta - Longbow Research

Okay, thanks.

Operator

The next question will come from Ian Zaffino with Oppenheimer & Co.

Ian Zaffino - Oppenheimer & Co.

Hey, great, thank you.

Craig Shular

Good morning, Ian. How are you today?

Ian Zaffino - Oppenheimer & Co.

Good. How are you doing?

Craig Shular

Great, thank you.

Ian Zaffino - Oppenheimer & Co.

So the 80%, that’s annual contracts, make sure quarterly or whatever?

Craig Shular

Ian, it is primarily annual contracts. And as we’ve gone through the trough you recall a couple years ago, it was kind of quarterly, and then a few went six months. I think, what the steel customers are seeing in general worldwide is an improving outlook, so the majority of our contracts this year, the steel industry has requested annual contracts, and we see that as another positive sign to recovery.

Steel kind of ran worldwide around 75% op level in Q4. We see that starting to come up our own op level, I see coming up. We exited Q4 last year at 75%. I see our own operating rate increasing over the course of this year. I say that because of the book that’s been built and the work with our customers.

Ian Zaffino - Oppenheimer & Co.

Okay. So this time last year you had a bunch of quarterly contracts. And as you went from quarterly to annual, you experienced higher pricing. What were really the dynamics? Maybe it’s a little bit of different time last year, but seeing that last year, our pricing rose throughout that period. Why the rush to lock in for full-year when you’re competing with everyone else, why not wait until they’re sold out, someone sold out, and then you come along and get the higher pricing?

Craig Shular

Let me just go back to some of your commentary on 2010. I’d say over the course of 2010 Graphite Electrode prices; in general, they softened over the course of the year, so that should be a reference point. As far as annual contracts or quarterly, really our customer base drives that. They come to a bid and they ask for annual and these are very, very large global customers in many, many cases. They request an annual contract. If you don’t want to give an annual, bitch them, they’ll go to someone else, so they really drive that.

Our takeaway would be that the fact that they’re virtually all moving annual. Their view of the recovery in the steel industry is starting to look better. And they have a better line of sight. So I view it as a positive, but net-net, Ian, they drive the contract. They want quarterly generally; they are going to get quarterly. If they want to go annual, they’re going to get annual.

Ian Zaffino - Oppenheimer & Co.

Okay. And then the last question would be with higher oil, how does that flow through your P&L? If you disaggregate Seadrift and the core GE business separately, I’m just trying to get a sense of how each business would fair in a higher oil environment?

Craig Shular

Ian, a couple comments on that. Obviously, it’s all reported in the IM segment, so those are reported together. Higher oil puts cost pressure on Seadrift obviously, and oil has had a significant move, point one. Point two, we are very proactive on a hedging strategy, we have a very successful and sophisticated hedging strategy to minimize risk. So everything that you see in the oil movement in price and enhanced cost to Seadrift, we have factored into our annual EBITDA guidance.

Ian Zaffino - Oppenheimer & Co.

Okay. But now would you be in a disadvantage to what you are without Seadrift in that, previously, you were able to lock in your needle coke at a fixed price, so in a rising environment, it didn’t really matter because you were locked in where now you are exposed a little bit more?

Craig Shular

No, I don’t see with a good solid hedging strategy on the decant oil side, the raw material for Seadrift; I don’t see that our risk profile has changed at all on the negative side. On the positive side, we have supply, we have input to the quality of that supply and our scientists are working on that and we’re in that business, which is a very good business. And it represents about 45% of our cost structure. So when you roll all of that into IM, it’s a very powerful addition to our business model. And when you add all of that up, at the end of the day, we are the industry’s low-cost producer better-positioned to serve our customers.

Ian Zaffino - Oppenheimer & Co.

Okay, thank you very much.

Craig Shular

Thank you, Ian.

Operator

The next question will come from Eric Glover with Canaccord.

Craig Shular

Good morning, Eric.

Eric Glover - Canaccord

Hi, guys. I just want to go back to this Graphite Electrode pricing issue. Just seems that the steel industry utilization rate as you mentioned is around 75%. It’s going to go higher this year. It could get up to 80% plus even. At what point do Graphite Electrode suppliers like yourselves regain some of the pricing power and be able to actually increase average electrode prices?

Craig Shular

Obviously, we like to see a much higher steel operating rate, 80% plus, we really like to see that. Two, it indicates global economic recoveries. Three, it means our customer base is probably doing much better financially. That’s a better environment to operate with them.

But lastly, Eric, really electrode operating rates are probably a bigger driver. And you recall that over the last couple of years, electrode operating rates, in general, have been below steel operating rates because of where we sit in the chain. Well, now, our operating rates have come up over the last couple of years and now we’re right around the 75% with the steel industry.

I think, as we see, steel continue to improve, it will drive higher electrode operating rates. And we’d expect for ourselves over each quarter this year we’ll see our electrode operates come up each quarter with probably the second half of the year being the highest we’ve seen in the last two years to three years, so, that will be the big driver. And when we get to that kind of a situation, that’s probably favorable to the marketplace to selling Graphite Electrodes.

Eric Glover - Canaccord

Thanks. How much needle coke do you expect to obtain from Seadrift this year in terms of tons?

Craig Shular

We said we would probably take somewhere around 70,000 metric tons to 100,000 metric tons in that range that it would be an integration process. It wouldn’t happen all at once. It would be a transition. So think of us taking somewhere around two-thirds of Seadrift’s production, or maybe a little bit less than that and then the rest we sell to third-parties. And as I said earlier, Seadrift has built a very nice global book, an excellent global book so far.

Eric Glover - Canaccord

Okay. And then final question, how are customer electrode inventories at this point?

Craig Shular

There are no excess inventories in the chain. Steel has done a very good job across all the raw materials, not just electrodes, but have really thinning out the supply chain, so another positive I think, for all of us as the economies recover. We don’t have excess inventories out there in the chain that have to be burned off in the case of electrodes. It’s quite a tightly managed supply chain. So, as demand picks up for our steel customers, and then demand picks up for our electrodes, you’ll begin to see that in short order. There won’t be a larger lag, because someone’s burning off large quantities of electrodes.

Eric Glover - Canaccord

Okay, thank you.

Craig Shular

Thank you sir.

Operator

The next question will come from Mark Parr with KeyBanc Capital.

Craig Shular

Good morning, Mark. How are you today?

Mark Parr - KeyBanc Capital

Hey, Craig, good morning. Had a couple of questions, if I could. First, as far as the 2012 outlook and how it may be unfolding and we’re in a period of rising oil prices again, which has all the normal source of consequences for the price of decant oil and the cost to produce needle coke. And I’m curious do any of your contracts have the ability to pass through rising needle coke prices, as we look at the ‘11 book, and is this something that you think the industry may move to more aggressively, as you head into 2012?

Craig Shular

Well, Mark, too early to tell if any of those changes are coming. What I can say, first, looking at 2011 as we said, those risk in our hedging and what not is all baked into our EBITDA guidance for this year. What I can also say, we have no sales contracts committed for 2012, so that is wide open. And if there is cost pressure then that will have to be dealt within the marketplace to try and recoup some of that cost structure.

Mark Parr - KeyBanc Capital

Because you’ve got annual contracts in your very volatile commodity markets, recognizing you do have a hedging strategy. But I guess another way of hedging is to actually include pass-through clauses in contract language with customers. And I’m asking do you have any of that or is there any of that going on in the industry right now?

Craig Shular

We really don’t comment on that aspect of our book. And I guess all I can point you to Mark is that on the EBITDA guidance it’s baked into that. What I can say about 2012 is if steel operating rates continue to come up as they’re forecasted by World Steel and many others and electrode operating rates continue to come up obviously 2012 has the potential to look very, very attractive to our company.

And you see us on the capital front making a number of moves to put capital in the ground and a lot of this is going to our ES business, we have a number of product lines in ES that are running at very high op levels. So the demand is good, solar, oil and gas etc. And you have a number of things we’re doing at the two companies we acquired.

So, we view 2011 as a lot of work to get ready for what we see in 2012 could be high operating rates, where we’re going to want those capital projects done and behind us so we can run our facilities at very high op levels, pull out very efficiently and take care our customers.

Mark Parr - KeyBanc Capital

Just another question. Is your 2011 EBITDA guidance, does that include any expectation of pre-buying as far as customers who may want to buy now at lower prices in anticipation of stronger market dynamics for next year?

Craig Shular

No sir, that’s not in there at all. Obviously, the market is going to determine where price goes, but with cost pressure building, I think, we all see it on many fronts, that won’t be our direction as we go into 2012. As I said, 2012, we have no selling commitments or sales prices fixed at all.

Mark Parr - KeyBanc Capital

Although I understand that, but any of the purchasing managers at the mills are very cognizant of what’s going on in the oil markets. And they know that historically that’s had a very high correlation to needle coke and ultimately electrode pricing. So that’s the only reason I bring it up. I was curious, if to the extent that any pre-buying may unfold, do you think that could positively impact your outlook, based on what you said thus far?

Craig Shular

The way we would view pre-buying is that’s really not what we want in a rising cost environment. So what we have booked is for this year’s requirements, they line up with what we see running in the individual customer shops. And so our view on pre-buying with increasing cost that that would have to be dealt with differently than the contracts today. That’s all things being equal, the cost is going up, and that’s at a higher price.

Mark Parr - KeyBanc Capital

That’s what I was trying to get at. Another thing, I just wanted to try to confirm, based on the level of profits that you expect to be transferred into inventory from Seadrift, and some of the commentary that referred, does that imply that your takedown from Seadrift this year will be somewhere in the 65,000 to 70,000 ton level?

Mark Widmar

I think, as Craig mentioned, our view is that we would start to buy backward integrate that to the range of between 70,000 and 100,000 metric tons, but given where we are and the timing of when the deal closed, you would expect us to be on the lower end of that range in year one and we could start to see a little bit more volume coming into 2012.

Mark Parr - KeyBanc Capital

So that’s just consistent with the numbers that I was running. Just last, Craig, you’d indicated in the Engineered Solutions area that you’re seeing some very strong operating rates. Is there anything you can tell us as far as how you had looked for the volume or for revenues in that business in ‘11 versus ‘10?

Craig Shular

Mark, it’s not an individual guidance we give, but I’d expect that this year would be an all-time sales record for that business, being driven by solar, some of the latest generation electronics products, all those latest generation tablets you see coming out from RIM, iPhone, smartphones, all propelling that, oil and gas drilling propelling that, so, yes, we see all-time record year for 2011 in sales.

Mark Parr - KeyBanc Capital

All right. Thank you very much. Good luck to you this year.

Craig Shular

Thank you, sir.

Operator

(Operator instructions) The next question will come from Ray Rund with Shaker Investments.

Ray Rund - Shaker Investments

Thank you for taking my question.

Craig Shular

Good morning, Ray.

Ray Rund - Shaker Investments

Good morning. Just wanted to get a clarification. I’m not as familiar with the acquisition accounting as I could be. In the first quarter you are talking about $11 million in intercompany profit in inventory elimination on the sales of needle coke and an additional $3 million in the related inventory step-up cost. Now, this is a total of $14 million. Will this be coming out of the cost of good line, or I should say going into the cost of goods sold line, so it is directly affecting your gross margins?

Mark Widmar

So what will end up happening is the inventory step-up will clearly reflect in cost of goods sold and therefore weight down on our margins. The intercompany profit really will be neutral to results because essentially we’ll eliminate the intercompany sales therefore it won’t be reflected in the top-line and then we eliminate the profit on the transactions, right. So you won’t see that as a margin weight, if you want to use that word.

But what will start to happen is we’ll start to see higher top line revenue and margin flow-through associated with those sales, as we ultimately produce the electrode and sell them on to the third-party customers.

Ray Rund - Shaker Investments

I see. That’s a good clarification. Thank you.

Operator

The next question is a follow-up question from Luke Folta with Longbow Research.

Luke Folta - Longbow Research

Hi, guys. Firstly, can you remind us when the needle coke sales agreements reset from a pricing standpoint?

Craig Shular

Each year, it is roughly around Q3 type period. We try to lock in our needle coke cost structure at that period which is at the front end of the electrode book building.

Luke Folta - Longbow Research

So sometime in probably early fourth-quarter is when we might start to see some of the impact of whatever happens to needle coke prices next year?

Craig Shular

Luke, probably what would happen is as we get into Q3 this year somewhere in there maybe early Q4, Seadrift will begin building its book for 2012.

Luke Folta - Longbow Research

Just on the hedging side, I guess I’m trying to understand if I were to tell you that needle coke prices are up 10% or whatever next year. I’m just trying to get a sense of what the sensitivity of earnings would be to those higher needle coke cost for Seadrift, keeping in mind that you are hedging, I mean are you hedging at the entire book or how does that work?

Craig Shular

What we did Luke, as we worked through the finalization of the acquisition obviously we did some very important strategic hedging strategy work and development and what not so that as soon as we completed the acquisition, we are very well prepared to execute on the hedging strategy, so that’s gone very well for us. And I think, that should be your takeaway and that it is baked into the $285 million to $315 million of EBITDA guidance we’ve given.

I think, your other takeaway should be there are cost pressures, I mean we all see them from natural gas to electrode across the entire chain and especially all of the volatility we see in oil, so a lot of that will be influencing. And I think what the cost structure looks for 2012 and then where the market tries to go.

Mark Widmar

Luke, this is Mark, I think, the other thing maybe is helpful to understand is that there is somewhat of a natural hedge position because Seadrift is buying decant oil and then through the production process of producing the needle coke they generate liquids that are byproducts that are sold into the open market and those are obviously oil derivatives.

Therefore, you have a little bit of a natural hedge in terms of what they are producing versus the value of the byproducts as long as the correlation of those to stay relatively in sync, you have a natural hedge from that standpoint and then what we look at is the net exposure and we put our hedging strategy in place from that standpoint. Back to the question around is the risk profile of our business better or worse with Seadrift and Craig talks to that as well.

What I’d say is that even though we had an annual fixed price with Conoco or other suppliers that entire value, that contract was opened up to negotiation each year which had 100% exposure to volatility in oil markets.

What we have now is because there is a natural hedge with the value of the byproducts we’ve minimize our exposure, our net exposure will be lower now than it would have been under our relationship with a third-party supplier and then with the hedging strategy that we are able to put in place that allows us to secure a forward position and secure that cost structure that eliminates more volatility, so from my standpoint, I think, risk profile of our business has much improved relative to what it would have been before.

Luke Folta - Longbow Research

When you think about Seadrift in 2012 you had mentioned that on the electrode business that you could expect to see some pricing power return to that business once operates and volumes improve, should we think of Seadrift in the same way as where spreads of needle coke over decant oil should it start to improve as operating rates go up, is that the right way to think about it?

Mark Widmar

It’s always hard to tell where it’s going in the future, but let’s just look at where we are now. Q4, our electrode facilities ran at a 75% op level and steel was about at 75% op level. Recall that’s the first step our op levels have caught up with steel.

For the last 2.5 years, we’ve been operating and the whole electrode industry has been at a low level, below the steel level. Now, we’re level with it and I’d expect our electrode operates will go up each quarter this year so that we could exit the year at a very attractive op level. That will probably be the primary driver here.

Luke Folta - Longbow Research

And just one last one. Guys, thanks for taking all my questions.

Craig Shular

No worries. Perfect.

Luke Folta - Longbow Research

Just on free cash flow for the year, it looks like based on your operating cash flow guidance and CapEx that you have a pretty decent amount of free cash this year, can you give us a sense of what you plan to do with that in terms of either debt reduction or future expansion of ES or whatever?

Craig Shular

All of our internal expansion opportunities that we see today are covered in the CapEx guidance. So all things being equal, we would expect to continue to delever and then we are continuing to be very proactive on the external growth. You’ll note just on the timeline, we closed the two large acquisitions for Industrial Materials, November 30th.

On December 22nd, we signed the LOI and the exclusive on Micra [ph] and then much smaller deal of course that we were able to close that very efficiently. That was closed the second week of February. So we will continue to look for great external growth opportunities. And if we see those and they’re fairly priced, you would see us probably use some of our balance sheet for that, Luke.

Luke Folta - Longbow Research

Okay, thanks, again, guys.

Craig Shular

Thank you. Thanks for the questions. We much appreciate it.

Operator

The next question is a follow-up question from Ian Zaffino with Oppenheimer & Co.

Ian Zaffino - Oppenheimer & Co.

Thanks. Just really quickly on the ES side. Margins, was there anything negatively impacting the margins other than the usual characters, or was there anything like product launches or anything like that affecting it?

Mark Widmar

Ian, I’m assuming your comment is more sequentially when you’re talking to the margin performance were yes?

Ian Zaffino - Oppenheimer & Co.

Yes.

Mark Widmar

Really what that was is there was a slight unfavorable mix from Q3 into Q4. As you would anticipate, especially a lot of our Electronic Thermal Management products, there is a ramp-up in activity, more of seasonality of that business in advance of the holiday season.

So what you’ll see is Electronic Thermal Management revenue was much higher in Q3 than it was in Q4, and I think, as we stated before, that’s some of the highest margin products that we have. So sequentially a little bit unfavorable product mix drive drove the margin down about 80 basis points I think.

Ian Zaffino - Oppenheimer & Co.

Okay. Going forward, is it safe to assume that it might have been like just big one large product launch, as opposed to a whole host of them?

Mark Widmar

Yes, again, if you want to do anything I’d look at the second half margin profile and say that’s indicative of what you ought to think going forward versus just looking at one discrete quarter.

Ian Zaffino - Oppenheimer & Co.

Okay, great. All right. Thanks, guys.

Operator

The next question is a follow-up question from Mark Parr with KeyBanc Capital.

Mark Parr - KeyBanc Capital

Thanks very much. I wanted to just think a little bit more about the Seadrift situation. And so I guess Craig, to your comments, you believe that the cost situation for Seadrift has been, call it, leveled to the pricing that you have committed to over 2011. Is that fair?

Craig Shular

Fair enough

Mark Parr - KeyBanc Capital

Okay. And then there is a hedging strategy associated with this. All right. Just there is one another question. I don’t know if you answered this already, but do you have any mark-to-market issues associated with hedging that could impact quarterly results. I know some companies that do metals hedging have significant mark-to-market issues with the hedging strategy. Is there any of that up and coming for GrafTech in the next several years?

Mark Widmar

Mark, obviously, the hedging that we did will qualify for hedge accounting treatment and then that will ensure that the gains and losses associated with those contracts will flow into our results commensurate with the activity throughout the year. So, we won’t have any large spikes in mark-to-market adjustments. You’ll just see it flow-through as part of cost of goods sold, which should normalize our results during the year.

Mark Parr - KeyBanc Capital

Okay. So, you don’t really have the ability to lock in a decant oil cost per se but you do have the ability to lock in that cost via your own hedging operations?

Mark Widmar

I mean if you look at from that standpoint, I guess clearly with the supplier there will be movement in the supplier in terms of the market prices of decant oil. Well, I have forward contract at which I’d have sold about dependent upon the byproduct or the decant oil that we are hedging that should normalize the cost of the P&L.

Craig Shular

So Mark, there is a forward market that’s out there, that’s liquid, and we utilize it and there is also natural hedge we have because we are selling some oil byproducts. So we have both vehicles and obviously, we look at the net exposure and that’s what we.

Mark Parr - KeyBanc Capital

All right. I understand. That’s very helpful. I know the other question I had the capital budget that you have put out is larger than we’ve seen in a while, how much of that capital is associated with Seadrift. Could you talk a little bit about how much you think it’s going to cost to accommodate the capital needs to meet the quality requirements that you’re looking for?

Craig Shular

One of the biggest components in the increase is in Engineered Solutions in increasing capability, capacity and putting some assets in the ground to do some new products that we’ve developed, so ES is a big portion of that increase. So rather than give you buckets of every one of our businesses, maybe the way to look at it, the CapEx guidance we gave the 135 to 150 is our largest number. But, on a regular basis it might be somewhere 100 to 120. It might look like that in more normal years. And so I think, for your longer-term modeling if you use something in a range of 100 to 120, that’s probably indicative of what we would be putting in on a regular basis.

Mark Parr - KeyBanc Capital

Okay. Any new machining centers going in to the electrode manufacturing operations in 2011?

Craig Shular

No new discrete centers, separate centers, but a lot of activities at our existing facilities on productivity improvement, quality improvement, etc.

Mark Parr - KeyBanc Capital

Is there a step up there from 2010, or are you maintaining that level that you spent in 2010?

Craig Shular

For the electrode facilities?

Mark Parr - KeyBanc Capital

Yes?

Craig Shular

Yes, it’s least that, obviously, we’ve added a new facility in St. Marys. So it’s been increased for the addition of the St. Marys facility. There’s a number of opportunities at St. Marys, because we’re bringing together a couple different technologies and best learnings. So there’ll be some capital that go in to St. Marys that’s going to transfer some of the best practices we’ve learned at our other facilities. And then on the other side there’s some capital that’s going to go across our platform on some of the great learnings we have from the St. Marys team, and so that is baked into our CapEx number.

Mark Parr - KeyBanc Capital

Okay. All right. Terrific. Thanks, Craig.

Craig Shular

Thanks, Mark. Have a great day.

Operator

The final question will come from Charles Bradford with Bradford Research.

Charles Bradford - Bradford Research

Good morning.

Craig Shular

Good morning, Chuck. How are you?

Charles Bradford - Bradford Research

Hi. We have not gotten the World Steel Association’s breakdown of output for last year, electric furnace versus BOF but their total output was up by 15%. China being less than that as being low in EAF. Do you think the EAF sector leaving China aside picked up any share last year or what do you think?

Craig Shular

Too early to tell. We’re waiting for those same published numbers. But, if I look at a trend on EAF, we have seen over the last four years, a lot of very large new EAF furnaces go in the ground. Some of those projects were started in ‘08 before the downturn and the economic crisis. Some were started in 2010. We’ve been impressed with the number of new EAF furnaces going in the ground. Now a lot of them are running at low rates today, one, the economy and demand, some of them are in their start up phase, they never run real efficient the first several months.

But, what’s encouraging to us is, as we look forward to the economies recovering we see a significant portion of the EAF furnace capability are going to be these very largest, latest generation furnaces which demand very high quality electrodes and play right to our sweet spot. So we believe when we start to see the economies get back on their feet that there will be wind at our back as a result of all these new EAF starts that are in the ground.

Charles Bradford - Bradford Research

Obviously, there are two big EAFs going in the U.S. I wonder actually might have just started up, another coming later in the year. But, outside the U.S. we’ve seen some mini mills getting built in Russia and a few other places. Is there any specific spots where you happen to be strong geographically, where you’ve seen the EAFs go in?

Craig Shular

Remember, we have electrode facilities on four continents, so we believe we serve customers globally better than anybody. So, wherever EAF is growing, we are so well-positioned to serve either with a local facility or with a very strong well prepared local distribution channel. So we see a very large latest generation EAFs going into Russia, China and Middle East. You mentioned a couple in the U.S.

What’s encouraging to us is they are running at low op level today. When the economies recover, because they are little over cost weigh, they are efficient, they’ve got a small carbon footprint versus they are the old integrated. We believe those will run very, very nicely, and they play right to our sweet spot, large diameter, very high quality electrodes.

Charles Bradford - Bradford Research

Thank you very much.

Craig Shular

Thanks, Chuck. Have a great day.

Operator

There are no further questions.

Craig Shular

Thank you very much. Ladies and gentlemen, thanks very much for joining our call. We appreciate very much for your support and look forward to talking to you next quarter. Have a great day.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. You may now disconnect.

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