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GrafTech International (NYSE:GTI), a maker of graphite electrodes and other graphite products, operates three segments.

The Graphite Electrodes segment, which produced 78% of 2006 sales, makes and supplies high quality graphite electrodes that are used to produce steel and other ferrous and nonferrous metals. They act as conductors of electricity in electric arc furnaces (EAFs) to help generate sufficient heat to melt scrap metal, iron ore, and other raw materials. U.S. steel makers account for 18% of GTI’s graphite electrode sales, but the company also sells its products in 70 other countries.

The Advanced Graphite Materials segment produced 12% of 2006 sales. It makes and sells isomolded, molded and extruded graphite products to the energy, defense, and transportation industries. These are used in continuous casting and hot press manufacturing processes. They are also used to make resistance heating elements, high temperature furnaces and crucibles, chemical processing and centrifugal casting equipment, diamond drill bits, and semiconductor components. They can also be combined with advanced flexible graphite to provide better heat management solutions in industrial applications.

The Other segment (10% of 2006 sales) makes natural graphite products including electronic thermal management solutions for use by the electronics, power generation, automotive, petrochemical, and transportation markets. It also sells carbon, semi-graphitic, and graphite refractory blocks that have thermal conductivity applications.

GTI 1 Higher prices for raw materials, particularly needle coke, its largest input, forced GTI to implement aggressive price increases. This caused volume to fall to 201,300 metric tons in 2005, well short of the expected 210,000 metric tons. Despite price increases the $2,846 average revenue per metric ton fell short of expectations. But volume rebounded in 2006 to 211,000 metric tons and net sales climbed 10.7% to $855 million. The gross profit margin improved 79 basis points to 29.15%. But higher employee compensation costs caused the pro forma operating profit margin to fall slightly to 5.61%. Pro forma net income from continuing operations increased 15.5% to $59 million or 53 cents per share. GAAP net income was $91.3 million or 86 cents per share versus a net loss of $125.2 million or $1.28 per share in 2005.

Rising costs for raw materials remains a key worry. The company has initiated further price increases to offset higher costs, but volume is expected to fall about 3% in 2007 as a result. Yet guidance calls for 10-12% growth in net sales, which implies that price increases will offset volume decline.

In addition GTI has secured pricing on 70-75% of its key raw materials needs, so any further cost increases should have a minimal nearterm impact on profitability. Higher selling prices should help maintain profit margins, which should also benefit from the recent sale of GTI’s cathode operations. The sale eliminates a lower-margin business that had been running at a pretax loss the past two years. As a result, GTI expects income before special items to grow roughly 25%, or about twice the sales growth rate. Furthermore, proceeds from the sale of the cathode business were used to retire some of GTI’s highest-interest debt obligations. This will lower interest expense in future quarters and add incrementally to earnings.

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Source: Eye on GrafTech International