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GrafTech International Ltd. (NYSE:GTI)

4Q FY07 Earnings Call

February 28, 2008, 11:00 AM ET

Executives

Kelly J. Powell - Manager of IR

Craig S. Shular - President & CEO

Mark Widmar - CFO

Analysts

Brett Levy - Jefferies & Company

Robert LaGaipa - Oppenheimer & Co.

Luke Folta - Longbow Research

Michael Gambardella - J.P. Morgan

James Mikya - Private Investor

Gary Madya - Bank of New York

Sam Martini - Cobalt Capital

Michael Christodolou - Inwood Capital

Justin Bergner - Gabelli & Co.

Operator

Welcome to today's GrafTech fourth quarter and year-ended 2007 earnings conference call. Please be aware today's conference is being recorded.

Now, at this time for opening remarks and introductions, I'd like to turn the call over to Kelly Powell, Manager of Investor Relations. Please go ahead.

Kelly J. Powell - Manager of Investor Relations

Thank you Michael. Good morning and welcome to GrafTech International's fourth quarter and 2007 year-end 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 Jen Raedake at 216-676-2281 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'll find reconciliations in our press release, which is posted on our website at www.graftech.com, in the Investor Relations section.

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

Craig S. Shular - President & Chief Executive Officer

Thank you Kelly. Good morning everyone and thank you for joining our conference call for today. Today, we'll take you through our fourth quarter and full-year 2007 highlights and then we'll open up for questions.

In '07, net sales increased 18% to over $1 billion, while at the same time, we were successful in reducing selling and admin expenses by 11%, as a result of our ongoing productivity initiatives. Gross profit improved 36% or $331 million and gross margin expanded over 4 full percentage points to just under 33%.

Net income from continuing operations, before specials, increased more than 250% to $151 million or $1.35 per share. Operating cash flow more than doubled to $131 million. And then on the debt side, net debt was reduced to $370 million, that's lowest in our company's history.

Finally, recapping the full-year structural improvements we've made to the business along with ongoing productivity initiatives are allowing us to leverage our top-line growth in the solid operating results.

Year-over-year, our operating income more than doubled to $231 million and return on sales, ROS, improved a full 8 percentage points to over 15%. On this front in Q4, we closed our South African defined benefit pension plan and replaced it with a cost-efficient defined contribution plan. This better positions us to be low-cost and more competitive in the future.

Looking at the fourth quarter '07, net sales increased 14% to $269 million. Gross profit increased 17% to $81 million. Income before specials more than doubled to $44 million or $0.38 per share. Operating cash flow almost tripled to $55 million.

In our Graphite Electrode segment, sales were up 15% to $218 million, while operating income for the segment increased 47% to $50 million. Volume for the quarter was 53,000 metric tons. Our Graphite Electrode segment benefited from higher electrode selling prices and successful productivity initiatives, partially offset by rising raw material cost and of course the one-time charge for the aforementioned South African pension.

In our Advanced Graphite Materials segment, fourth quarter sales were $31 million as compared to $28 million a year ago in the same period. Operating income for the segment was $6 million. We continued to gain traction in this business and the quality of this business is improving. For the full year, operating income margin expanded over 6 full percentage points to nearly 18%.

Finally, turning to outlook. On February 15, 2008, in our single largest call to date, we retired $125 million of our most expensive debt, our 10.25% senior notes. This leaves just $75 million of senior motes remaining from the original $550 million issue.

We are encouraged by underlying global demand for our products and based on steel industry forecast, EAF steel production is expected to grow 2% to 3% in 2008.

Our Graphite Electrode order book is over 90% built and we expect a solid year in 2008. We have secured firm pricing for approximately 70% of our key raw materials related to Graphite Electrode production, including 100% of our needle coke requirements.

We expect to deliver gross and operating margin expansion for the full-year 2008. We expect CapEx to come in the range of $70 million to $75 million, as we continue to enhance our production platform, improve quality, increase efficiencies, and continue to lower cost.

We are targeting expansion of operating income before specials of 25% to approximately $295 million. We expect cash from operation to improve approximately 25% to $165 million.

Finally, I would like to make a few brief comments on our reporting segments as we go forward. We have realigned our operating segments in order to best serve our customers efficiently and cost-effectively. As a result of the ongoing consolidation in steel, many of our customers now operate EAF steel furnaces, as well as integrated steel furnaces. And thus we are combining our Graphite Electrode business, which services primarily EAF steel, and our refractory business, which services integrated steel, into a new segment called Industrial Materials. Previously, refractory was supported in our third segment, Other segment.

We are also combining our Advanced Graphite Materials business with our Natural Graphite business into a new segment called Engineered Solutions. This segment offers a host of tailored solutions to customers in the electronics, chemical, nuclear, and solar industries. These changes allow us to eliminate the Other reporting segment having only two segments go forward and perhaps more importantly allows us to combine sales and marketing teams, as well as admin functions with a net result being better service to our customers at a lower cost.

That's the end of our formal remarks. Let's open it up for questions and Mike if you can open up the line please.

Question and Answer

Operator

Certainly sir, thank you. [Operator Instructions] Our first question will come from Brett Levy of Jefferies & Company.

Brett Levy - Jefferies & Company

Hey guys, congrats on yet another very strong quarter.

Craig S. Shular - President & Chief Executive Officer

Good morning Brett, thank you very much.

Brett Levy - Jefferies & Company

Good morning. You know one other thing that’s started to come up is kind of a question I keep getting on you guys is, given that Steel Dynamics bought OmniSource and Nucor bought [inaudible] is there a model where one of your customers shows interest in buying you? Would that cause so much breakage with your other customers or that would be really problematic? Is it a stuff that you even think about?

Craig S. Shular - President & Chief Executive Officer

Brett, it’s tough to speculate on the future what may happen or not. Obviously, our size of production of graphite electrodes far exceeds the largest individual consumer out there. So, obviously, it is things we look at and study as we look at the global marketplace, but very hard to speculate on anything like that and perhaps a bit remote, given we are so much larger than the largest single consumer of graphite electrodes.

Brett Levy - Jefferies & Company

All right. And then the next one is just can you give... I mean it seems like needle coke is going to be a problem, just foreseeably, can you talk about any hope that capacity additions will start to relieve some of the stress there?

Craig S. Shular - President & Chief Executive Officer

You are correct, Brett. Needle coke has been and we see it will probably continue to be tight. I think the producers of needle coke are not expecting to add major new capacity. I think all of them are getting some creep capacity, which may help alleviate somewhat some of the tightness. But, we will have to wait. Time will tell. Right now, it is tight. We like our positioning being a very large buyer of these type products. So, I think it positions us well to leverage our volume to secure our quantity, to get the right quality, and hopefully to get a favorable price because of our large volume.

Brett Levy - Jefferies & Company

Got it. And then lastly and then I’ll get back in the queue. Can you guys talk a little about what you... what are your plans for the additional free cash flow that you guys are going to be generating, taking out the remainder of the 10.25%... I don't know, any other expansion or debt reduction plans?

Craig S. Shular - President & Chief Executive Officer

Obviously, we have our track records here... a well-earned track record of deleveraging. Our first move here right out of the box was to call that 125 of senior notes and we called them at the very earliest that we could to get the new step down in the call premium. So, I think one possible use of our cash flow going forward is to continue to delever. Obviously, another large area would be on the growth side and our company is looking at a host of growth opportunities. They exist internally. In some cases, they may exist externally. So, we are wide open looking at a host of growth opportunities to grow our company, grow our competitive advantages, and add more shareholder value.

Brett Levy - Jefferies & Company

Thanks very much.

Craig S. Shular - President & Chief Executive Officer

Thanks, Brett.

Operator

We will next take a question from Robert LaGaipa of Oppenheimer.

Robert LaGaipa - Oppenheimer & Co.

Thank you. Good morning.

Craig S. Shular - President & Chief Executive Officer

Good morning, Bob. How are you today?

Robert LaGaipa - Oppenheimer & Co.

Pretty good. Yourself?

Craig S. Shular - President & Chief Executive Officer

Great. Thank you.

Robert LaGaipa - Oppenheimer & Co.

I have several questions as well. Maybe, if we could just you pick up on that last one. When you referred to external opportunities, does that include the Carbide/Graphite facilities for sale in addition to the [inaudible] facility?

Craig S. Shular - President & Chief Executive Officer

Anything that we would talk about on a go-forward basis would be speculation. I guess the takeaway should be, given the improvement in our financials, given the improvement in our cash flow and our operating results, we believe we position the company to look at a host of opportunities globally. These exist around the world in all of our businesses, not just Graphite Electrode. So, you have mentioned a couple that may be out there. I think, it's too early to speculate on any specific ones for our company, but your takeaway should be GrafTech is positioned to seize opportunities as we go forward.

Robert LaGaipa - Oppenheimer & Co.

Okay. Terrific. And then maybe if you can just talk about the potential volume in 2008, I didn’t see it in the press release, previously you have given it. I mean, what kind of volume should we be expecting, similar to 2007?

Craig S. Shular - President & Chief Executive Officer

Yes, we are getting away from annual volumes and individual quarters. But, maybe just kind of kick off, yes, we would expect volume this year to be similar to last year and really recognize that [inaudible] are trying to put together some quarter lease and we're not going to give individual quarterly guidance, but maybe just behind.. as you all know, our business, Q2 is usually a bit stronger quarter for us, Q4 is usually stronger, these are seasonal in nature and usually Q1 is a little bit weaker, and then Q3 is a little bit weaker. So, usually out of the fourth quarters, Q2 is a stronger one, Q4 is a stronger, and then Q3 of course, as I said, a little bit slower because European slow down. We don't expect that trend to change much. So, as you look at our quarterly… the seasonal will probably look somewhat like you have seen in the past and annual volume would be similar to last year.

Robert LaGaipa - Oppenheimer & Co.

Okay, terrific. Another question, it’s just related to needle coke price increases. Last time in the third quarter you mentioned obviously secured the volume. What kind of price increases have you seen in needle coke, you know, that remaining 30% of the raw materials that hasn’t been locked up. What kind of variability can we expect there?

Craig S. Shular - President & Chief Executive Officer

The coke prices have gone up significantly, we won't specify a price, but obviously quality needle coke is tight and raw material pressures have been vulnerable as there have been in the last couple of years. On the balance of our raw materials, we are very pleased to be sitting here at 70% done. All the key ones that we wanted to get done are done and fixed. We have the quantity, we have the quality, and we have fixed the price. The remaining 30% are primarily minor ones and one example would be natural gas. We have not hedged that for the full year. We don't really want to at this stage. So, we have some that are open, but there are more open by design, rather than our inability to go ahead and lock them up. This is no different than we have done the last couple of years. Generally, at this time, we are about 70% fixed or it’s just like we did last year and then we manage throughout the year. Obviously, natural gas moves in different seasons. You got a winter season or a summer season and we monitor that very closely and take hedges over the course of the year.

Robert LaGaipa - Oppenheimer & Co.

Two other quick questions for you. One, the South African plant, obviously, there has been about stories about power outages and so on and so forth, that’s a fact, you know, many of the metal companies down there. Your plant down there, your customers, how that’s been impacted thus far? Do you expect it to be an impact, maybe if you can provide some color there?

Craig S. Shular - President & Chief Executive Officer

Yes, you are right. South African economy is tied on electric power and the government has been managing that and I think all of South African industry is going to feel that, it is already… in Q1 been feeling that. At this stage, we don't see it to be material to ourselves. Obviously, we are a buyer of electric power. Obviously, electric… our furnace customers use it there and obviously we export from that location. So, we have a large export business out there. So, we're not just selling to the South African industry. But net-net, Bob, if we add all that up, we are not anticipating at this stage whether the government has announced and put in some limitations on electric power. We are not anticipating a material impact. At this stage, everything that has been done there so far is fully incorporated in your guidance.

Robert LaGaipa - Oppenheimer & Co.

Last question before I pass it. It’s just related to the capital expenditures, obviously, you are in a much better position from the balance sheet. You are generating a significant amount of cash flow, you are expecting that to be over 25% in 2008. You mentioned this increase in capital expenditures, I was hoping maybe you could just expand on that. What specifically are you doing with that addition, that incremental capital? What type of benefits should we expect from that?

Craig S. Shular - President & Chief Executive Officer

Bob, the incremental portion is primarily to improve efficiencies at our facilities, lower cost, and improve the quality of the graphite electrode we produce. We're trying to raise the bar on Graphite Electrode performance and quality. So, that's the primarily increase in capital. There is a very minor component, there will be little bit of de-bottlenecking that we will get some additional capacity, but it's not material. The main focus of this CapEx increase is, as you say, we can afford it no, we have some new technologies we’ve developed that are more efficient and lower cost, and we believe at the end of the day when this is done we will have an even better quality graphite electrode for our customers.

Robert LaGaipa - Oppenheimer & Co.

Terrific. Thanks very much. Good job.

Craig S. Shular - President & Chief Executive Officer

Thanks, Bob.

Operator

We will next move to Luke Folta of Longbow Research.

Luke Folta - Longbow Research

Hi, good morning.

Craig S. Shular - President & Chief Executive Officer

Good morning. How are you today?

Luke Folta - Longbow Research

Not bad, yourself?

Craig S. Shular - President & Chief Executive Officer

Excellent. Thank you.

Luke Folta - Longbow Research

Great. I just had one question on your margin outlook for 2008. You said you are expecting higher margins, is that essentially due to increase in the price or cost reductions? Can you maybe give some color on that?

Craig S. Shular - President & Chief Executive Officer

Luke, it's all of the above. Graphite electrode prices of course have been going up. And then our team has a very well earned track record on cost in the manufacturing sector and obviously in overhead. Last year, as you saw, sales up 18% and overhead down 11% in the same year. So, it is all of the above, operating cost, efficiencies at our plant, elimination, reduction of scrap, and also some electrode price increases.

Luke Folta - Longbow Research

You said that your order book is at 90% full for 2008?

Craig S. Shular - President & Chief Executive Officer

Yes, sure.

Luke Folta - Longbow Research

Are those all firm pricing or...?

Craig S. Shular - President & Chief Executive Officer

Yes, sure. It's a bit over 90%, in fact, very pleased the way the books come together. We have a solid order book for '08. The volume and price in those is all set and fixed. Now, we do not have take or pay contracts with our customers. So, if the economies had a major fallback and we had a major drop in the global economies, our customers can cancel orders or reduce orders. Our industries never had fixed price, or take or I'm sorry... take or pay contracts. But, all the contracts are fixed in volume and price. So, if the economies and our customers run as is expected, the price is already set in all those, the price will not change and the volume commitment is already set in those. Just like we did last year and the years before.

Luke Folta - Longbow Research

Thank you very much and good luck.

Craig S. Shular - President & Chief Executive Officer

Thanks, Luke. I appreciate it.

Operator

We will next take a question from Michael Gambardella of J.P. Morgan.

Michael Gambardella - J.P. Morgan

Hi, Craig. Congratulations on another good quarter.

Craig S. Shular - President & Chief Executive Officer

Thanks, Mike. How are you today?

Michael Gambardella - J.P. Morgan

Good, good, good. Hey, I have question about the structure of your Graphite Electrode pricing. Have you seriously considered or tried to change the structure from an annual to say a quarterly pricing structure?

Craig S. Shular - President & Chief Executive Officer

Thus far our industry and... is probably 20, 25 years of history has had an annual pricing program. Obviously, it's something we always look at, especially with severe raw material pressures. Obviously, our customers have a much more frequent pricing throughout the year. They open up their books a couple of months forward. So, it's something we study. I guess the challenge is, there is 20 years, 25 years that this industry has been done on annual contracts. But, it's something that we study; it has some positive attributes to it, especially when raw materials are going up as much as they have the last couple of years.

Michael Gambardella - J.P. Morgan

I was just thinking like in the early part of the 20-year history, the industry was basically price-fixing, and then after that you saw the industry, yourselves, and the rest of the players really go into poor financial condition, and now that's turned where your financial condition is much better and the other players’ financial condition has improved. So, I was thinking maybe you could go to maybe more of a quarterly to try to capture a little bit more of the upside.

Craig S. Shular - President & Chief Executive Officer

Yes, excellent plan and definitely something we've looked at very, very hard in our industry and the challenges there too we talked about, we agree with it. There would be some real merit, especially given where raw materials and the rapid increase of raw materials have been in the last couple of years and our customers price that way. So, obviously, something we’ve studied. Future things on pricing, etcetera, we really can talk about, but we see the merits of it absolutely.

Michael Gambardella - J.P. Morgan

And lastly, could you just give us some color on how the pricing season went in terms of when you finished pricing? Could you give us any idea of the percent increases?

Craig S. Shular - President & Chief Executive Officer

We've stopped giving really price information or details by geography. The color I can give you is, I think the pricing started kind of Q3 last year and there are some customers that start-up early in Q3. It really gets rolling in Q4. We've got a number of customers and orders that really aren't finished up until January and February. So, that's kind of a timeline of it. I think it was very orderly customers, obviously, had seen our raw material increases and accepted increases on graphite electrodes. Net-net, like I said, we are very pleased the way the book came together. We've built a solid order book and we're 90% plus already fixed. We are at a very good point.

Michael Gambardella - J.P. Morgan

Last thing on the pricing. Did any one of the players you sell or any other players tried to go for really big number? I mean, your customers are looking at iron ore prices up 65%, potentially coal prices up over 100%, scrap prices for your direct customers, up significantly around the world. It seems like four bigger increases than the graphite electrodes, which as everyone knows is a relatively small component in the cost structure. Did you guys or anyone else tried to go for really big number this year?

Craig S. Shular - President & Chief Executive Officer

I think you've seen the activity the last couple of years and we've obviously on many occasions been upfront on price increases and trying to get a fair price for our product and get ahead of these large raw material increases. So, I can't really say that in this season anyone did anything different than the year before. Having said that, we also monitor very closely the sharp increases in iron ore and the others. So, we are very aware of some of the large increases that are being soft there in markets that are tight also.

Michael Gambardella - J.P. Morgan

Okay. Thanks, Craig.

Craig S. Shular - President & Chief Executive Officer

Thanks, Mike.

Operator

We will next move to Merrill Lynch's Arsat Bedie [ph].

Unidentified Analyst

Good morning, guys. I'm Arsat Bedie from Merrill Lynch. A couple of questions for you. The kind of operational improvements that you did at your plants. What kind of activities did you pursue and how much far do you think you can go? And the second is on improving your electrolyte quality. What do you have in mind and what you think you can achieve?

Craig S. Shular - President & Chief Executive Officer

Thank you for the question. In the plant side, we've done a lot of things to try and eliminate waste. We continue to work in that area. We've done a lot of things to improve productivity, a lot of things to reduce scrap rates. We're running some of the lowest scrap rates we have ever run. We've done a lot of things to improve cycle time, process our products faster through the constraint. We've spent a lot of time on that. So, it’s a host of items. It’s not one particular or two particular items that we’ve worked on. We’ve worked on a host of items. Over hedge speaks for itself, down 11%. We've gotten efficient there. A number of activities we've done the last couple of years have gotten us to this place, including consolidating our overhead, moving the headquarters, getting everybody under one roof, and Tom has been very supportive and helpful on that front. So, it’s a host of those kind of activities. On the quality front, we believe that today we're making the best electrode we've ever made in our history. Obviously, we have a strong R&D team and we continue to seek ways to get a better product, a better performing product, and a more consistent product that we sell around the world for our customers. Many of our customers are global customers, they have 30, 40 locations and they want the same grade electrode in every location. So, a lot of the work we've done is on consistency. I think there is room to go there, I'll never say that we're near that wall, I think that's not productive. So, I think we still have a lot of room to go on quality. We've made some great strides the last couple of years. The team has got momentum on the quality front, and you'll see us continue to put money into it, we can afford to do that now, and we see this… all of this is just adding to our competitive advantage, best global network, positioned on the right counts to service these large global steel accounts that keep getting larger, and then really trying to grow the quality gap between ourself and some of the other competitors.

Unidentified Analyst

That's great. Thanks a lot.

Craig S. Shular - President & Chief Executive Officer

Thanks, Arsat.

Operator

We'll next take a question from a private investor James Mikya.

James Mikya - Private Investor

Hi, Craig.

Craig S. Shular - President & Chief Executive Officer

Good morning James, how're you today?

James Mikya - Private Investor

Very good. I want to congratulate you on some great work over the last few years.

Craig S. Shular - President & Chief Executive Officer

Thank you sir.

James Mikya - Private Investor

Turned it into a real lean-mean company there.

Craig S. Shular - President & Chief Executive Officer

Thank you sir, we've put together a great team here.

James Mikya - Private Investor

Yes, very great. A couple of years ago, analysts were asking about capacity constrains, and your capacity at the time was about 230,000 tons, are we still at that level?

Craig S. Shular - President & Chief Executive Officer

James, right now, we are around 215,000 or so. So, we have 215,000 current and then we also have obviously a host of de-bottlenecking opportunities that we've talked about. Those de-bottlenecking opportunities are 30,000 tons to 40,000 tons is available at low cost to expand. What we've said, we'll continue to assess the market and when the market is there and the time it is right, we'll look to add capacity. But, right now, we set it 215,000 and we're happy to be at 215,000 right now.

James Mikya - Private Investor

Okay that sounds great. Does the shortage of coal in China increase the demand for electric arc furnaces? I would imagine so.

Craig S. Shular - President & Chief Executive Officer

Coal has so many other applications and not as a direct impact on EAF. Obviously, coal price is moving up rapidly like many commodity prices. So, on the energy side, it’s getting dragged along like all energies. But, as far as a direct or a strong correlation to EAF, it's not really that strong at all.

James Mikya - Private Investor

In India do you see a lot of… their production levels as you expected a few years ago, 20,000 ton, 30,000 ton increases per year or something like that?

Craig S. Shular - President & Chief Executive Officer

The Indian producers are both producing more than that. So, they have come up over the last few years on the graphite electrode side. But, what we've seen of courses is, Indian steel coming up nicely, Russia, Latin America, China steel has all come up. So, demand for electrodes has come up nicely and absorbed any of the increases in capacity, so electrodes remain quite tight right now.

James Mikya - Private Investor

Great. Sounds great. Great job to you and your team.

Craig S. Shular - President & Chief Executive Officer

Thanks James, have a great day.

James Mikya - Private Investor

Thank you.

Operator

Next we will go to Gary Madya of Bank of New York.

Gary Madya - Bank of New York

Thanks guys. All my questions have been answered, thank you..

Craig S. Shular - President & Chief Executive Officer

Thanks Gary, have a great day.

Operator

We will move on to Scott Martini of Cobalt Capital.

Sam Martini - Cobalt Capital

Hi guys, it’s Sam.

Craig S. Shular - President & Chief Executive Officer

Hey Sam, how are you today?

Sam Martini - Cobalt Capital

I am good, Craig, thanks. Just a couple of questions. First following up on Mike's question on pricing, two questions. First, can you talk just qualitatively about where SGL… where we saw SGL in the market in terms of their pricing strategy relative to your own and the discount perhaps they were pricing at if any? Are we seeing more rational approach to their pricing strategy this year?

Craig S. Shular - President & Chief Executive Officer

Sam, all I can really comment on the competitors' actions is that net-net… and I can look at our own book is that pricing came up across the board in all geographies.

Sam Martini - Cobalt Capital

So, would you characterize this year as more rational than two years ago, continuing to move towards a more reasonable pricing strategy away from you?

Craig S. Shular - President & Chief Executive Officer

I can only comment on our book, but I would say our book came together very orderly and here we sit with what 90% plus booked and very pleased the way our book came together. I think we have a very solid book for '08.

Sam Martini - Cobalt Capital

Craig, just answer question on that topic. In terms of the premier melter electrode versus the more… the ladle applications, did you see any pricing? Did one of those categories have a more dramatic price increase than the other or is pricing kind of moving up equally in both segments?

Craig S. Shular - President & Chief Executive Officer

I can't give you a specific color on the two segments, perhaps other than to say that both went up. There are raw material pressures on both those segments and both segments have gone up year-over-year.

Sam Martini - Cobalt Capital

There's been a lot of materials inflation and you'd given some numbers in the past about the cost of Brownfield expansion on a per ton basis. Can you just roughly give what you think on a per 1000 ton Brownfield expansion? What capital cost would be at this point?

Craig S. Shular - President & Chief Executive Officer

Yes, Sam. What we see is roughly to have kind of a 30,000-ton plant, in that kind of range 30,000, 35,000-ton plant, you are probably going to need about $250 million of capital Brownfield.

Sam Martini - Cobalt Capital

Okay. And that would take what do you think, permitting up and running three years?

Craig S. Shular - President & Chief Executive Officer

At least two, I would say, and it could stretch into that 3rd year. You said Brownfield, but I kind of interpret you as Greenfield.

Sam Martini - Cobalt Capital

That's right, Greenfield.

Craig S. Shular - President & Chief Executive Officer

Yes, that's what I thought, I just wanted… you said Brown, but I think really meant Greenfield. So, Greenfield, about $250 million, you'll get about 30,000 tons, maybe you could get 35,000 if you are good. It will take couple of years and might even get into year three depending on permits and approvals, etcetera.

Sam Martini - Cobalt Capital

Right. I think we had Brownfield opportunities in the past, maybe a year, 18 months ago, say, 30,000 tons, maybe $50 million, is that still a good number?

Craig S. Shular - President & Chief Executive Officer

That is still a good number Sam, and we have that opportunity, which I think is a real asset inside our plant gates. I guess, lastly, just on your Greenfield example, the $250 million is the construction cost and then you've got working capital on top of that.

Sam Martini - Cobalt Capital

Right. If you were to say, the Brownfield opportunity, would that be Monterrey?

Craig S. Shular - President & Chief Executive Officer

We have some of that in all of our locations, Monterrey is one of them that has that opportunity. Where we finally do it I think will be driven by the market. Where do we think those electrodes are really needed, do we do it in Monterrey, do we do it in one of the other plants would probably be driven by market demand, where is that demand growing and where is that closest to our customer.

Sam Martini - Cobalt Capital

What do you think the electrode industry capacity is now? I know it is hard to note, I think it’s 1.2 million?

Craig S. Shular - President & Chief Executive Officer

Yes, it's around 1 million, maybe a bit over 1 million. I think people talk 1 million 1.1 million, 1.2 million. It's somewhere in that neighborhood.

Sam Martini - Cobalt Capital

If you can start working with this, you could spend $50 million and $1000 a ton to bring on 30,000 tons, you spend $50 million to make 30,000 it's pretty good.

Craig S. Shular - President & Chief Executive Officer

It is a huge opportunity and that's why we’ve kind of laid it out there over the last couple of years. So, our investors realize we have this and we have the capability to grow at a very efficient capital cost and obviously with the balance sheet we have today, we got the wherewithal to do it very easily.

Sam Martini - Cobalt Capital

Two clean up questions for Mark. Mark, obviously you could say... call it $80 million in 10.25% is left, is there something preventing us from just putting a revolver in place and calling the rest of this and getting LIBOR plus 150 debt that we could just have reasonable access to? Is the credit markets that bad for a sub one times levered company?

Mark Widmar - Chief Financial Officer

No, I mean, there is really no constraint from that standpoint other than we have been trying to be as efficient and prudent as possible with the time limits of taking those out and trying to use working capital leverage opportunities that we have, as well as cash flow generations, and that's been the primary focus. But, we could use the revolver, if we needed to, but I don’t think the revolver will… 2010 does have a life on it. What I want to do is, stay out of that with any material amounts because sooner or later we are going to have to do some refinancing on that.

Sam Martini - Cobalt Capital

Right but... could we replace the current... the current revolver is un-drawn?

Mark Widmar - Chief Financial Officer

Yes, it is.

Sam Martini - Cobalt Capital

Right. I mean, I'm assuming we could... would be wrong to assume that we’ve got a new revolver in place by the end of the year that's giving us pretty good flexibility reflecting our new credit status?

Mark Widmar - Chief Financial Officer

Yes, but, you have got to remember that Federal markets are pretty tough right now. Our spread that we have in our revolver is pretty competitive right now.

Sam Martini - Cobalt Capital

It is LIBOR plus 2.25?

Mark Widmar - Chief Financial Officer

We are at 150 right now.

Sam Martini - Cobalt Capital

150. And cash tax rate for '08 still decent 20%?

Mark Widmar - Chief Financial Officer

It should be right around that.

Mark Widmar - Chief Financial Officer

Thanks guys.

Mark Widmar - Chief Financial Officer

Thank you. Have a great day.

Operator

We'll next move on to [inaudible].

Unidentified Analyst

Gentleman, thank you for your time. I just wanted a little more color on two points you made earlier. One is on the margin guidance. Margins, it looks like they may have come down slightly sequentially. I just wanted to get a sense of in the improvement, how you see it playing out? If you can give us any additional color on one-time things that might cause it to do weaker or stronger in the short-term versus for the year?

Mark Widmar - Chief Financial Officer

I think if you look at the margin sequentially and again it's one of the things we did call out with the impact of the South Africa pension termination. Once you adjust for that I think the sequential margins are relatively in line.

Unidentified Analyst

Could you give your adjusted margins that you're referring to on the gross and operating level?

Mark Widmar - Chief Financial Officer

If you look at on the script, we called it out, on an adjusted basis, it’s 32%, so we reported 30%. If you look at the press release it actually is at 32%.

Unidentified Analyst

Okay. And on the operating line?

Mark Widmar - Chief Financial Officer

Op margin for the quarter was right around 23%, again, that would be op margin excluding the special items such as the pension termination and the other income and expense items that we normally exclude from our operating results.

Unidentified Analyst

Okay. So, when we look at your guidance for them both to be up in '08, is there any kind of way you can help us calibrate how much upside possibility there is or I guess we can back into it slightly from the operating income guidance, but on the gross margin, I'm just wondering how much... what's the potential there?

Mark Widmar - Chief Financial Officer

The best way to look at it is start from kind of the op margin, we have given you an indication of the op margin or op income before specials. We have given an indication around the volume and the revenue growth.

Unidentified Analyst

And that is around 25% at the high end of revenue guidance. Is that about right?

Mark Widmar - Chief Financial Officer

Yes, it should be in that range, yes.

Unidentified Analyst

Okay.

Mark Widmar - Chief Financial Officer

And then yes, Craig has already mentioned around our overhead structure. We are going to continue to be as efficient as possible there. So, I wouldn't expect any material change other than the kind of normal inflationary growth that we normally expect in our SG&A structure.

Unidentified Analyst

Okay. So, on the gross margin line, is there a long term… should we think of that as having the ability to continue to move up or how should we view that? It was a very good year this year obviously?

Craig S. Shular - President & Chief Executive Officer

Obviously, the goal is to grow that, the guidance is as we've put out there and our teams are under great track record on a number of these metrics and the target will be to continue to improve the quality of our business, the efficiency of our production facilities, and then stay very lean and low cost on the overhead cost.

Unidentified Analyst

That's helpful. Is there anyway you can sort of parse out pricing improvements driving margin from the operational improvements that you are talking about?

Craig S. Shular - President & Chief Executive Officer

That guidance, we don't give, it’s more detailed guidance than what we provide.

Unidentified Analyst

Okay and then on the seasonality that you spoke to. I am just curious the… and I know you are moving away from quarterly guidance, but if you could just help me understand the nuance in that, the Street is expecting revenue and earnings to be up slightly in March when historically they have been down. So, is there anything that is impacting the seasonality of the first quarter this year that would enable that?

Craig S. Shular - President & Chief Executive Officer

No, we would expect the kind of the seasonality impact between quarters that you have seen the last couple of years, it will probably look the same. Q2 is generally a little bit stronger. You are coming out of the winter months. You have got more construction and our customers have a larger demand. Q3 is a little bit slower usually because you’ve got European holiday period and a lot of our customers do turnarounds during that period. And then Q4 is usually a stronger quarter. So, the two stronger ones are usually Q2, Q4 and the two slower ones are Q1 and Q3. So that...

Unidentified Analyst

I am sorry, I am referring specifically to the fourth quarter to the first quarter here. So, from December to March, historically, I have seen that down and this year folks are looking forward to be up.

Craig S. Shular - President & Chief Executive Officer

Maybe one impact that is playing into that is, we have been getting a much more linearity in our operations across the quarters. So, the differentiation between a stronger Q2 and a stronger Q4 versus the other two slower quarters is much lower today. We are running our plants much more consistent. We’ve worked hard with our customers to get a better planning and a more consistent off-take and it's mainly to drive better cost and quality. So, we have less overhead, we can plan better, and so we are getting much more linear. If you went back a few years, you had a much bigger Q4 and then Q1 would slow down. I think year-over-year, if you went back to Q4 '06, I think we did about 58,000 tons and then you see of course this Q4 we did about 53,000 tons. So we don't have as much of a spike in Q4 or Q2 that we had historically. And it is allowing us to... it has been an effort we have undertaken, a very focused effort working with our customers to run our machine much more consistent linear sales, and like I said, it has reduced cost and improved quality.

Unidentified Analyst

Okay, so revenues historically been down about 10% from December to March. Last year, we are down only about 3% and this year there is an expectation out there that they are flattish that may be the result of the process you just discussed?

Craig S. Shular - President & Chief Executive Officer

That's right. That’s right.

Unidentified Analyst

Okay. Thank you so much and great quarter.

Craig S. Shular - President & Chief Executive Officer

Thank you, sir. I appreciate your comments.

Operator

We will next move on to Michael Christodolou with Inwood.

Craig S. Shular - President & Chief Executive Officer

Michael, how are you today?

Michael Christodolou - Inwood Capital

Hi, can you hear me?

Craig S. Shular - President & Chief Executive Officer

Yes, sir.

Michael Christodolou - Inwood Capital

Yes. Good morning. A couple of questions. Of the $285 million of inventory on the books at the end of the year, how much would you say is finished goods, may ship in the first half of '08? We'd all expect to see some gross margin [inaudible] due to lower cost inventory sold at higher prices over the 2008 book?

Mark Widmar - Chief Financial Officer

I'm not going to get into too much detail around the components of the inventory, you'll be able to see that when we file the K, so that information would be disclosed in there. But, clearly the same as we had last year, there is some positive carry-over effect. We do have an inventory position of raw material and finished goods at the end of the year that will be at 2007 needle coke cost. So, when we flow that into 2008, we will see some benefit. I would say that benefit, and the profile that between Q1 and Q2 should be similar to what we saw in 2007.

Michael Christodolou - Inwood Capital

Very good. In terms of cash used, you mentioned of course debt repurchase and growth, you did put that buyback in place a month or so ago, and I don't believe you had any activity on that. Would you call that a distant third [ph] or does it just depend on the timing of other opportunities to either repurchase debt or some of these growth initiatives?

Mark Widmar - Chief Financial Officer

It's obvious in the forefront of our thought process and we’ll continue to evaluate in line with the other opportunities that we have for cash. But, it's also out there partly to help us manage through the dilutive impact of options exercised. So, as we receive proceeds against the options exercised, we will be looking at those, utilizing some of those proceeds for the share repurchase program.

Craig S. Shular - President & Chief Executive Officer

Michael, does that answer all of your questions?

Mark Widmar - Chief Financial Officer

I think we lost him.

Operator

I think we may have actually lost him. We will move onto Robert LaGaipa of Oppenheimer.

Craig S. Shular - President & Chief Executive Officer

Perfect.

Robert LaGaipa - Oppenheimer & Co.

Thanks. I just have a couple of quick follow-up questions. I guess, number one, just with regard to the capacity expansions, I mean, obviously you've mentioned the ability to increase capacity by 30,000 or 40,000 tons at a minimal capital cost. You mentioned the Greenfield cost etcetera for any capacity expansion. I guess, my question is related to the ability to do that in light of the needle coke constraints. Obviously, needle coke is still in very tight supply. There's been some de-bottlenecking, but probably not as much as what was lost with that Lemont facility or maybe, at this point, it has a gotten at breakeven, but probably not more. Sitting here right here today, looking out over the course of the next year or so, is there enough needle coke available to even pursue the capacity expansions at this point?

Craig S. Shular - President & Chief Executive Officer

Bob, you're absolutely correct. Needle coke is tight. There is some coming via creek capacity. We've never struggled to get all the needle coke we need. I think the thing that's on our side and one of the advantages of been a large buyer… I believe one of the largest buyer in the world of the high quality needle coke is the leverage that brings. So, I think, if we look at adding some additional capacity when the market is ready for that, we will be able to get that coke. We're just a big buyer, we're a great partner with our suppliers and that gives you a lot of leverage. We've been with our suppliers for decades. So, I think, as you look out there, we'll be able to get the coke we need.

Robert LaGaipa - Oppenheimer & Co.

Terrific. I guess this is a related question, a follow-up to that. If you look at your mix, between melter versus the non-melter, the typical 70/30 that we've seen over the course of the last several years, what was that mix in 2007 and do you expect a similar mix in 2008? How does the needle coke or I don't know… it should effect that, but obviously you can mix different things in and so on and so forth and adjust the quantities, but has that mix changed at all? Do you expect it to change?

Craig S. Shular - President & Chief Executive Officer

No, Bob, that mix hasn't changed in any material fashion over the last few years or as we go forward here in to '08, we see that mix pretty much the same.

Robert LaGaipa - Oppenheimer & Co.

Terrific. Thanks again.

Craig S. Shular - President & Chief Executive Officer

Thanks Bob. Have a good day.

Operator

We will move to Justin Bergner of Gabelli & Co.

Justin Bergner - Gabelli & Co.

Good morning Craig. Good morning Mark.

Craig S. Shular - President & Chief Executive Officer

Good morning Justin. How are you today?

Justin Bergner - Gabelli & Co.

Good, thanks. When you talk about your forecast for EAF steel production growth of 2% to 3%, are you talking about the entire world or the subset of the world that you address?

Craig S. Shular - President & Chief Executive Officer

No, that's global. That's what we see globally, all geographies, we see it growing 2% to 3% and that's based on a number of sources that are out there, steel industry analyst and steel industry data-banks that are out there that do these kinds of things. Globally, I think most of them are in that range, 2% to 3%.

Justin Bergner - Gabelli & Co.

Do you see the number being lower, the same, or higher in Europe and North America?

Craig S. Shular - President & Chief Executive Officer

Where we see the biggest growth is kind of been in the classic BRIC countries. So, Eastern Europe, Russia, South America, Brazil, China, India, very good growth. A lot of good new furnace is going that we are prepared and currently servicing. Some of them are very good at doing the start-up to those furnaces and partnering with the customers. So, that's where we see the biggest growth. But, having said that, there are some new furnaces going in the US, there are some new ones going into Europe. But, the biggest growth would be primarily in those BRIC regions.

Justin Bergner - Gabelli & Co.

Okay. To follow-up on that question of market growth. What sort of trend are you seeing in terms of the, I guess, increase in the productivity of the electrodes in '07 versus '06? You typically filed a number in your 10-K in terms of how many electrodes are needed per ton of steel and the trend of overtime. What are you seeing for '07 now as you look back on the year?

Craig S. Shular - President & Chief Executive Officer

That improvement continues, that's an ongoing process and it continues usually to improve a little bit each year. What we have seen when you step back and look at the data is the rate of improvement is slowing. So, if you went back… 15 years ago the rate of improvement was much greater than what you've seen in the last a few years here. So the rate... the improvement continues, but the rate of year-over-year improvement has dropped of significantly and is relatively minor today.

Justin Bergner - Gabelli & Co.

When you say relatively minor, are you kind of talking 1% to 2% as opposed to 2% to 3%. Can you kind of...?

Craig S. Shular - President & Chief Executive Officer

Yes, in that kind of range. 1% to 2% is kind of the annual improvement we see. If I took you back 15 years ago, you might see 5% improvement in some years. So, it has really started to level off. What you get is, there's a theoretical limit that it can get to and it's just based on the chemistry of graphite. So, as we go forward, we’ll get closer and closer to that and that's where it's bumping up to now, it's somewhere at that theoretical limits. Each year as we go forward we're going to see that the continue would improve, but the rate has slowed down significantly.

Justin Bergner - Gabelli & Co.

Okay, thanks. Good quarter.

Craig S. Shular - President & Chief Executive Officer

Thanks very much.

Operator

We'll now move back to Michael Christodolou of Inwood Capital.

Michael Christodolou - Inwood Capital

Hi, just a few follow-ups. Your capacity is 215,000 tons. Earlier you mentioned de-bottlenecking was 30,000 to 40,000, but as the de-bottlenecking [inaudible] another 5,000 to 10,000 right now, and the Brownfield is another 25,000 to 30,000, if you ever pulled those plants out of our side drawer, am I looking at that right?

Craig S. Shular - President & Chief Executive Officer

No the... what we call de-bottlenecking is the 30,000 tons to 40,000 tons we get. These are in the existing graphite electrode facilities. They're very well delineated projects. We know what they are. So, that's the 30,000 to 40,000. Did we lose Michael again I had him click there?

Mark Widmar - Chief Financial Officer

I think we may have.

Craig S. Shular - President & Chief Executive Officer

We did.

Operator

We have. And that was the final question in the queue sir.

Craig S. Shular - President & Chief Executive Officer

Very good. Well, thank you very much for joining our call. And we look forward to talking to you next quarter. Have a great day.

Operator

That does conclude this conference call. Thank you all for joining us and have a wonderful day.

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Source: GrafTech International Ltd. Q4 2007 Earnings Call Transcript
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