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GrafTech International Ltd. (NYSE:GTI)

Q1 FY08 Earnings Call

May 1, 2008, 11:00 AM ET

Executives

Kelly Powell - Manager, IR

Craig S. Shular - President and CEO

Mark Widmar - CFO

Analysts

Ian A. Zaffino - Oppenheimer & Co., Inc.

Brett Levy - Jefferies & Company, Inc.

Asad Abedi - Merrill Lynch

Frank Bisk - Pilot Advisors

Michael Gambardella - J. P. Morgan Securities, Inc.

Philip Gibbs - KeyBanc Capital Markets

Arieh Coll - Eaton Vance

Operator

Welcome to today's GrafTech International Q1 Earnings Conference Call. Today's conference is being recorded. Now at this time it's my pleasure to turn the conference over to Kelly Powell. Please go ahead.

Kelly Powell - Manager, Investor Relations

Thank you Dwain. Good morning and welcome to GrafTech International's first quarter conference call. On the call today is GrafTech 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 will 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 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 discussed any non-GAAP financial measures, you will find reconciliations in our press release which is posted on our website at www.graftech.com in the Investors Relations section.

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

Craig S. Shular - President and Chief Executive Officer

Thank you, Kelly. Good morning to everyone and thank you for joining GrafTech's conference call. Today we will take you through our first quarter highlights and then open it up to questions.

Net sales increased 27% to $290 million, gross profit increased 44% to $108 million, while gross margin improved over four full percentage points to 37.2%. Operating profit increased 66% to $83 million and operating income margin expanded more than 6 percentage points to 28.7%. EPS before special items nearly doubled to $0.53.

Net cash from operating activities improved $49 million to $67 million. We continue to de-lever our company and we completed the quarter with net debt at $313 million, nearly a 40% improvement over Q1 last year. Return on sales improved nearly 9 percentage points to 21.4% in the first quarter '08 versus 12.7% in the same period last year.

Finally, recapping overall Q1 performance, positive cash flow from sales to operating results was enabled by our team's continuous strive to achieve fair value for our products and relentless attention to cost. We continue to deliver against our stated goal of reducing debt and positioning the company for future growth.

As discussed in our last conference call and outlined in today's release, we have realigned the management of our business segments. This is done to better serve our customers in a low cost effective manner. This has resulted in two reporting segments, Industrial Materials and Engineered Solutions. Industrial Materials is designed to serve global steel and represents about 83% of our sales. And Engineered Solutions is a material science business, it's about 15% of our sales and this serves solar nuclear electronics and several energy-related markets.

In our Industrial Materials segment, net sales increased 27% to $248 million. Operating income for the segment was $75 million, an increase of 55% over the prior year. Operating income margin expanded more than five full percentage points to 30.1%. Our Industrial Materials segment benefited from a number of factors including higher selling prices, successful productivity initiatives, and the benefit of lower cost raw materials purchased last year and sold from inventory in the first quarter of this year. It is important to note that we experienced significant increases in petroleum-based raw material costs in 2008, which will be more fully reflected in Q2, Q3, and Q4 of this year.

In the Engineered Solutions segment, first quarter sales grew 24% to $42 million. Operating income for this segment was $8 million as compared to $2 million in Q1 last year. Operating income margin for this segment expanded over 15 full percentage points to 20.2%. This segment continues to gain traction as we penetrate fast growing markets, obtain higher pricing for tailored solutions and achieve productivity savings.

On the corporate front, selling, admin and research and development expenses were held flat year-over-year at $25 million. We continue to maintain a 10% plus reduction in overhead achieved last year. As a percentage of sales, overhead costs have now fallen from 10.8% in Q1 '07 to 8.6% in this quarter.

Interest expense was cut in half this quarter to $6 million versus Q1 last year as we continue to de-lever the company. Finally, we exited the quarter with our $215 million revolver virtually undrawn.

Turning to the outlook, we are encouraged by underlying demand for our products and based on input from our customers continue to anticipate a solid year for global EAF steel and the markets that drive our Engineered Solutions segment.

We expect '08 sales to increase 16% to 18%, up from our prior guidance of 12% to 14%. As a result, we target income before special items to improve 35% year-over-year to $310 million to $320 million and cash flow from operations to be approximately $180 million. While we did see a benefit in Q1 from a lower tax rate, we do not foresee this continuing throughout the year and we reiterate our prior guidance on the tax front of a rate of 27% to 29% for the full year.

This concludes our prepared remarks, and let's open it up for questions.

Question And Answer

Operator

[Operator Instructions]. Our first question will come from Ian Zaffino with Oppenheimer.

Ian A. Zaffino - Oppenheimer & Co., Inc.

Hi, good morning, very good quarter.

Craig S. Shular - President and Chief Executive Officer

Thanks, Ian. How are you today?

Ian A. Zaffino - Oppenheimer & Co., Inc.

Not too bad. Alright, just wanted to get in to your guidance a little bit, can you give us an idea of how much is driven by pricing, sales mix, currency, just if you could break that down, it will be helpful.

Craig S. Shular - President and Chief Executive Officer

Well, on the annual guidance, we don't break it down that way. In Q1 we've given some color that sales mix was about $0.03 impact in the quarter and then the favorable tax rate was about $0.05, but on a go forward, annual guidance we do not break it down by the components.

Ian A. Zaffino - Oppenheimer & Co., Inc.

Okay. I guess, let me try to get at it a different way here. If you look at your order book, how much of it is done for the year?

Craig S. Shular - President and Chief Executive Officer

The order book, Ian, is in very good shape for the year. I would say the majority of our electrode order book is built. We are running at a nice high op level in electrode business. And then on Engineered Solutions, that order book has been strong so far and I would say kind of the back half of the year is still being built, which is very normal in that business.

Ian A. Zaffino - Oppenheimer & Co., Inc.

Okay. And as you get into... when does the negotiation season start again for your electrode business?

Craig S. Shular - President and Chief Executive Officer

They will probably start up all kind of middle of the year, Q3.

Ian A. Zaffino - Oppenheimer & Co., Inc.

Okay. So you should start getting some data points from that coming in the next couple months or so?

Craig S. Shular - President and Chief Executive Officer

Yes, probably kind of June, July, August we will have a few customers start some dialog on '09 prices and volume requirements. But for '08, on the electrode side, we've got a strong book built, very pleased the way the book came together. Obviously we've had margin expansion on that book. So we've been able to get price increases beyond what we've faced in the raw material front and the volumes we've been pleased with.

Ian A. Zaffino - Oppenheimer & Co., Inc.

Okay, alright. And then just final question when are you going to start locking in the needle coke for '09 and the rest of your raw materials?

Craig S. Shular - President and Chief Executive Officer

I would say those discussions usually start end of Q2 and we will work very hard to get that locked up, of course, before we start any real negotiations with customers. So the goal will be to get that done kind of middle of the year, having that locked up, the price and the volume requirements of our key raw material. We would then begin entertaining orders for the '09 season.

Ian A. Zaffino - Oppenheimer & Co., Inc.

And it's a great business when you are able to lock in your raw material costs before you get pricing. Well, congratulations on a good quarter again.

Craig S. Shular - President and Chief Executive Officer

Ian, thank you sir.

Operator

Our next question is from Brett Levy with Jefferies & Company.

Brett Levy - Jefferies & Company, Inc.

Hey, congrats on an awesome quarter guys.

Craig S. Shular - President and Chief Executive Officer

Thanks, Brett. How are you today?

Brett Levy - Jefferies & Company, Inc.

Good. One question and I mean, this is more on the bond side, not that there is a ton of bonds outstanding anymore, but you do have the coverts as well. Have you guys talked to the rating agencies? I mean, for a B single the company that have 17 times interest coverage, seems to a bit miss-rated.

Craig S. Shular - President and Chief Executive Officer

Brett, we have had dialogs with the rating agencies and both agencies, of course, gave us on positive outlook. And you are absolutely spot on, the ratios and what not have improved dramatically and I would expect we will probably have some favorable movement from both of them on that front as we go forward.

Brett Levy - Jefferies & Company, Inc.

Alright. And then, I mean, it's a nice luxury to have, but in terms of what you do with the free cash flow here, can you talk a little bit about your priorities, are there internal growth opportunities, are you guys looking to be acquisitive to either backward or forward integrate, are you going to de-lever further, just talk a little about the some of the options and what your priorities are?

Craig S. Shular - President and Chief Executive Officer

Brett, as you've highlighted, we have done an awful lot of de-leveraging and the drive behind that has been to position our company for growth. So we have a number of internal growth opportunities. I think you see on the Engineered Solutions side we are starting to get some very nice traction in that business, year-over-year of 15% operating margin improvement, 15 full points. So there is some very nice growth opportunities there internally, likewise in electrodes.

But on the acquisition front, I mean, really we've got the luxury for the first time in many-many years to have business open on that front. So we are looking for great opportunities out there on the acquisition front that would allow us to grow our portfolio and we are looking at forward and back integration and putting everything on the table. We have that luxury now, obviously, with the balance sheet in the fine condition it is today.

Brett Levy - Jefferies & Company, Inc.

And this is a question, I think, I ask almost every quarter. Can you talk about any capacity additions you are seeing globally? Clearly based on the way the bidding has gone and your ability to get price increases through rolls [ph] very tight here, where do you see the potential new capacity threats or opportunities coming?

Craig S. Shular - President and Chief Executive Officer

Well, you right. Globally, Brett, electrodes are in very tight supply. I think all the producers are running at high op levels. And then as far as new capacity coming, we all are constrained by the availability of quality coke. And so coke additions are really not out there planned in the marketplace. These are major construction projects.

So a coke plant that was started today might take two, three years before it came on stream. So... as we look forward and given global steel continues to perform well, we see tight electrode market for a while existing. We just don't see the raw material available from needle coke side to support any real electrode manufacturing expansions.

Brett Levy - Jefferies & Company, Inc.

Alright. And, I guess, this is a follow-up on that, would you guys build the coke plant?

Craig S. Shular - President and Chief Executive Officer

Well, we will look at anything. There is some unique technologies there. And as I said earlier, really we're open for business on that front, all the heavy lifting that's been done the last two years has positioned us to grow the company and we are really not taking anything off the table on that front.

Brett Levy - Jefferies & Company, Inc.

Thanks very much.

Craig S. Shular - President and Chief Executive Officer

Thanks, Brett, have a great day.

Operator

Our next question is from Asad Abedi with Merrill Lynch.

Asad Abedi - Merrill Lynch

Good morning. Great quarter guys. Just three questions for you. You talked a little about your opportunities in electrodes. Could you expand a little there?

Craig S. Shular - President and Chief Executive Officer

Yes, Asad. On the electrode front, we have the capability internally to do some de-bottlenecking, which would free up capacity right now that, as we said earlier, is constrained by coke. But as more coke becomes available, as we get more efficient in our plants, we've got some excellent opportunities to increase our capacity at our plants for very low CapEx. And obviously the improvements to the cost structure and where our plants are, any volume that we increase in those facilities really helps the economics of those facilities. So on the electrode front, as more coke becomes available, we've got the ability to de-bottleneck very attractive cost and produce more electrodes.

Asad Abedi - Merrill Lynch

Okay, that's great. And you also talked about input cost increases, particularly on the needle coke side when you were talking about petroleum-based inputs.

Craig S. Shular - President and Chief Executive Officer

Yes, it's needle coke, it's pitch, and then it's several energy-related ones such as power and natural gas.

Asad Abedi - Merrill Lynch

Could you give us any kind of a feel for how much your input costs have increased by?

Craig S. Shular - President and Chief Executive Officer

It's one we don't guide to. We are big buyer of... and maybe the largest buyer of a lot of our raw materials. And so we have a nice purchasing leverage in a number of those raw materials and it's a guidance we don't give for competitive reasons.

Asad Abedi - Merrill Lynch

Okay. May be I can approach this from a different angle then. You managed something like 600 BPs of margin expansion year-on-year. Could you give us a feel of how much of that came from net pricing and how much from restructuring, for example?

Craig S. Shular - President and Chief Executive Officer

Well, obviously price played a part in that, but if we look at restructuring and you go back over the last several years, we've gone from 10 graphite electrode plants that were kind of small to five very large graphite electrode plants in the right locations, the right countries close to our customers. We've gone in total from 5500 people to 2550 people today. And so all of that's played into the cost structure and the competitiveness that we've built today. Overhead last year, we took another 11% out of overhead last year while growing sales 18%. That's playing into the numbers you see here today.

Asad Abedi - Merrill Lynch

That's very impressive. I mean, could you give us any kind of an idea how much pricing helped you, say, last year, year-on-year?

Craig S. Shular - President and Chief Executive Officer

Well, we won't give you a percentage. We don't guide to price, but obviously I think big picture, we have been able to get ahead of a lot of these significant raw material increases and get price up and then we've also been very aggressive on the cost front and that's operating cost, plant cost, it's overhead like the 11% we took out last year. And so we've just been relentless on the cost front at this company.

Asad Abedi - Merrill Lynch

Okay, that's great. Thanks for a very good job.

Craig S. Shular - President and Chief Executive Officer

Thanks, Asad. Have a good day.

Operator

Our next question is from Frank Bisk with Pilot Advisors.

Frank Bisk - Pilot Advisors

Hi, good morning guys, great quarter. Wanted to... could you just may be expand and talk a little bit more about Engineered Solutions and kind of exactly who you are selling to, solar seems like a really great opportunity over the few years, as well as the selling into the electronics market. Can maybe just spend a minute or two kind of talk about that, so we could hear about it?

Craig S. Shular - President and Chief Executive Officer

Yes, sure. Solar, a very attractive area, growing very rapidly, and we offer a number of unique tailored solutions into the solar industry. And we sell to most of the players there and many of the customers depending on their mode of technology, we have a different solution at each customer. And we would sell things such as insulation packages that are critical to their manufacturing process and we may have a unique material, in some case it's even patented that we've developed here in our lab and would be a critical to their manufacturing process. So, solar has been coming along very nicely, growing rapidly, and we have some tailored solutions in there.

In the electronics field, we sell to kind of the who's who in the laptop and cell phone arena. So virtually everyone in the cell phone arena or in the ultra-light laptop arena, we have sales into. So from Dell to Samsung et cetera, Motorola, Nokia, we would have sales into those, helping those companies manage their thermal issues in those very small, yet very powerful electronic devices.

Our nuclear is still very small, but we've had more nuclear activity and request in the last six months than probably the prior 10 years. As China and some other countries start to move down the nuclear energy path, we've had a number of requests for nuclear products, which we have a strong portfolio that are going into test plants, pilot plants as they start to get ready to really move forward on nuclear, and I'm not going to say nuclear is here today, this is out 5-10 years. But some countries have announced some very ambitious nuclear programs where a number of reactors are going to start to come on stream, kind of 2013, 2015 and some of those trails and pilot plants are under way today. So nuclear is starting to pick up for us.

Frank Bisk - Pilot Advisors

Okay. And then just on solar, could you just kind of explain who our competition would be? If you don't use graphite or the products we're making, what would they use and, I guess, can you talk about that a minute?

Craig S. Shular - President and Chief Executive Officer

Well, what we've seen in solar is that graphite and graphite-based products are the only type of material that can withstand the temperature and the chemical issues involved in the solar process. So we've developed a line of products that work very well in these very challenging environments. So, I would say generally outside of graphite solutions, there aren't too many other products or materials that can be cost effective and withstand those applications.

Frank Bisk - Pilot Advisors

Great, thanks a lot.

Craig S. Shular - President and Chief Executive Officer

Thanks, Frank, have a good day.

Operator

Our next question is from Denise Kong with Deephaven [ph].

Unidentified Analyst

Hi. Again a follow-up on Brett's question about debt and the balance sheet, now that the high yield bond is pretty much hardly anything left, the only thing that's left is a convertible note issue. Question is with the bonds being in the money, I wonder whether you see it in the capital structure, do you get them [ph] of equity or do you intend to equitize them and then so that you can move on to restructuring your balance sheet further?

Craig S. Shular - President and Chief Executive Officer

Good question, you are right. The 75 million in senior notes are either virtually gone, the 550 down to 75, we've done a great job of taking those out. On the convert, our convert will convert to equity at $20.73 and the terms of it are this that in any 20 days out of any prior 30 days, if we close at $20.73 or above, then it converts to equity and the convert has 13.6 million shares on it, which, as everyone knows, that's followed our company and our long-term shareholders, are fully calculated in our outstanding shares. So they sit in the 118 million or so shares, embedded in there is the 13.6 as if it's already converted.

So, you're right. If we trade above that, we meet the requirements, the convert, the 225 is going to go away, obviously there is only 75 on the senior notes and you see our guidance on cash flow. So literally, I mean, down the road at some stage, we could be debt-free and obviously that's not the right capital structure for us, but as I said earlier, what that's done for our company is to position us for growth.

Unidentified Analyst

Okay.

Craig S. Shular - President and Chief Executive Officer

And we're open for business on that front and we will look at a number of opportunities and if we can find the right opportunities to grow our company and prove the portfolio, we will seize those opportunities.

Unidentified Analyst

Okay. So sounds like you would take advantage of the so called provision for those and, I guess, also wait for any update from the rating agencies?

Craig S. Shular - President and Chief Executive Officer

Well, that's right and that... as I said, that will be married up against the opportunities we find on the acquisition front and on internal growth.

Unidentified Analyst

Okay. The other thing is that you didn't completely close the door on building your own coke plant, but just out of curiosity, how much would a project like that cost and how long would it take?

Craig S. Shular - President and Chief Executive Officer

Well, remember, building our own coke plant, there is... as I said, there's some unique technologies to that. So you one, you'd have to acquire some technology. I guess, our message is, I really, at this stage, after the turnaround of our company and getting positioned where we can consider all of these types of opportunities, I really at this stage don't want to close any off.

Unidentified Analyst

Okay.

Craig S. Shular - President and Chief Executive Officer

So when asked, Geez, you would you look in the area of coke? Absolutely, we really don't want to limit ourselves. We've worked several years to dig out of a tough turnaround and clean up our balance sheet and really all of those are great opportunities around our table right now.

Unidentified Analyst

Okay, well, thank you, congratulations.

Craig S. Shular - President and Chief Executive Officer

Thank you, ma'am. Have a great day.

Operator

Our next question then comes from Michael Gambardella with J. P. Morgan.

Michael Gambardella - J. P. Morgan Securities, Inc.

Hi, Craig, congratulations on another good quarter.

Craig S. Shular - President and Chief Executive Officer

Thanks, Mike.

Michael Gambardella - J. P. Morgan Securities, Inc.

I have got a question about the pricing structure for graphite electrodes in terms of the ability to change it, is there anything new on that? Because when you look at most of your customers in the steel industry, I mean these guys have seen their raw material costs go up, whether it's scrap and then the integrated guys on coke and iron ore. And they are slapping surcharges on their selling prices for these increased costs. Why couldn't you guys do away with this kind of ridiculous annual thing that you have and go to a more frequent, say, quarterly pricing and if you have a big increase in the raw material, I mean, the industry is fairly consolidated in terms of your business, put a surcharge on like your customers do to their customers?

Craig S. Shular - President and Chief Executive Officer

Well, Mike, that's a very interesting proposition and it's something we always have on our table. We attempted a surcharge a few years ago and really got very little traction following from the electrode market. So, it's something we look at. Unlike steel, steel started some surcharges and they had great traction in the steel market. I mean, a couple started and then pretty soon 20 followed on surcharges. The future will tell what really happens in the global graphite electrode market. I think it's early to tell. I think it's a good point. Our customers do it, but thus far that's not been executed or successful in the electrode market.

Michael Gambardella - J. P. Morgan Securities, Inc.

Andhave you seen any of your costs go up after signing your pricing agreements?

Craig S. Shular - President and Chief Executive Officer

No, after we signed... we signed fixed price. For instance, on coke, it's fixed for the year, that's...

Michael Gambardella - J. P. Morgan Securities, Inc.

No, I'm saying your selling prices on electrodes, after you sign you selling price agreements on electrodes and fix then the price of the year, have you seen other costs... I know you've locked in a majority of a needle coke before that, but have you seen other costs go up?

Craig S. Shular - President and Chief Executive Officer

Yes, we'll see some of the minor ones. I mean, we... last quarter, I think, we said we had a about 70% or so fixed. Obviously, at this stage of the year, it's probably 85% plus is fixed now of the remaining year, may be closer to 90. But, yes, we've seen some go up. For instance, some electricity and some natural gas has wandered up.

Now, we've built... we've anticipated that in our plan, of course, but to your point on a surcharge, yes, some of those have gone up and I think in the steel industry, they would have surcharged that very quickly. Thus far, that's not been successfully executed in the electrode industry, but it's a very good point you bring. Our customers are doing it and some of those costs do creep up that we are not able to fix for full 12 months.

Michael Gambardella - J. P. Morgan Securities, Inc.

I mean, yes, because... I mean, you guys must have... graphite electrodes must be one of the smallest price increases that the steel companies are sealing in terms of their raw materials.

Craig S. Shular - President and Chief Executive Officer

We agree. We are a small portion of their cost structure, 2% or less, and they have seen some huge increases on scrap, iron ore et cetera and I think it's upside for us. I really think it's upside and electrodes are very-very tight. So I think we are just speaking about is spot on and is all upside.

Michael Gambardella - J. P. Morgan Securities, Inc.

But in term of this pricing structure that you have where you start negotiating in the summer for the upcoming calendar year, it seems like in this year you really missed out quite a bit because the dynamics of the market were such that you probably couldn't even have thought about going for like 80% increase or more and now you see the steel guys getting hit with scrap up almost 100%, iron ore up, iron ore pellets up 87% or more, even in Australia and then coal up 200%. And your price increases kind of dwarf those numbers because the structure of the industry's pricing is to start these things so early in the year; it seems kind of crazy to continue that pricing structure.

Craig S. Shular - President and Chief Executive Officer

Yes, it's a... I can't disagree with you, Mike. It's been a 30-40-year thing in this industry where they have done annual prices. And so I think you raised some very valid points. What we've tried to do for this year, obviously, is fix what we can well ahead of time, like the needle coke example, and then build in also some anticipated increases, but would we like the luxury to go at it again here in Q2, Q3, Q4 like the steel guys too? Sure would.

On the spot front, the spot is going up. So what we put into the book here since our last call, prices are going up in graphite electrodes. So we have gotten on the spot front, which is a small component, but the point you raised are very valid. If we had the ability to more frequently price, we'd probably be at a higher price today.

Michael Gambardella - J. P. Morgan Securities, Inc.

And what's the one thing that's holding you back? Is it... I mean, it can't just be tradition.

Craig S. Shular - President and Chief Executive Officer

Well, not. It's not tradition. I think it's a global marketplace. There is many, many competitors, it's very competitive in our marketplace. We looked and attempted a surcharge a few years ago, no one else followed unlike the steel industry and so it's not tradition, it's really are the other producers feeling sharp increases in costs and under pressure. I think it's those types of things that might change the global industry, it's a very competitive market.

Michael Gambardella - J. P. Morgan Securities, Inc.

It's just... I just have trouble dealing with this, it's a very competitive market, yet the industry is fairly consolidated and we are running at capacity.

Craig S. Shular - President and Chief Executive Officer

Yes, I think your point is well taken, as I said. And time will tell if down the road this form of annual contracts can be changed.

Michael Gambardella - J. P. Morgan Securities, Inc.

Alright, thanks a lot, Craig.

Craig S. Shular - President and Chief Executive Officer

Thanks, Mike. Have a good day.

Michael Gambardella - J. P. Morgan Securities, Inc.

You too.

Operator

Our next question will come from Mark Parr with KeyBanc Capital Management.

Philip Gibbs - KeyBanc Capital Markets

Hi, this is Phil Gibbs for Mark. How are you?

Craig S. Shular - President and Chief Executive Officer

Hey, Phil, how are you today?

Philip Gibbs - KeyBanc Capital Markets

Doing well. Can you quantify the effect of the lower price needle coke inventory flowing through the system on margins? I know it had a similar phenomenon at the beginning of last year. I just kind of wanted to know what the sequential impact was on that?

Craig S. Shular - President and Chief Executive Officer

Absolutely, let me toss it over to Mark.

Mark Widmar - Chief Financial Officer

Yes, hi, Phil. I think the best way to look at it, clearly we did get a benefit in Q1. We've highlighted that in our results and it's an items which we would anticipate to see a sequential impact as we move forward. And easiest way to probably think about it, Phil, is as we move in to Q2, you're probably going to see about a penny impact sequentially as that higher cost raw material flows in and then we'll see a little bit more of that flowing into the second half of the year as well.

Philip Gibbs - KeyBanc Capital Markets

Okay, great. I also had a question on kind of spot opportunities this year. I know historically that you've tracked anywhere from 0% to 5% spot sales, what are you looking for this year?

Craig S. Shular - President and Chief Executive Officer

Well, as we said a little bit earlier Phil, we've pretty much filled up the book, prices have come up. So the spot prices have been running up. As we said, I think the global market is tight on the supply-demand front for electrodes. And so I'd say that 5% or so that you talked about, we've been able to fill up the book very nicely. We're pleased with the volumes in the book.

Philip Gibbs - KeyBanc Capital Markets

Okay. And then just last question, this has to do with the Engineered Solutions segment. I was just kind of trying to back in to an Advanced Graphite Materials number to take a look at the growth on a year-over-year basis and unless you had a huge pick up in natural... your contribution from natural graphite, it looks like your top line was up close to 25% in that business. So, year-over-year what's really changed, what's at the core of that? I know you spoke to solar and some other opportunities, what's just apples-to-apples in the quarter?

Craig S. Shular - President and Chief Executive Officer

It's... you're absolutely right. We've gained some traction there on the sales side, and then obviously the operating income has jumped dramatically. But it's solar, it's nice growth in solar, it's some energy-related fields. We have some products that go into the oil drilling area and that is picked up nicely. We've got some products that go into transportation in the rail business, and of curse the rail business in China and a number of countries has been expanded. And so it's a number of attractive markets that have been growing nicely. Nuclear started to add a bit for us and I think some markets that, as we look forward, we're going to look to expand and get some future growth on. I think solar has a very nice future. We've got some unique products. I think some of the energy-related fields and alternative energies have some nice future. Some of them will be medium to long term, but these are unique products, good margins, unique technology, and we'll continue to work to grow those.

Philip Gibbs - KeyBanc Capital Markets

Great. And how are you looking at growth in your refractory business? Is that something that kind of grows with production growth? Is that something that gets a better run rate than, let's say, global steel production growth?

Craig S. Shular - President and Chief Executive Officer

Well, refractory, we have a unique technology here, different than anyone else in the marketplace, and the section of the blast furnace, which is the lower section that we take care of, is the most difficult challenging area of the blast furnace, temperature corrosion et cetera. We have a unique technology, a proprietary technology and we make blocks and bricks for that, that have a long life, that allow our customers to have great productivity. And we're running at very, very high op levels there. A lot of it's driven by some of the integrated facilities being put into China and the relining of existing facilities in China. So we've got a great product there, good growth, good return on our product, great margins. And so I think you'll see that continue to grow as steel grows in China, and these are consumable and as these furnaces that are already out there in production come up and need reline.

Philip Gibbs - KeyBanc Capital Markets

I appreciate the insight, great quarter.

Craig S. Shular - President and Chief Executive Officer

Phil, thanks so much, have a great day.

Philip Gibbs - KeyBanc Capital Markets

Thank you.

Operator

[Operator Instructions]. We'll next go to Sam Martini [ph] with Cobalt Capital.

Unidentified Analyst

Hi, guys, how are you?

Craig S. Shular - President and Chief Executive Officer

Hi, Sam. We're great, how are you today?

Unidentified Analyst

Good, thanks. Just a follow-up on Mike's question. In terms of the industry capacity utilization right now, it's always something that's hard to get your arms around and specific consumption changes every year. But, I mean, just back to annual pricing, it seems that you did move to something may be more quarterly or shorter term, you would have a better sense of tightness in the industry and I am curious if you agree with that and if you do or don't, I'd love your thoughts on current industry tightness, how you are feeling. I mean, to Mike's point, these products couldn't be more essential to minimal production and from everything that we can discern, they are tight. I am curious if you could speak to relative tightness, and if you think that you would be more in tune with tightness in the industry, if you did do something that was perhaps more quarterly or real time? Thanks guys.

Craig S. Shular - President and Chief Executive Officer

Well, Sam, I'd say the electrode producers from your vantage point around the world are running at virtual capacity. Things are very tight in electrodes, demand has been very solid. And I agree with you. If you went to more frequent pricing, we would get more data points throughout the course of the year on tightness and demand. And so more frequent pricing, don't get me wrong, we are a proponent of that. We tried a few years ago to go surcharge and more frequent and we were not as successful at that time.

Unidentified Analyst

And you are still paying the price for that customer from what we here?

Craig S. Shular - President and Chief Executive Officer

Well, unlike steel, I think steel has a great job there and they've moved to very frequent pricing and even surcharges, and like I said, time will tell where the electrode industry comes out. I think everyone is feeling very sharp cost increases in the electrode business, the petroleum, needle coke, the power requirements et cetera.

Unidentified Analyst

Craig, I am not advocating, I am not advocating gouging your customers far from it. I mean, you guys always get great remarks on... from your customers on how hard you work to be a good partner with them. The only thing I am curious about is potentially protecting yourself down the road as well as getting a fair price for your material, which is, as we all know, very hard to bring on and ostensibly in pretty short supply. I guess, it would seem to Mike's point that there wouldn't be anything stopping you, may be a couple of years ago things weren't this tight and that was the big problem and today things are different. I am just drawing it out there because it just seems like, it seems like no one really loses and you get a better sense. Frankly from a budgeting perspective you would have a better sense of making more informed capital allocation decisions if you had your real finger on the kind of the real-time pulse of the supply-demand to the market. May be it was just mistimed a few years ago.

Craig S. Shular - President and Chief Executive Officer

Right, well, Sam your points well taken.

Unidentified Analyst

Thank you. Nice quarter guys.

Craig S. Shular - President and Chief Executive Officer

Thank you, sir. Have a good day.

Operator

And the last question in the queue is from Arieh Coll with Eaton Vance.

Arieh Coll - Eaton Vance

Good afternoon folks. Quick question about the currencies that you are selling your graphite electrodes in, can you just explain when you negotiate the terms for your contracts, what portion of it is done in U.S dollars versus the local currencies, the steel or other customers might be operating in their countries?

Craig S. Shular - President and Chief Executive Officer

Yes, so let me toss it over to Mark.

Mark Widmar - Chief Financial Officer

Yes, I guess, I don't want to get into too much details specifically around how we negotiate around currency with each of our customers because obviously that does vary to some extent. But what I would say is largely we are selling into with two currencies functionally, the U.S dollar and euro for the most part. We do some in other currencies, but our exposure is largely to the euro, and we try to hold that position and align that to where our cost structure is in same currency and where we can trade a natural hedge, but that's typically how we negotiate.

Arieh Coll - Eaton Vance

So, just proportionally, can you just give us a sense what portion of your functional revenues on euros versus dollars?

Mark Widmar - Chief Financial Officer

Yes, I really wouldn't... prefer not to get into that level of detail, but what I can tell you is that from a currency exposure standpoint, if you are trying to get it from that perspective, we are along the euro, no doubt.

Unidentified Analyst

Okay. And because you have a fine currency benefit in the first quarter that just would suggest that clearly you have a material amount of revenue being realized in euros. So the prices might have been fixed, but as you translate them into dollars for reporting purposes, you are seeing the currency benefit today?

Mark Widmar - Chief Financial Officer

Yes, I mean, we highlighted in terms of the impact to revenue line. We had about a 5% favorable impact of the currency year-on-year. But as you look at that flowing through to the bottom line, the end of the impact was to the operating income was essentially zero. And you will be able see more of that as you look at the Q, which we will be releasing today. It will give you more view of the currency impact on both revenue and cost. So we did see positive impact on the top line, but really no impact on the bottom line.

Unidentified Analyst

And just stating the obvious, that's because the cost structure is set up that you have, I guess, a similar amount of cost in euro as well?

Mark Widmar - Chief Financial Officer

We have other currency exposure as well like through the Brazil reais, and if you look at the Brazil reais over the last quarter or so, that has strengthened as well. So you have to look at it in total, that's why it's kind of complicated to get into the individual currency.

Unidentified Analyst

Understand, okay. One last thing, your graphite electrode manufacturing facilities, you have in Mexico, Spain, and where else?

Mark Widmar - Chief Financial Officer

We have Mexico, Spain, France, South Africa, and Brazil.

Unidentified Analyst

And what portion of the capacity is in South Africa... excuse me, in Brazil.

Mark Widmar - Chief Financial Officer

I'd rather not get into that level of detail.

Unidentified Analyst

Okay. That the five big plants in those five countries?

Mark Widmar - Chief Financial Officer

Right.

Unidentified Analyst

Great, thank you.

Operator

And with that, there are no further questions in the queue. I would like turn the call to Craig Shuler for any additional or closing comments.

Craig S. Shular - President and Chief Executive Officer

Dwain, thank you very much. Ladies and gents, thanks for join our call and look forward talking to you next quarter. Have a great day.

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