GrafTech International Ltd (EAF) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the GrafTech fourth quarter earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded today, Thursday, March 9, 2006. I would now like to turn the conference over to Ms. Keya Epps, Manager of Investor Relations. Please go ahead, ma'am.

Thank you. Good morning and welcome to GrafTech International fourth quarter and year-end 2005 conference call. Presenting today is Craig Shular, GrafTech's Chief Executive Officer. If you did not receive a copy of the press release this morning, please contact [Soneta] Harper at area code 302-778-8218 and she will be happy to fax 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 of 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 information, you will find reconciliations in our press release which is also 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.

Thank you, Keya. Good morning, everyone and thank you for joining GrafTech's of conference call. Today we'll take you through the fourth quarter and our full-year '05 highlights and then we'll open it up to questions. In the fourth quarter '05, net income before special charges was 16 million or $0.15 per share as compared to net income of $0.11 per share in the fourth quarter '04. Net sales increased 7% to just under $250 million and gross profit came in at 68 million, representing a 21% improvement year-over-year. The improvements were mainly due to improved prices in our graphite electrode business and continued strong cost control. Graphite electrode average sales price increased 12% on a year-over-year basis and volume was just under 58,000 metric tons.

The fourth quarter EBITDA was 49 million, a 19% increase over the fourth quarter of 2004. We recorded a restructuring charge of 9 million related to our previously announced productivity and cost-savings programs, given the recent performance of and outlook for our carbon electrode product line we plan to exit this business over the next 12 months. We expect to record expenses of approximately 2 million in '06 and 3 million in 2007, related to the exit. The carbon electrode business 2005 sales were about $36 million with small negative earnings before interest and taxes. Q4 free cash flow before antitrust and restructuring payments improved $30 million year-over-year, to 16 million from a negative 14 million in the fourth quarter of 2004. We recorded $150 million noncash charge in the fourth quarter to increase GrafTech's allowance against its U .S.-deferred income tax assets. An increase to the valuation allowance was determined to be appropriate in accordance with the Statement of Financial Accounting Standard Number 109.

Valuation allowances are provided against deferred tax assets when it is considered more likely than not that the recorded deferred tax assets will not be utilized in future periods. GTIs current utilization profile and outlook when weighed against historical evidence has decreased the likelihood below the level of more likely than not that we would utilize the existing U.S. deferred tax assets.

Finally, let me reiterate, this is a noncash charge. This adjustment does not affect the Company's ability or intent to utilize the deferred tax assets with strategies to grow future profitability in the U.S. In fact, we have not lost any credits generated since 1999. In addition, this charge does not impact any existing financial covenants or any other provisions of GrafTech's existing credit agreements.

Next, turning to 2005 overall results. Sales were up 5% to just under $890 million, including ETM sales, growth of 58% to $19 million. Graphite electrode production costs increases were contained to 7% versus 2004. As I said earlier we had a very strong year on cost control and productivity initiatives. Gross profit increased 11% to $232 million, and EBITDA increased 8% to 159 million or 18% of sales before special items. Free cash flow before legacy payments increased 31 million, and net income was $0.43 per share before special charges. Our team also had continued success commercializing Advantage Technologies. For the third year in a row, we received the prestigious R&D 100 reward. The '05 award was for a new generation, large diameter, graphite electrode. GTI was also awarded the Frost and Sullivan 2005 award for excellence in technology. This award was for our electronic thermal management product line.

Finally, as some of you may know, a few law firms have issued press releases last week stating that a securities class action has been filed against us. The complaint is currently being reviewed by our counsel. Please note it is our policy not to comment on the substance of pending litigation. We do intend to vigorously defend against this case.

Now, turning to '06 outlook. We are targeting graphite electrode net sales growth of 15%. We have secured pricing on about 75% of our graphite electrode production costs and we anticipate graphite electrode cost increases in the range of 10 to 12% in 2005. Overhead, including selling, admin, and research and development is expected to be 1 or 2 million lower in '05 as compared to '04. And interest expense is expected to be about 58 million due to higher average interest rates and slightly higher average borrowings. Our effective GAAP book tax rate is expected to be between 37 and 40%. We expect '06 free cash flow before antitrust and restructuring payments to be about 10 million or a 38 million increase as compared to a cash use of 28 million in '05.

We expect Q1 '06 to be our weakest quarter of the year. In addition to Q1 being a historically slow quarter, as previously discussed, customers took all remaining tons available under there 2005 annual contracts in the '05 fourth quarter, and, therefore, enter '06 with high graphite electrode inventories. Accordingly, we expect graphite electrode sales volume for Q1 to be about 40,000 metric tons. Graphite electrode volumes is expected to recover in the second quarter of '06 resulting in graphite electrode sales volume for the first half of '06 to be very similar to the first half of '05. Full-year graphite electrode sales volume is expected to be between 210,000 and 215,000 metric tons for '06. With that, that concludes our prepared remarks and let's please open it up for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question is from Bruce Klein with Credit Suisse.

Hello, this is Tom Trine in for Bruce.

Hey Tom, how are you today?

I'm good. I have a question about the $10 million of free cash flow for '06. Can you give us a little color on what the sources of cash are on that number?

The source is primarily from operations.

Can you tell me is working capital expected to be a source or use in '06?

Working capital will probably be a use in '06, due to higher graphite electrode sales volumes and of course higher graphite electrode selling prices. So sales up and I would expect a use of working capital and that is factored into the 10 million.

Okay. And then for the antitrust payments, how much is remaining for 2006?

2006 is 21 million to be paid in -- over the course of 2006 and then in '07 is the last 5 million, Tom.

Okay.

And then we are all done.

One last question.

Yes, sir.

Is there any bank amortization that is occurring in '06, bank debt?

No, our amortization schedules are up to 2010 for the revolver, 2011 for the convertible, and 2012 for our senior notes, so they are quite a ways out.

All right, thank you very much.

Thank you, our next question is from Brett Levy with Jefferies & Company.

Hey, guys.

Hey, Brad, how are you doing?

Good morning. As you guys look out a little bit here, you've got rather expensive 10.25% notes. The fact that you don't have any amortizations has worked well for the Company in the last several years. As you guys look forward, does this company look like it's going to be able to handle some amortizations and in the context of that, what are your thoughts about taking that piece of paper out at early call dates?

Brett, as you rightfully note, we've got a call date, our call, coming up in February of '07 on those senior notes and of course it would be our strategy to look at every alternatives available to us to improve our amortization schedule, to lower interest expense. And so obviously we look at every opportunity in the market to improve that. I can't really give you guidance or play-out ahead what we will do when we get to that date, but I think it's just important to note that that date is coming up and it's our call option. And I think as you look at those notes, they're trading pretty much at the call price.

Got it. All right. And then can you guys talk about kind of what's going on in needle coke? Is there any potential new supply coming on? It sounds like it's a perpetual problem and I know you guys have secured what you need, but I just wanted to get a sense from you, as to kind of what's the long-term outlook or the capacity addition outlook as you guys see it in that raw material?

Brett, you're correct. It remains tight and we believe that we'll get increasingly more tight over the course of this year. We have secured all of our '06 requirements. Looking beyond that, what we see in the industry and what the industry manufacturers of needle coke communicate to us is they don't see any significant new sources coming on. What they would see is perhaps some debottlenecking of existing cokers but they really don't see any new cokers being built, these are very, very large capital projects, and only a handful of companies have the technology. What they've communicated to us is they don't see any new step changes in capacity coming, but obviously I would think all of them are going to try and get some additional creep capacity out. But when you add all that up, it remains tight. I think '07 is looking like it will be even tighter than '06 will run needle coke.

That leads to the next question; are you guys doing anything to secure supply in '07?

Absolutely. We've had a very strong effort on this front and we have a very good track record, of course, on this front. So we continue to work forward on our coke requirements and we've had, as I said, tremendous success on that front. So absolutely we've looked forward to '07 and even beyond that to ensure that we are well-positioned to get coke.

Last question -- in the '06 and potentially '07 and '08 agreements on needle coke is there any fixing of prices or is this all basically at spot market?

'07 would still be open, for, I believe, everybody in our industry on price. As I said, I would expect good pressure on coke price in '07. I think it's going to definitely be higher than '06. Because of the supply/demand equation.

The '06 agreement, is that fixed price?

'06 is all fixed price and all quantity secured. So we don't have any exposure there. Okay. Thanks very much guys.

Our next question is from Robert LaGaipa with CIBC World Markets.

How are you doing?

Good, yourself? I had a few questions for you. One, I wanted to get back to the volume anticipated for 2006. How much of the volume, I remember about a month ago, it was about 75%, how much is locked up as of right now?

Right now, Bob, it is north of 80%. And as always, that's a very normal place for us to be at this stage and as we move forward that would continue to grow. And then historically, we would generally get to about 95% or so would be in the book, and about 5% would come throughout the year. Spot and miscellaneous.

Right, when you look at the volume anticipated, when you gave the preliminary results last month, you looked for a 5 to 7% increase which would anticipate or imply 2.11 to 2.15. In the press release today you talked about 2.10 to 2.15. I was wondering if there's any change there, is the average pricing possibly a little bit better? Because you have the net sales store up 15%. What's happened over the last month that may be causing that thousand-ton difference?

Bob, absolutely no change. You're reading too much into it. No change. The only change is we have increased the amount in the book, as I said, it's now north of 80%. So no change in the outlook. That little thousand is just, you're looking too much into it.

Okay. And also, I just wanted to get a better sense from you, you're looking at 40,000 tons in the first quarter, obviously that's a 15% decline sequential from last quarter. I understand customers built up inventory, et cetera. When you look at this 39% increase to get you to flat volumes first half of '06 versus first half of '05, what's changing here from the first quarter to the second quarter? What are your customers telling you? Is it coming from Europe? Is it coming from the states? What's causing the sequential increase of that magnitude? When I look out over time historically, we've never seen a volume increase quarter-to-quarter of that magnitude. What gives you the confidence that you're going to get that volume increase in the second quarter?

Well, Bob, I don't think it's so much a change in their operating levels, it's, as we said, they've entered, I think across the board, into '06 with sizable graphite electrode inventories. So I would expect they'll use those up in Q1 and then they'll be right back in in Q2. That's what their production plans say to us. Lastly, I think the sentiment in the steel industry, and there's been a number of those come out over the last three weeks, and Mitel was maybe one of the most recent ones on their sentiment, I think as you can see when you add those up, I think the steel industry sentiment is that '06 will be a better year than '05, and that they will have an improving operating level.

Okay. Last few questions, if I could, Craig. One on the cost side. You mentioned that you continue to see cost pressures, obviously the needle coke's all locked up. The 70, 75% which implies 25 to 30% that's not locked up, can you just walk us through exactly what's not locked up, where there might be potential risk, either up or down?

Well, let me do it in a general fashion. But there would be some natural gas, there would be some miscellaneous raw materials like metallurgical coke. There would be perhaps some variation in electric power. So it's those type of items. But you're right, Bob, the big items we've secured well in advance of the year. That's been our strategy the last couple years. And I've got to say our team did a very good job in '05 managing costs. I think our original guidance was 10 to 12, and as you see, they brought it in under seven. We've got a number of productivity projects underway that we detailed in our last call and so I think our track record's been good in that area. So our guidance is that costs will be up 10 to 12% in '06. We feel comfortable with.

Sure, last question, if I could, Craig. I just wanted to circle back to a decision to cease the carbon electrode operations. I know you mentioned that you planned on exiting that by the end of the year it represents $36 million in sales, at least this past year, in 2005. Is there going to be any scale-down? I mean, what should we expect that $36 million? Should we expect it all to disappear all at once as we enter into 2007? Is it going to be just declining as 2006 progresses? What kind of time line do you have there?

Bob, it's winding down over the course of this year. And I would say by the end of this year, we will probably have no production at all, or the pipeline will be emptied out. And then carrying into '07 we may have some shipments and we will of course have the final collection of accounts receivables and pulling our working capital out of that business in early '07.

Okay. Terrific, thanks very much, Craig.

Thanks, Bob, have a good day.

Thank you. Our next question is from Ashis Kumar with Capital Consortium. Please go ahead with your question, Mr. Kumar.

Yes, hi, I have a couple of questions. The first one is, you have reported an average selling price of $2,846 in 2005. Can you share with us the average selling price for melted and nonmelted electrodes.

Kumar, we do not give that level of detail, and as we said in the last call, we are on a go-forward basis, not going to talk about individual price or price per ton for competitive reasons. And also, in our efforts to increase price.

Right. And I was looking at your 2005, the actual number that you reported and the guidance for 2006. And it seems that margins in the graphite electrode business will remain almost flat in 2006. Is that correct?

Kumar, I think that statement is pretty good, and it's probably applicable to the cost pressure and that 10 to 12% increase in cost.

That is different from what the other players seem to be reporting. A lot of other players globally seem to be reporting healthy growth in margins. So what's different for you?

Well, when you look at the two years, year-over-year our volume will be up in '06 versus '05, and price will be higher, and of course costs will be up. So I think you've got cost, double-digit cost increase 10 to 12% up, and you've got price struggling to mitigate the cost pressure.

Right. Well, thank you.

Thank you, Kumar.

Thank you. Our next question is from Michael Gambardella with JP Morgan.

Good morning, Craig.

Good morning, how are you today?

Looking back to last year's price negotiations and the outcome for the '05 calendar year, I mean, it looked like what happened was you raised the price at the end of -- in December, at the end of last year '04, and that caused you to lose market share to SGL. And your volumes went down and their volumes went up for '05. Now, it's kind of interesting that SGL is saying their volumes are going down in '06 and you're saying your volumes are going up in '06. Does that mean that you undercut the price with SGL in the marketplace in these negotiations?

No, Mike. I wouldn't see it that way at all. You saw our efforts on price. The way I would look at it is we make an outstanding electrode, tremendous service, our delivery's outstanding, our production facilities are right in the correct places for our steel customers. The footprint is excellent. So whatever was taken in '04 from GrafTech, you've got to realize I think we've got a global customer base that really wants to work with GrafTech. So I don't view it at all that we undercut price. In fact, that's not been our direction or initiative the last several years and we've been I think very clear on that.

I think what we got was what we got back, and I think a lot of people had concern, well with will this business come back to you. I think our commentary's always been, well, based on quality, service, delivery, technical service, that's what will bring business back. So I think all you have is ourselves at the prevailing market price and these customers naturally, we get our fair share of their business.

But I mean, didn't you lose market share last year because you tried to raise the price? I mean, customers didn't say, well, we have to have product from GrafTech because it's such superior quality. They went -- they left on price.

I agree with your observation in '04. I think there was, from the competitor side, there was absolutely a -- let's say a strong emphasis on volume in '04. And they took every opportunity they could to take that up. And in '05, we had a very similar portfolio on pricing, centrally-controlled firm, and some of that business came back to us. And some of that in Europe, as we said, it was priced at the prevailing market and we get our fair share back at that.

I don't know, I'm just trying to think about it and say to myself, if a customer is really ticked off at you for last year for raising the price after the contract negotiations, why would they give you the volume back, kind of voluntarily without some price, lower price to them as opposed to say SGL or some of the other guys? And then just going back to what the previous guy was asking you, it seems like a lot of the competitors are saying that their margins are going to be up for '06, not flat.

Well, on your first point, I think a lot of those customers came back to us for all the reasons we just articulated, but also I think a lot of the customer base, in looking at the supply of quality needle coke, et cetera, recognized that having a supplier like GrafTech in their book is important on a medium-long-term basis. I've got to tell you the customers that I've been with, that was a consideration. I mean, they want GrafTech in their book. They want to spread their orders around a bit because of the tightness that they see also in quality needle coke as we go forward.

So I would think, then, that would lead you to get a premium price over your competitors and a higher margin?

Well, that for sure has been the effort. But it's a very competitive marketplace, and as I've said in the past, I think our raw material stream into our industry faces significant increases, many of them are driven by oil and energy. As I've said, I think needle coke will be higher cost in '07 than '06 due to supply/demand in that industry. And so our efforts have been absolutely to try and get proper pricing to offset the -- those cost increases.

Okay. And then last question, just on the free cash flow kind of forecast for '06, the $10 million. So you're saying that that includes an increase in working capital requirements over 2005?

Yes, it does.

Okay. Because I had thought you were going to take down working capital because you had built it up with the excess needle coke and some other issues.

Working capital will be an increase in '06, and I'd say the majority of that is due to growth in AR.

Okay. All right. Thank you.

Mike, thanks very much, have a good day.

Thank you. Our next question is from Bob Schenosky with Jefferies & Company.

A couple things. Per Michael's question, then, in terms of the volume increase that you're going to see in '06 versus '05, is it fair to assume -- we don't need hard numbers here, but is it fair to assume that the increase in tonnage will be planted in favor of the small diameter versus the melter tonnage?

No, not necessarily. Looking at EAF steel production, we -- and I think the majority of the participants in the industry look that '05 EAF steel production will see a growth in '06. So '06 EAF steel production will be higher than '05. So some of it is just the steel guys are going to run better and bigger.

Then switching gears here for a minute on ETM. For most of the year you were talking about a revenue number of 20 million. You came in at 19. Is it anything that we need to be concerned about that you saw a small shortfall there?

No, I think that's a minor shortfall. We came in at 19, we expect 30. I think you've seen us over the course of last year talk about success in a number of new segments from cell phones to new-generation cell phones to LCD. So we've been pleased with that business so far. Obviously, technology there is moving quickly. The product life cycle in some of these segments is very short. So I wouldn't read anything into the 19 versus 20.

Okay. Now you've talked about a lot of major wins there including Dell. Within that 30 million, are there any major platforms that you can discuss?

Our practice so far, Bob, for competitive reasons is really not to delineate in great detail exactly the models and the platforms we're in. I think had we've tried to do is give you and the marketplace a flavor for the customer base, and as you said, Dell, HP, Samsung, Sony, they are big names. Our goal has been to get into them, get into the premier platform and then to migrate in some cases across their platform. A number of them may make flat screen TVs, but they're also in cell phones or they're also in LCDs. So we've targeted those large premier names, they've got very challenging thermal management issues, so they've been very good customers to us and they have been customers that have allowed us to build a reputation of providing solutions to the electronics industry.

What I'm trying to get to though is over the next two to three years is there a product line out there which could lead to exponential growth of this business that you have some visibility in at this point?

I wouldn't focus on one, but I would tell you obviously cell phones, plasma, LCD, ultra light laptops, all of those are very attractive segments. They're segments that we believe over the next five years-plus will see significant growth. We see the cell phone, the new-generation cell phone, the 3G generation coming out as having more thermal management issues than the phone of three years ago because the functionality has increased. So all four or five of those segments, Bob, we find very attractive. So I really wouldn't point to one and say, gee, that one's going to overwhelm it.

Can you give us any sense of margins in that business?

Well, the guidance we've set in the past, again, it's for competitive and customer reasons, but these are some of our best margins in our company. This is a technology sale, a solution sale.

So at the EBIT line you would be much higher in the ETM business than you are in anything else?

Percentage-wise you're talking?

Yes.

Yes, this would have our best percentages.

Okay. And one final one in terms of cash flows for '06. Can you give us a total number of cash outlays for restructuring?

Yes, I can. We talked a lot about those in our last conference call. And we've got 17 -- let's see, we've got 17 million in '06 and I think there's another two in '07, is the cash outlay.

Right, I'm sorry, can you delineate the 17 is what I'm after.

As far as which projects?

Yes.

In our last call, we didn't give that level of detail. High level, what I can tell you is we have nine projects underway. I think I gave color to the majority of those in the last call. We've not broken down by location or project which one is the cost, which one is the benefit. The high level we said we would spend about 19 million, 17 in '06, 2 million in '07, and we would generate reoccurring annual savings of about 20 to $22 million.

Okay. And can we anticipate more deal at the end of each quarter when those are reported?

I would look at it this way -- Heavy lifting in '06 so I wouldn't look for a lot of benefit in '06, get it done. So a small increase -- a small benefit in '06, maybe it's 4 million or so, but the majority of that benefit you're going to start to see in '07.

Thanks, Craig.

Thanks, Bob, have a good day.

Thank you. [OPERATOR INSTRUCTIONS] Our next question is from Richard Harmon with Roscoe Associates.

Craig, on the last conference call you mentioned that you were finding softness and difficulty in Europe. Checking with SGL, they found no softness and no difficulty in their business there. Why the difference?

Richard, what we had spoken to was we were not pleased with the actual price increase realization in Europe. And that was our dialog. I wouldn't look at it as overall softness, meaning gee, the market isn't good, the steel customers aren't running well. It was an actual graphite electrode price realization.

Well, SGL said they were having no softness is prices, experiencing no softness in prices.

Well, I hate to comment on a specific competitor, but I think from what I've seen in their release, their price realization in Europe was low also. And when compared to their other realization, it was one of their lowest realization in Europe versus, say, the Americas.

Thank you.

Thank you, Richard.

Thank you. Our next question is from Ashis Kumar with Capital Consortium.

Well, this is a follow-up question on my previous question, which is about the melter and nonmelter electrode selling prices. Do you have just some clarification on that. You've in the past, your average selling price is quite low. In terms that in 2006, it will be in the region of 3,000 to 3,100 per ton. In the past you've announced price increases and to the tune of 4,000 to $4,200 - per ton. And this will -- this is against the average that you hope to realize in 2006, which is 3,000 to $3,100. And well, even if you consider that the $4,000 pricing is for production that UHP grade, which is about 70% of your product mix, so is there something wrong from there? Am I missing something somewhere?

No, Kumar you're correct, mix is about 70/30%, 70% melter, 30% nonmelter. As we've discussed in the past, nonmelter is lower price segment. As far as price, the announced price versus the realized price, I think directionally you're correct there, that actual price realized was below the announced prices.

Right. Thank you.

Thank you, Kumar, have a good day.

Thank you. Our next question is from Daniel Pisnol , private investor.

Hello, Mr. Shular, I'm calling -- I have some question about the termination of a contract with CGI, the outsourcing contract that you announced on November the 21. What is the strategy of GrafTech in order to bring back all those accounting function in GrafTech and what would be the impact in the cost of that termination and -- of their contract?

Daniel, with CGI, we like a lot of companies, embarked on an effort of some outsourcing of accounting services, and it was entirely in an effort to try and reduce cost. And so we did that for a few years with CGI. And after having done that and then gotten experience with that, we decided to bring those accounting services back in-house ourselves. And after a lot of analysis we felt we could do it cheaper. And I won't get into all the details, but some of that is us leveraging up our facility and fine team in Mexico, and some of the transactional accounting work will be done in Mexico. Again, leveraging up the strength that we have, that large facility there, that's going to help on cost. And then as far as migrating that out of CGI, we have professionals working on that. Obviously, there's always risk when you migrate some accounting or systems. But we have professionals managing that risk. And that will all be completed here in the first quarter, and then we will be completely disengaged from CGI's accounting outsource business.

Okay. And because when you announced that contract three years ago, the economies were intent to upgrade your IT systems. So what -- is that IT system upgrading has been completed now?

Yes, the IT work with CGI continues. And that has gone better for us than the accounting outsourcing. So there's two pieces of business. The first piece of business was the accounting outsource we talked about earlier, we've brought that back in-house in Mexico, of course. The IT outsourcing that we do with CGI, we continue that. And CGI is one of the top five players in North America in IT. So IT's really their speciality. They have a very large IT outsourcing practice and a very successful IT outsourcing package. Accounting outsourcing I think is a much smaller business for them, a newer business. And so we will continue the IT outsourcing with them. And like I said, they're strong and large in that area.

Okay. Thanks a lot.

Thanks, Daniel.

Thank you.

Thank you. Mr.Shular, there are no further questions at this time. Please continue with any additional remarks you may have.

Thank you very much. Everyone, thank you for joining our call. We look forward to talking to you at the end of the next quarter. Have a good day.

Thank you. Ladies and gentlemen, this concludes the GrafTech fourth quarter earnings conference call. Thank you again for your participation today and you may now disconnect.