GrafTech International Ltd (EAF) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to today's GrafTech International Q4 earnings conference call. Please be aware that today's call is being recorded. At this time I would like to turn the call over to Kelly Powell for opening remarks and introductions. Please go ahead, ma'am.

Thank you, Sarah. Good morning and welcome to GrafTech International's fourth-quarter and 2006 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 Radeke] at 216-676-2281 and she will be happy to fax or e-mail a copy to you.

As a reminder, some of the materials discussed during this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Please note the cautionary language about our forward-looking statements contained in our press release; that same language applies to this call. Also to the extent that we discuss any non-GAAP financial measures you will find reconciliations in our press release which is posted on our website at www.GrafTech.com in the Investor Relations section. At this I'd like to turn the call over to Craig.

Thank you, Kelly. Good morning, everyone, and thank you for joining GrafTech's conference call. Today we'll take you through our fourth-quarter and full-year '06 highlights and then open it up to questions. In 2006 net income from continuing operations before specials increased 18% to $59 million or $0.57 per share as compared to $50 million or $0.48 per share in 2005. Net sales increased 11% to $855 million and gross profit improved 14% to $249 million.

Graphite electrode sales volume was up 5% to 211,000 metric tons and graphite electrode production cost increases were contained to 7% for the second consecutive year. Our team has done an excellent job on this front, productivity initiatives, headcount reductions and have offset some pretty significant increases on the raw material site.

Free cash flow before antitrust and restructuring payments was a source of $69 million, better than our prior guidance of $50 million to $60 million, representing almost a $100 million improvement over 2005. Net debt was reduced $180 million to $509 million; this is virtually the lowest net debt in our company's history.

In recognition of our expertise in fuel cells the U.S. Department of Energy awarded GrafTech a two-year grant of $1.6 million to advance fuel cell product development and commercialization. This is our company's first grant from the federal government, so a very nice achievement by our team. We also received a three-year research grant of $3.9 million from the state of Ohio to support our development of electronic thermal management solutions, an area in which we've had success commercializing a number of new products.

Looking at the fourth quarter '06, net sales were up 9% to $235 million; gross profit increased 13% to $71 million; income before special items was $22 million or $0.21 per share. Free cash flow before antitrust and restructuring payments was a source of $40 million, a $26 million improvement over the fourth quarter '05.

In our synthetic segment graphite electrode sales volume was 58,000 metric tons and gross profit for the segment was $69 million, a 17% increase year-over-year. In our other segment fourth-quarter sales were $18 million as compared to $25 million in the same period the prior year; gross profit was $2 million as compared to $4 million in the 2005 fourth quarter.

As previously discussed, our ETM productline has performed below our expectations this year primarily as a result of lower sales to the plasma display panel end market. This plasma display panel market has experienced an increasing competitive atmosphere as they faced competition from LCD in the flat panel market. So we have felt some of that in the volume. We and they have also been under pricing pressure, so this performed below expectations and we will continue to work on this area developing new products and growing our sales. The results of the other segment also include our carbon electrode operation from which we are in the process of exiting. We should complete that process by the end of 2007.

Before moving to outlook, I'd like to comment briefly on our reporting segments as we go forward. As a result of the cathode sale in December '06 we have reexamined and redefined our segments to best represent continuing operations. The full-year '06 results presented in the 10-K and future periods will present the business in three operating segments -- graphite electrodes, advanced graphite materials and other. The other segment will consist of our advanced energy technology, AET sub, our refractory line of business and, for a short time, the remaining carbon electrode operation as we wind that down over the course of '07.

Lastly, as a result of the complexities of the successfully completed year-end cathode sale and related divestiture accounting, we plan to file a 15-day extension notification with the SEC related to the 2006 annual 10-K. We expect to file the 10-K on or before March 16th. You will recall that companies our size for the first time this year had their reporting period shortened by 15 days, so we're going to ask for the same 15 days we had last year to finish up the complex accounting around this very normal process for us.

Turning to outlook, we enter '07 with our best balance sheet in years. In January '07 we made our final DOJ antitrust payment of $5.3 million. We have now resolved this large legacy item that has burdened our company over the past nine years. From this point forward the cash flow we generate will be utilized to grow our company, improve our competitiveness and better serve our customers with the goal of creating long-term value for our shareholders.

Also, on February 15th we retired $120 million of our most expensive debt, our 10.25% senior notes, resulting in an improvement in our leverage ratio and our overall financial position. As part of our ongoing effort to improve capital structure we have recently announced a second call of our senior notes for an additional $15 million. These will be retired in March of this year. This represents a total reduction of $135 million of our senior notes' most expensive debt and, as a result, we expect interest expense to be $40 million to $45 million for 2007.

On the market side we are encouraged by underlying demand for our products. We anticipate another solid year for global EAF steel. We anticipate EAF steel growth of about 2 to 3% and we also expect continuing good operating rates for steel. We've secured firm pricing on 70 to 75% of our key raw materials related to graphite electrode production including 100% of our needle coke requirements in order to reduce volatility in our cost structure. We expect margin percentage expansion as a result of higher price realization for our products and previously identified and successfully executed productivity initiatives.

We have built a solid order book for 2007; we're very pleased the way it's come together. Our order book is approximately 95% firm and we expect a solid 2007 year with graphite electrode volume of 205,000 metric tons for the full year and 48,000 metric tons in Q1. We are targeting income before special items to grow at approximately 25% year-over-year from $135 million in '06 to a range of $165 million to $175 million in 2007. Finally, we expect cash from continuing operations to improve approximately 25% from $64 million in '06 to a range of $80 million to $90 million in 2007. With that, Sarah, let's open it up for questions.

(OPERATOR INSTRUCTIONS). Bruce Klein, Credit Suisse.

Good morning. Could you just help us on -- how did it work out with regard to the coke cost and pricing in terms of what it's going to be priced kind of '07 versus '06 either in dollar or percent terms? Can you possibly give us a ballpark of what that might look like?

I won't give you a percent -- that is a competitive item of course on how much it went up -- but I can tell you we had a very sizable increase in needle coke and our other petroleum related raw materials. So it was a large increase, as we anticipated, and I think as we've talked for the last couple quarters that we've anticipated would be coming just based on the market price for oil.

Is there a supply issue or you're comfortable on the supply?

We are comfortable on the supply front. We have secured our supply for '07 and we have fixed the price and terms.

Is that market getting better or worse or --?

There's been virtually no improvement, it has remained very tight. The exit of the Lemont coker, as we've talked over the last several quarters, has tightened that market up and very little new capacity has come on. It's been mainly a creep capacity people have been getting, so the coke market for quality needle coke remains quite tight.

Okay. And then just the other on the -- if you can give us some more color on how the negotiations went for GE contract pricing in the U.S., Europe and Asia? How did that process go and I guess the prices obviously are below -- certainly below spot, but is it kind of where you thought it was going to be? How competitive was it out there?

We're pleased, very pleased in fact the way the book has come together. We're very pleased with the names and accounts in our book, so that was a very orderly process. Obviously the marketplace determines price and, as you can see from our guidance, price has come in at a level that will allow margin expansion. Currently the spot price is about $59.50. Obviously the contract price came in below that and, as you know, we do not give specific price guidance, but on an overall basis we're pleased the way the book came together.

Was Europe -- you cut out on my phone for some reason -- but Europe remains more competitive than the U.S.?

No, I'd say globally -- prices came up globally. And Europe also came up -- and globally every market went up. We've talked about in prior years Europe lagged. This year we didn't see that. Europe came up quite nicely.

I'll get back in queue. Thank you.

Scott Levy, Jefferies & Co.

It's Brett Levy. A couple of quick questions. First up, you gave volume for the first quarter. I know that historically it's been a little bit of a lighter quarter. Can you give a little bit of a sense in terms of operating income or any other useful either working capital or other guidance in terms of the spacing and the seasonality that you expect for 2007?

48,000 for Q1. It's a bit better than last year. Remember, last year we had some inventory overhang and the steel industry was in a different position. But in general Q1 is one of our lighter quarters; Q2 is a stronger quarter; Q3 a little bit lighter because of European shutdowns; and then Q4 is usually another strong quarter. So historically that's the way we've looked.

And you think it will progress that way this year?

Yes, usually the pattern looks like that. Q1 is a little soft; Q2 is strong; Q3 European slowdown; and then Q4 back to another strong quarter. So it's probably going to play out that way.

I think I ask you this every other conference call, but last we checked in there was some new capacity globally coming from India. Can you talk about whatever you are hearing in terms of debottlenecking or additional capacity that you're seeing coming on globally? And also if there perchance happens to be anything that's getting closed down recently?

Well, on the new front, from what we understand from the marketplace, the Indian capacity has come online and obviously that's been absorbed I would imagine over this bid season, so it's in the book building process already. Most of the markets have already bid. As I said, our book is 95% firm. So on the new front I think it's already been done and absorbed. On the closure front, we continue to see at the low end of the market exit in some of the small producers around the world, especially China. These are not typically direct competitors of ours, but we continue to see some of those small shops struggle, go out of business or get consolidated.

And last question and I'll get back in the queue. In terms of your CapEx and anything going forward, are there any strategic projects to either enhance quality or volume in any of your plans in your CapEx budget and how much would that cost?

In the $50 million guidance we've given, Brett, there's a number of productivity initiatives, there's a number of quality initiatives. We continue to improve the quality of our product. Our analysis would say that last year was the best quality product we've sold to date. We'll continue to grow that. As far as capacity, we really have very little increase in capacity. We're not spending any significant money to increase capacity. We do get more productive all the time and so we do get more out of the existing machine, but right now we don't have any significant monies to increase capacity.

All right, thanks very much, guys. Good quarter.

Robert Lagaipa, CIBC World Markets.

Good morning. I had a few questions. One, I wanted to talk a bit more about the volumes that are forecast for 2007 and get your sense of what dynamics are going on behind the scenes to get to those volumes. What I'm getting to with this, Craig, is if we think about the 48,000 tons expected in the first quarter, that's up roughly about 6,000 tons from last year, which you had noted earlier. If we think about the 205,000 minus the 48,000, that would imply roughly 52,000 tons on average for the rest of the year.

Now I recognize the fact that you do have some volatility, especially in the third quarter with Europe. But I guess my question is the fact that that's lower year-over-year for second, third and fourth quarter where you're getting this bump year-over-year in the first quarter, can you just talk about what's causing that?

I don't know necessarily that Q2, Q3, Q4 you should look at being lower year-over-year. I think it's more the dynamics that when you're comparing to last year we had a very low Q1 and there were some market dynamics you'll recall that drove that. So I think the pipeline got very little feed in Q1 of last year and I think a lot of the other producers also, their Q1 was quite low. And so here 48 I think we're going to have a good first quarter and I don't look -- I don't think you should read into anything that that means Q2, Q3 is lower or off. I think it's more driven that last year we started out very, very low in Q1.

So you're saying that it was just made up the rest of the year last year where that's not going to be the case this year?

Well, I think the pipeline wasn't filled up the way it was last year with almost nothing, very little volume going into Q1. Here you've got more of a steady draw I think; it's a more normal draw. And I think when I look at some of the inventories, graphite electrodes around the world; it's a more steady draw that represents their utilization.

Okay. The second question is just with regards to mix, both within the products in graphite electrodes and also geographically. If we think about the mix, typically it's been about 70% the higher value electrodes with the pricing you had mentioned on the spot market being $59.50, you're pricing on the spot market. Has that held at this 70% higher value added electrodes and 30% the lower value added or has that changed recently and is that incorporated to '07?

Bob, that's held; we're still about a 70/30 mix and that's incorporated in the '07 book. So that's come together virtually as we would have expected. And as I said, I'm very pleased with the way the '07 book has come together. We've got an excellent book, especially at this point in time and this early in the year.

How about geographically? Has there been any shift there? I mean, usually -- for the overall company, for example, your sales have been about half in Europe with most of the remainder in North America and the rest kind of spread out throughout the other regions of the world. Has that changed recently, has that changed for '07?

No major geographical shifts. There's always a little bit plus and minus as you build a book, but I would say there's no material shift. As I said at the outset, we've built a very good book with excellent names in it around the world and so we're pleased the way Asia came together. We talked a little bit about Europe earlier, European prices came up nicely and of course in the Americas where we have two very fine facilities, that book came together very nice. So we've been pleased with the book building process.

Terrific. Just a couple quick ones. The costs, previously you had given cost estimates for the year both for graphite electrodes and also SG&A and R&D. Those weren't included in the press release. Is there any reason why or can you provide a little bit more color across those areas?

We've tried to give adequate disclosure, and you're right, we're not going to pinpoint those items. Obviously over the last two years our team has earned a very good reputation in containing cost, I mean 7% or below the last two years in a row. We've identified a number of productivity projects that we've been successful on.

So we're not going to give you a specific cost, we're not going to give you a specific on R&D and overhead as far as the guidance. We may give an update towards the end of the year on some of those items, but on cost we're going to stay away from it; it's a competitive item and obviously an item that we feel in the guidance we've given not really required here for you to understand our financials.

Okay. Last two questions. One, given the divestiture of the cathode business, the exit of the carbon electrodes over time and the fact that you did call in some of these 10.25% notes, what are the cash levels right now as we speak? Do you have any ideal what that is? Obviously you ended the year, but you've done a number of things since the end of the year. What's the cash on the balance sheet today?

Well, we don't guide to it but we always have a $20 million plus or minus in the system. And so we've got cash in the system of $20 million plus. We have virtually no draw on the revolver; I think the revolver of $215 million, and maybe we got a couple little LCs somewhere. But the $215 million revolver undrawn. So we are in a very good position right now. As I said at the outset, best balance sheet we've had in years, net debt is down I think year-over-year 26 or 27%. We're starting to pay down in significant amounts our most expensive debt.

You recall right now we sit with about $300 million after this last $15 million of senior notes. They're 10.25, they're our most expensive. After that we've got a $225 million convert that's at 1 5/8. Amortization schedules are good on all of that, so we sit with a very nice capital structure right now. Our goal is to continue to delever. I think if you look at our guidance you'll see that we've got the potential for further deleveraging. I think if you run our numbers you would probably come to something that looks like probably $470 million of net debt and dropping and so I think very well positioned.

Obviously we've never been in a better position in the last nine years having put the burden of the DOJ drain and all those other antitrust drains behind us, those totaled up to maybe $450 million when you count all the refinancings. All that's behind us. And we're really excited here as we look forward in the graphite electrode business. We're looking forward in our continuing businesses. And we look forward in the technology side which we're getting some very nice support from the federal government and the local governments.

Speaking of -- last question and then I'll pass the baton, Craig. If we think about ETM and obviously you mentioned earlier in your commentary that it has been disappointing. I mean, if we look at the sales in the fourth quarter for example year-over-year, down almost 50%. And you had mentioned previously over the years that this was an area that you were looking to for growth.

In light of this decline and in light of the difficult market conditions that you're seeing in this particular business, what's your vision for the Company moving forward? Are there other areas that you're counting on for growth? Are there additional divestitures we should think about to provide additional cash flow to reduce the debt levels? Where do you see the Company over the next few years?

Let's deal with the ETM first and then we'll talk about some of the other items you mentioned. On the ETM front we still believe we've got some pretty unique technologies and we've hit some trouble here with the flatscreen market, it's a very competitive arena. We've of course the plasma competing against the LCD. Most of our products go into plasma. We are developing LCD products, but we have felt that competition in the marketplace in our sales, so the sales have been very lumpy. We're not happy with them, we're disappointed, they're below expectations, but we continue to work on growing those.

We've got a number of products in cell phones, laptops, etc., so we will continue our efforts in ETM. We still believe we have a very unique competitive technology and productline there and we believe we can continue to grow it nicely. As far as other technologies, we have some in the pipeline and, as they become more mature and we start to grow sales, we'll start to talk more about them. Some of them you've seen in R&D 100 awards.

For instance carbon foam is one of the last ones we had an R&D 100 award for. As we develop the market, as we commercialize and we get a customer list, etc., we may talk about those more in the future. So Bob, yes, we do have a pipeline. Yes, we are getting government support to grow that pipeline. And we continue to be encouraged by the technology side.

As far as further divestitures, where we sit right now we like very much the portfolio we have. We think it's very competitive, it's running very well. It's running at good op levels and the end markets we're excited about -- whether it's graphite electrodes, AGM, refractories or the AET productline. So we like what we've got. And the debt reduction we have go forward I think you should look as coming from continuing operations, cash flow, especially without all the drain of the DOJ type items and not from divestitures.

Terrific. Thanks very much, Craig.

Michael Christodolou, Inwood Capital.

Good morning. Craig, help me reconcile -- so your tonnage is going to be down about 2.8% year-over-year and yet the EAF industry is growing 2 to 3%. And I guess on the surface after a cup of coffee I'd either conclude that you're abdicating or losing share or the specific consumption ratio is improving which seems improbable to me given that the weighted average maturity of a lot of the capacity out there would suggest it's still inefficient. Can you help me reconcile all that?

Yes, Michael. I would say the primary reason our volume is down is we work very hard on the pricing front. We executed and initiated a number of price increases in 2006 and of course when you do that many times you'll give up a bit of volume and obviously we gave up a bit of volume. Having said that, with what was done on the pricing front, the execution of that and to be sitting here at 205; again, we're very pleased the way the book came together.

So what is your manufacturing capacity now for graphite electrodes?

We can probably get up to about 215 or so. So we've probably got another 10,000 tons in the machine or so.

And if we put the other divisions aside or just keep them constant, so I guess we could look at it and say tonnage -- let's just the whole company were graphite electrodes, tonnage down 2.8% but you're saying sales for '07 will be at 15%. So that would imply a high teens if not a 20% price increase. Is that directionally how we should look at what you've achieved?

Directionally I think your logic is very good. I can't comment on price, we don't give that guidance, but directionally I think your logic and the margin expansion wrapped into that, your logic is correct.

And two other quick questions. So originally or a couple years ago you had some additional capacity on the drawing board. Is it safe to say you've kind of put those plans in the shredder?

Not in the shredder. We have, as we identified, probably another 30,000 tons that we can get out of our machine. And obviously it's very low-cost capacity to add, it's debottlenecking and obviously it's in some very nice low-cost locations. And finally, it would be additions to some very large plants. One of the things we worked very hard on the last few years is to grow the average size of our plants and get the economies of scale. So we are sitting on probably 30,000 tons of very attractive capacity.

So we've not put it in the shredder. We've put it off to the side. And when the market demand is there for the product we will go ahead and execute and grow that capacity which will be very, very cost-effective from a capital standpoint and which will be very, very competitive from a production cost standpoint.

And then you had given some parameters for developing an '07 model. And if my math is right, are you effectively guiding to $0.70 to $0.75? It seems like the three estimates out there are kind of mid to upper 50s?

Obviously directionally we're guiding above the First Call, yes. I've got to stick to our guidance and I've got to let you guys run your models, but obviously we're guiding to a 25% improvement in cash, 25% improvement in income from ops before specials.

Well, Craig, listen -- you've been there what, several years? I want to congratulate you on being named Chairman. And clearly there was a time over the last several years that you and the Company needed to play to not lose and my sense is you're now trying to play to win and I commend you for that.

Michael, thank you very much. I much appreciate your comments. And my team is so excited where we sit today. Obviously we've put a large nine-year legacy behind us; the best balance sheet in years. We're almost at our company's all-time record net debt level. And so we've never been positioned better and our intention is to grow this company. We are literally unencumbered at this point. There is nothing holding us back right now and with this balance sheet literally it's in our hands to grow it and generate a lot of cash flow.

Good luck.

(OPERATOR INSTRUCTIONS). Adam Seessel, Gravity Partners.

I'm having trouble reconciling the free cash flow numbers for '06 and '07 and here are the numbers I'm coming out with -- tell me if I'm right or wrong. You have free cash flow before antitrust and restructuring of about $69 million for '06. In '07 you're saying that the operating cash flow will be roughly $85 million in the midpoint of the range and the CapEx will be about $50 million. So that gives me $35 million of free cash flow. Is that right or wrong? Because I would have expected with the positive fundamentals free cash flow to be up.

Let me toss that over to Mark and Mark will take you through it.

I think if you look at it just from a free cash flow unadjusted for the antitrust and restructuring you're correct in the math. We also have $15 million of antitrust and restructuring payments for next year, so on a comparable basis the number for '07 would be $50 million.

Okay. But help me and probably other investors understand, if all the fundamentals are good and all the indicators are up, how do we get free cash flow going down 30% from $70 million to $50 million in rough numbers?

There are two issues in there. One of the things obviously that helped drive our cash flow performance in 2006 was strong performance in our working capital. When you look at it --.

Right. How much was that a positive?

Working capital net positive was around $15 million.

$15 million?

Right. And then when you look at 2007, when we look at the price increase that we're seeing in the market as well as the overall cost of our raw material we'll see a negative impact of working capital year on year as we go into '07. The other item though that needs to be kept in front of everybody is the cash taxes. If you look at our cash taxes that we paid out in 2006 it was about $18 million. As we look at next year our cash taxes will be up significantly, a portion of it attributed to the sale of cathodes. So we sold the business and the taxes associated with that will be paid out in 2007. Plus we also have improved profitability that will drive higher cash taxes in 2007.

I got you. Can you quantify the negative working capital and the negative impact of cash taxes for '07?

We do not provide that information and that level of guidance.

But it looks like -- so we're talking really about $50 million of free cash flow for '07, is that right?

Right.

So it's about -- at $8.00 a share it's about 16 times free cash flow and I guess at $0.70 about 11.5 times earnings, something like that.

Yes, I think that math works.

Okay, thanks a lot.

Bruce Klein, Credit Suisse.

Craig, I think you referenced earlier a $470 million net debt -- trending to versus the $509 million. What was the $470 million you represented?

I think if you take our guidance and just to the math you'll get to around $470 million net debt in our guidance.

Okay. And then the free cash flow, it sounds like you still have 10.25's to repay and debt reduction is probably the highest priority. Is there anything else -- are there other significant options?

Debt reduction very high on our list as it has been the last several years. So you'll see us continue to work on that front. And also we will look at growth opportunities. I think we'll be looking very hard at growth opportunities. If we find the right growth opportunities that bring shareholder value we will execute on them.

Thanks a lot.

At this point we have no further questions.

Sarah, thank you very much. Everyone, thank you for joining our conference call and I look forward to talking to you at the end of next quarter. Take care.

Once again, that does conclude today's conference. Thank you for your participation and have a nice day.