GrafTech International Ltd (EAF) 2007 Q2 法說會逐字稿

Good morning and welcome to today's GrafTech International Q2 earnings conference call. Please be aware that today's conference is being recorded and at this time I would like to turn the call over to Kelly Powell for opening remarks and introductions.

Thank you, Michael. Good morning and welcome to GrafTech International's Second Quarter Conference Call. On the call today is GrafTech's Chief Executive Officer, Craig Shular, and our Chief Financial Officer, Mark Widmar.

We issued our earnings release this morning. If you did not receive a copy, please contact Jen Raedake at 216-676-2281 and she'll be happy to fax or email a copy to you.

As a reminder, some of the matters discussed during this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Please note the cautionary language about our forward-looking statements contained in our press release. That same language applies to this call. Also, to the extent that we discuss any non-GAAP financial measures you will find reconciliations in our press release which is posted on our Web site at www.graftech.com in the Investor Relations section.

At this time, 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 second quarter and first half 2007 highlights and then open it up to questions.

Sales increased 15% to $256 million in the quarter. Gross profit increased 57% to $94 million while gross margin improved nearly eight percentage points to 36.7%. Income from continuing operations before special items more than tripled to $42 million resulting in $0.37 EPS. First half '07 operating cash flow was $54 million as compared to $20 million a year ago, up 170%. In addition to operating cash flow, we received another $22 million in cash proceeds from the sale of our land and miscellaneous assets in Caserta, Italy related to our former graphite electrode facility in that country.

We completed the quarter with net debt of $440 million, a reduction of $255 million year over year. This is the lowest net debt level in our Company's history.

Turning to the graphite electrode segment, sales increased 21% to $209 million. Sales volume was 54 thousand metric tons for the quarter. Operating income for this segment was $62 million, almost a 60% increase year over year. Our graphite electrode segment benefited from a number of factors including higher selling prices, execution on productivity initiatives and the continued benefit of lower cost raw materials purchased last year and sold from inventory in the first half of this year. It's important to note that our lower cost raw material has been virtually all utilized in the first half of this year and we anticipate that the full impact of '07 raw material cost increases will be more fully reflected in the second half of '07.

In the advanced graphite materials segment, second quarter sales were $28 million as compared to $25 million in the same period last year. Operating income for this segment was $6 million as compared to $3 million last year, largely as a result of favorable sales mix and higher selling prices.

Recapping first half '07 performance, we are continuing to see year over year improvement in our results as the initiatives we have undertaken begin to gain traction. The impact of these initiatives is reflected in our first half '07 results. Sales in the first half up 22%. Income from continued operations before specials more than tripled to $72 million. Operating cash flow increased more than $30 million to $54 million. Return on sales in the first half '07 tripled to 15%, up from 5% a year ago. Net debt declined over 35% to $440 million. This year alone, we have called $235 million of our most expensive debt, our 10.25 senior notes.

On the liquidity front, unlike last year our $215 million revolver stands virtually undrawn.

Turning to outlook, we remain encouraged by underlying demand for our products and continue to anticipate a solid year for global EAF. We continue to expect '07 graphite electrode volume to be approximately 210,000 metric tons and anticipate Q3 graphite electrode volumes to be approximately 51,000 metric tons. We expect total Company '07 sales to increase 14 to 15%, up from our previous guidance of 12 to 14% and we currently expect graphite electrode sales to increase 20% year over year. As a result of this, we are increasing our guidance for 2007. We target income before specials to improve approximately 65% year over year to $225 million and cash flow from operations to be 95 to $100 million for the year.

We've also revised downward net interest expense. We expect it to be approximately 37 to $39 million as we continue to retire expensive senior notes and we continue to improve our debt profile.

Finally, we expect the tax rate before special items to be approximately 26% to 28% driven by improved profitability and a favorable mix of income in lower tax jurisdictions.

This concludes our prepared remarks. We'd like to open it up for questions. Michael, we're ready to go.

Thank you very much.

(OPERATOR INSTRUCTIONS)

Our first question today will come from Robert LaGaipa with CIBC World Markets.

Hi, good morning.

Good morning Bob. How are you doing?

Pretty good, Craig. Good quarter.

Thank you very much.

A few questions. I guess one, it was our understanding from last quarter that the higher priced needle coke was going to start impacting the second quarter. Now, I think you had mentioned I think in the first quarter that there's about a four to $5 million impact from the lower priced needle coke in the first quarter. What was that impact in the second quarter?

Bob, in the second quarter it was similar to the first quarter, four to $5 million, and based on sales mix and demand from our customers, we've used up as I said in the call, virtually all of the lower cost inventory. So it's come through a little bit faster than we expected and it was about four to $5 million benefit in the quarter.

Okay, so the mix helped out the second quarter. You didn't have to use as much?

It's based on the demand of those products and those different grades that the low cost coke got used up.

And speaking of mix, with regard to the pricing, now obviously by our calculations, the pricing in the quarter for the electrodes was up $260.00 a metric ton. I understand that there are some of your customers, ten to 15% of our customers, that rolled over in March, given they're on the March to March year, but I would think that that doesn't entirely explain the large jump in pricing. Was there additional spot tonnage in the quarter? Was there a higher mix of the higher priced electrodes in the quarter? Can you just walk us through that?

I think as we said earlier in the year, part of our book, about 10% or so, was still open as we were in the first quarter and we have pretty much filled out the entire book and those prices have come in higher than expected and so you're right. Pricing has come in better than expected and that's definitely part of the story.

How much spot tonnage was there in the quarter relative to the first quarter?

It's not an item we guide to. There was spot in both quarters. There was probably a little bit more in Q2 but net net, prices have come in firmer and higher than we expected and you're seeing that in our raised guidance.

An additional question is just with regard to the guidance. If I run through the numbers here, obviously it implies that the margins, the gross margins, are going to be quite a bit lower in the second half versus these second quarter numbers and I understand in the third quarter, there is some level of seasonality with that but can you just walk us through the step down function, how much of an impact you're expecting the higher priced needle coke to have and if there are any other items we should be aware of.

It's basically just the higher cost raw material flowing through in Q3 and Q4 and obviously the challenge to our team is to continue to drive productivity improvements and try to offset some of that. So that's factored in our revised upward guidance and let's see how we finish up the year on productivity initiatives, see if we can do better than that.

Great, and then last question if I could, with regard to the debt, now obviously you've done a great job reducing the debt levels, the restructuring, the sale of assets, etcetera. With the remaining $200 million at 10.25s out there, what are the plans for refinancing there? Can you just update us on that especially obviously, spreads have widened out in the marketplace and can you just talk about the timing relative to that as well?

Yes Bob, as you've seen, we've called $235 million so far this year. As always, we continue to evaluate refinancing alternatives. We have many but thus far this year, the generation of cash flow on our own has been substantial and we've got to balance what we see coming in the future with our own generation of cash flow as far as that retirement. So we weigh ourselves paying it down versus redoing it in the marketplace. I think in hindsight we're pleased we didn't redo it because our financial profile is improving rapidly and if we would have redone the debt, say, end of last year or Q1, I think we would have been premature because our own results have allowed us to continue to gain traction, generate cash flow, and pay down and improve the credit profile of the Company. So it's one of those you've got to balance with what's out in the marketplace but thus far, I think our own generation of cash has positioned us well to continue to pay these down.

Right, terrific. Thanks very much.

Thank you Bob. Have a good day.

You too.

We have a question from Jefferies and Company's Brett Levy.

Hey guys.

Good morning Brett. How are you doing?

Good morning. Can you talk a little bit, give us a little bit of an update -- I seem to ask this question every quarter but can you give us a little bit of an update on what's going on with global capacity and then also talk a little bit about the longer term outlook for needle coke, sort of how far out have you gone with this and is there anything that sort of, I don't know, suggests that maybe at some point the pricing dynamic stabilizes here?

Thank you, Brett. On your first question on supply/demand in the graphite electrode business, we see that supply and demand remain very, very tight. Our book, as I said earlier, is full and EAF steel globally is running well. U.S. of course as everyone knows, has been one of the slower areas but even the U.S. we've seen a little bit of a pick up from the January, February type operating levels to more recently. I think early in the year the op level in the U.S. was more like the low 80s and now we're kind of up in the high 80s in the op level. So supply/demand for graphite electrodes, we see tight this year and we don't see much change to that picture going into '08.

On the needle coke, we are fixed for all of '07. We've got our quantity. We've got our price so that's very, very much a stable item. Looking forward in '08, our mission will be to fix that price and obviously we're working on it. Quantity, I'm not worried about securing the quantity we need. As we've talked before, we're one of the world's largest buyers and so quantity I don't have much concern over. Price, we're working on and we will fix that as soon as we can, stabilize that, and then build a very good '08 book. In fact I think we're positioned very well as we go into '08. The heavy lifting on cost, productivity, restructuring the platform, our team is really looking forward to building an '08 book. Demand is good for our product. Things are tight and we're looking forward to building an '08 book.

Thanks very much, guys. Great quarter.

Thanks, Brett.

As a reminder, if you'd like to ask a question today, please press *1 on your touchtone telephone.

Next up is Bob Chaunsky with Jefferies.

Morning, Craig.

Morning Bob, how are you doing?

Good, how are you?

Excellent, thank you.

A couple questions for you. First off, you mentioned in the press release FX. Can you tell us what the benefit was in the quarter in both sales and operating profit?

Yeah, Bob, let me toss it over to Mark and he'll give you just some color on our FX for the quarter and the year.

If you look at it from the standpoint of the top line revenue, we had about $7 million or so of benefit on the top line. You can think of it almost as 3% of the growth rate was driven off of favorable currency. When you take that down though to operating profit, because of the impact on our cost structure was an adverse impact of around $4 million, we had about a $3 million benefit into the quarter on operating income and for the year to date, that number is about $5 million on operating income.

Great, and can you also -- if you take out the gains, what was your effective tax rate in the quarter on operating profits?

Bob, say that one more time. If we take out the --?

If you took out Italy, what would have been your effective tax rate on the operating profit?

The effective tax rate for the quarter is around 27% when you exclude that one off item.

Okay great, and then two others. I got knocked off the call real briefly Craig, so I don't know if you answered this on Bob LaGaipa's question but in terms of the quarter, say, versus 1Q or versus maybe the second half of the year, what was the percentage of the value added larger electrodes versus the commodity electrodes?

About equal, no major swings there between the quarters or between the halves. The higher value, the melter electrodes, are about 70% of the mix and then the lower value is about 30% of the mix.

Okay great, and then just finally, could you give us an update on ETM? The last couple years this was an important business for you with all the major wins that you were getting. Could you give us an update in terms of where you are with those and are we expecting any big hits there from a revenue perspective as we move forward?

We continue, Bob, to work with a number of large accounts -- Apple, Motorola -- and continue to seek getting in some of their latest design products and I think as we're successful on some of that and as some of those new, small, high powered electronics reach the marketplace, we'll see some growth in that business. This is an item we no longer give guidance on but our team continues to work with some high profile accounts and grow the penetration into those segments.

I appreciate that. Can you give us a sense though, is it an '07 story in terms of some revenues or are we looking at '08 or '09?

I think we're looking '08, '09, as far as any materiality. Here we sit as a billion dollar plus company now and so this is '08, '09 plus type story and what we need is really very high powered electronics like the new Razr phone. It's gotten very small, very thin. Functionality is high and those are some of the targets that we need to get into and then look for some volume around that and value equation.

Okay great, and then finally, I guess for Mark -- what's built into your assumptions for the back half of the year in terms of FX?

We're assuming that the FX rates stay where they are right now. So we're not assuming any change in FX. Obviously we don't have a crystal ball that accurately allows us to forecast FX so typically we'll just hold constant FX so there will be a slight benefit in the balance of the year from currency.

Okay great, thanks for your time.

Thanks Bob. Have a good day.

You too.

Next up is Michael Christodolou with Inwood Capital.

Morning everybody.

Morning Michael, how are you doing?

Fine, thank you. A few questions. So within your traditional mix of 70% higher value added melter and 30% lower value, was there at all a shift between extra sized and regular sized electrodes?

No, pretty constant.

Okay, and depreciation was a bit lower. What -- are you just kind of burning through some of the capital improvements you put in three or four years ago or --?

Largely in terms of the depreciation guidance is mostly driven by slightly lower cap-ex than we had anticipated. If you look at our full year guidance of $50 million, our cap-ex in the first half is only around $20 million so that's the primary reason for this slight change in the guidance.

Okay great, and Craig, a hypothetical question. If your volume has stayed flat for the next several quarters and your pricing stayed flat -- or let's just say the two or three quarters. If your volume stayed flat and pricing stayed flat, your cost of goods basically would be four to $5 million higher, correct? Which is basically not having that four to $5 million benefit that you had in each of the first two quarters from '06 [inaudible] needle coke. Is that --?

Directionally, you're correct.

Okay, so that's -- on your new tax rate guidance, that's $3.6 million of net income basically lost or $0.03 a share for each of the next two quarters. Is that kind of directionally the impact of your higher raw materials costs for the next two quarters?

Directionally, I think you're correct.

Okay, I for one, if you guys kept earning 50 something cents -- or I'm sorry. If you kept earning what you've been earning, less $0.03, I don't know that I'd complain but that's just a comment. So now, your needle coke, you said you've locked it in through '07?

That's correct.

But you've been using actually some '06. So is it effectively, could it be said that the '07 needle coke you've bought is going to be consumed now through the first half of '08?

Now through Q3, Q4, maybe a little will carry into Q1 is what we would anticipate.

Okay, but less will carry into '08 than carried in from '06 from '07?

Probably, probably, and again, it depends on demand, which products, which level of quality. So there's some variation around, driven by our customers' demand.

Right, and could you walk us through the synchronization that you hope to have between preparing the '08 book and going to your needle coke supplier and locking in costs for '08?

Our drive would be to fix the needle coke sometime in Q3 as we've done the last couple years so that we have our largest cost item, some 30, 35% of our cost structure, fixed before we really start building the books. So that's the mission and that's what I would expect so that going into '08 we've got a pretty good line of sight to our costs. Some of them will be fixed. Some of them will have the goalpost already set with the suppliers and then as I said earlier, we believe we're very well positioned going into '08 and that the traction we've talked about, you'll see more of that into '08 and that the environment as we see it right now, to be building an '08 book right now is very good. Demand is good for our products. Supply is tight and as I said, we're looking very much forward to building this '08 book.

So notwithstanding maybe a $0.03 impact, negative impact, for each of the next few quarters on gross, on earnings, because of the higher cost of goods, it's inconceivable really that gross margin percentage could be down over the next two or three quarters. Is that directionally a fair statement?

It's not something we guide to so I've got to take you to our total year guidance.

Okay, thank you.

But obviously as I said earlier, we're starting to see some of the traction on the heavy lifting we've done. We've had a number of large items in repositioning the platform -- cost initiatives, productivity initiatives -- and you start and you see some of that flow through to the bottom line. Debts come down significantly. I remember when interest expense was 82, $83 million a year and I think if you calculate it on a go forward basis right now, all things being equal and you held the debt and the complexion of the debt we have today, it's down to about an annualized rate of $25 million. So structurally, we've tended to a lot of items. We like the market we're seeing right now and we are looking very much forward to putting together an '08 book. We're well positioned.

I remember those days too, Craig, so yeah, this is, these days are better. Last question on pricing, or really on spot price -- is that even a moot concept now given that you've pretty much filled your book? In other words, does spot really matter? You know, the numbers you've been quoting which is 59.50 for regular and 65.45 for extra sized? Is that really a moot concept or does it really matter if somebody called you up now and needed volume in the next three months?

Our book is virtually full and it depends on when they called and how much they needed. Could we squeeze some out? Yes. It depends on which account. Obviously we have some very, very large accounts that we have long term relationships with so I don't think I would say that's a moot point or there's none of that but the book is virtually all full and it's tight right now.

Okay, last question I promise. Your German competitor put a price increase through on April 2 and they came up pretty dramatically but they were still 8% below you in regular size and 12% below you in extra sized. Do you know, has there been anything else that you've heard of or could you even talk to that?

I really can't comment on price other than that's determined in the marketplace and obviously price has come up. Supply/demand is tight and as I said, I think we're very well positioned here to build the '08 book.

Thanks for the time.

Thank you Michael. Have a good day.

You too.

And as a final reminder, please press *1 on your touchtone telephone if you would like to ask a question today.

We'll move to Trang Lee with Merrill Lynch.

Hi good morning. I'm Trang Lee. My question to you is regarding the outlook. Your net sales of graphite electrodes is expected to rise to 20% so does it reflect improvement in pricing, more volume, or is it FX?

No, it is primarily higher prices coming through than expected so it's primarily driven by price is the higher GE sales. Volume is relatively as guided, 210,000 and so Trang Lee, it's price.

Right. I understand that you fixed your price in February this year so how could the price can possibly rise afterwards?

No, maybe what you're referring to is earlier in the year we talked about, about 90% of our book was together and 10% was still open and would be built in the forward months and so the building of those, that other 10% has come in higher. Pricing has come up and it's come in higher than expected.

Right, so the 2% rise in your estimate is due to the 10% price that is not fixed in February?

That's right, the 10% of volume that was not fixed.

Right, okay.

And that volume has come in at a higher price.

Right. So the volume basically has not changed very much from your estimate?

That's right. We still expect 210,000. Our max capacity right now is about 215 but right now from what we see, it looks like about 210 is a good number.

Right, okay. Thank you very much.

Thank you. Have a good day.

We have a question from Michael Gambardella with J.P. Morgan.

Hey Craig, good morning.

Good morning Mike. How are you doing?

Good. Congratulations on all of your success over the last several quarters.

Thank you sir.

I've got a couple of questions and just want a clarification on some of the comments of some of the previous participants on the call. Someone just said to you that gross margins wouldn't be going down in the second half of the year and I don't know, maybe I'm looking at it wrong but based on your guidance, they have to go down in the second half of the year.

That's right, and I think our answer was we don't comment on individual items like that. You have to look at our annual guidance and the annual guidance, directionally you are correct and it's, as we said earlier, it's due to the raw material costs flowing through.

And then also, along with your guidance, $0.03 per share lower in the next two quarter also seems to be a little bit on the light side in terms of what your guidance is.

We'll stand by our guidance as always.

Right.

In productivity initiatives, achieve some targets faster and larger? Yes, there is always that opportunity. Are we driven in that direction? Absolutely, and that would be the upside.

And then based on the last call in May, it kind of sounded as if you had pretty much run through most of the low cost needle coke inventory already and that obviously wasn't the case. Were you surprised by how much you still had around?

No, it wasn't that we didn't know the quantity. I think in Q1 we felt, and I think what we indicated in the call, that it would be spread over Q2 and Q3 and so based on the products demanded by our customers in Q2, we used virtually all of it in Q2. So we used it faster than we thought. We thought it might carry into Q3 but it's been primarily used in Q2.

Okay, because I kind of remember you saying that we experienced significant increases in petroleum based raw materials in '07 which would be more fully reflected in future quarters.

That's right and I think what we were trying to do is just don't straight line the first quarter results because these higher costs will be coming.

Now you're saying they're pretty much wiped out?

Yeah, I would say virtually all of the lower cost inventory has been drawn off and utilized by customer demand in Q2 and Q3, we may have a little bit of it but not material and that Q3 and Q4 will more fully reflect the cost increases.

And final question, have you started discussions or booked any '08 business yet?

Discussions have started. We haven't booked anything yet but discussions are underway. Customers are coming in for bid requests and so it's just getting started up over the last couple weeks.

And would you book anything before you knew what your needle coke costs were going to be?

No. Our practice is we want to know our needle coke, get that secured pricing, and then commit to orders. So that big cost item, 35%, we will have in hand before we make any kind of significant commitments.

Okay, that's good to hear. Alright, thanks a lot Craig.

Thanks Mike. Have a great day.

You too.

Next is Ethan Steinberg from Friess Associates.

Hi, I don't mean to belabor it but I'm just a little confused on the gross margin question. If you look at the second half, assuming the volumes are stable, other than the $0.03 people keep talking about, or the four to $5 million in higher cost, is there anything that should look different in the P&L from the first half or from this quarter?

I think Ethan, maybe one way to look at is obviously, product mix and geographies which we sell into can impact our results. When you look at the second half of the year, the primary item is going to be the change in our raw material cost as we enter into the second half of the year. Our guidance though does factor in some of those other elements as well, how our book sits right now and knowing what's ahead of us. One of the things that Craig has mentioned is we did have a favorable mix, especially in terms of the grade of coke and obviously, allowed us to benefit from lower cost coke in the first half of the year. When you look at the balance of the year and the mix of product as well, that'll be one thing that is going to be slightly unfavorable with what we saw in the first half. So the combination of the two is what's reflected in our guidance.

The other way maybe to look at it is if you think about our guidance, we guided to 220 to 225 I think, excluding specials. The first half came in somewhere around 118 or something like that. If you pull out the impact of the benefit of the raw material costs -- let's call it nine to $10 million -- if you normalize for the first half and use that as a basis for the second half, you're going to pretty much land in right where our guidance is at and you factor in a slightly unfavorable mix, that kind of aligns to the information we provided.

Okay, and is that assuming you continue to get some cost benefit on op-ex improvements?

It doesn't assume anything dramatic on the cost side that we don't already have in hand so if we did better and we had some more productivity initiatives, that would be the upside.

Okay, and then somebody mentioned the difference in pricing between you folks and the German competitor being 8% to 12% depending on the product. How does that compare to this point last year?

It's much closer. The gap is much closer than last year and as I said earlier -- so the gap is much smaller than last year -- and as I said earlier, the marketplace is going to determine the price and right now, supply/demand is tight for graphite electrodes.

Okay, and do you have any reason to think that you shouldn't be able to increase price at least as much as whatever you end up seeing on needle coke pricing increases?

Looking forward, and remember for this year we had a very significant needle coke increase and we talked about it being one of the largest in a couple decades, but looking forward, our expectations would be that we will have margin expansion in 2008.

Gross or operating margin?

Both.

Okay, because yeah, if you get gross margin expansion, it's tremendous leverage on operating margin because I assume you don't need to do much on op-ex.

Directionally, you're correct.

Okay, thanks, great quarter.

Thank you very much, Ethan.

Again, it is *1 to ask a question. We'll pause for just a moment.

Nobody else has signaled at this time. Mr. Shular, I'll turn the call back to you for any additional or closing remarks.

Michael, thank you very much. Everyone, thank you for joining our Q2 call and we look forward to talking to you next quarter. Have a good day.

Once again, thank you all very much for joining us. That does conclude the presentation. Have a great afternoon.