GrafTech International Ltd (EAF) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to today's GrafTech Reports Q2 2008 Results Conference Call. Please be aware today's conference is being recorded. At this time I'd like to turn the call over to Kelly Powell for opening remarks and introduction.

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

We issued our earnings release this morning. If you did not receive a copy, please contact Jen Raedake at 216-676-2281 and she will be happy to fax or 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 our call today. Today we'll take you through our second quarter and first half '08 highlights, and then we'll open up to questions.

Net sales in the quarter increased 25% to $320 million. Operating income was up 36% to $89 million while operating income margin improved more than 2 full percentage points to 27.7%. Income from continuing operations before special items increased over 50% to $60 million, resulting in $0.51 EPS.

First half '08 operating cash flow nearly doubled to $102 million as compared to $54 million a year ago. In June we completed the redemption and conversion of all of our $225 million outstanding convertible debentures allowing us to complete the quarter with net debt at $163 million, a reduction of $277 million year-over-year.

We are pleased to announce also in the quarter the acquisition of an 18.9% stake in Seadrift Coke, the world's second largest needle coke producer. This strategic investment reinforces our view on the strong electrode industry supply chain fundamentals and allows us a partial hedge for our most important single largest raw material, needle coke, which currently represents approximately 40% of the cost to produce a graphite electrode.

Turning to our industrial materials segment, net sales increased 25% to $275 million. Operating income for the segment was $80 million, an increase of 30% over the prior year. Our graph electrode segment benefited from a number of factors, including higher selling prices, execution on productivity initiatives, positive impact with currency, and the continued benefit of lower cost raw materials purchased in '07 and sold from inventory in the first half of this year.

It's important to note that as expected and detailed in our Q1 earnings release, our lower cost raw material has been virtually all utilized in the first half of '08 and we anticipate that the full impact of '08 raw material cost increases will be more fully reflected in the second half of this year.

As a result, we expect a $0.03 EPS headwind as we move into the third quarter as higher cost raw materials begin to flow through our results. We also anticipate in Q3 an approximate $0.02 decline sequentially as a result of lower sales volume associated with the usual seasonal slowness in Europe as a result of their summer holiday period. Both of these items are very consistent with our experience in Q3 last year.

In the engineered solutions segment, second quarter sales grew 27% to $44 million as compared to $35 million in the same period last year. Operating income for this segment more than doubled to $9 million. This segment recall serves non-fuel sectors with solid growth profiles. These include the electronics, solar, oil exploration, transportation, and thermal processing industries. Increased sales into these end markets resulted in improved operating income for this segment.

Recapping first half '08 performance we are continuing to see solid year-over-year improvement in our results as the initiatives we have undertaken continue to gain traction. The impact of these initiatives is reflected in our first half '08 results. Sales are up 26%, operating income improved 49% in the first half.

Operating margins in the industrial materials business improved 3 full percentage points and engineered solution operating margins are up a full 12 percentage points.

Income from continuing operations before specials increased 77% to $121 million and operating cash flow nearly doubled to a little over $100 million. Return on sales for the first half '08 improved over 5 full percentage points to 19.9%, up from 14.1% in the same period last year. Net debt declined in the first half over 60% to $163 million. Our team has delivered a very solid first half result.

Turning to outlook, yesterday we announced the retirement of $35 million of our most expensive debt, our 10.25% senior notes. Following this redemption, we will have just $40 million of senior notes remaining from the original $550 million outstanding issue. Congrats to our team.

We remain fully -- we remain encouraged by underlying demand for our products and continue to anticipate a solid year for global EAF and the markets that drive our engineered solution segment. We expect total company '08 sales to increase 20% to 22%, up from our previous guidance of 16% to 18%. As a result of this, we are increasing our full-year guidance for '08. We target income before specials to improve approximately 35% year-over-year to the $320 million to $330 million range and cash flow from ops to be approximately $190 million. That concludes our prepared remarks and let's open it up for questions.

Thank you. (OPERATOR INSTRUCTIONS) And we'll take our first question from Ian Zaffino with Oppenheimer and Company.

Great. Thank you very much. Good quarter.

Thank you, Ian. How are you today?

Good, good. My question would be, you gave a lot of detail on the cost increases you're seeing. Can you actually give us an idea of the pricing that you're seeing for your products on the electrode side in the spot -- little spot market you're doing or about how your negotiations going for '09 and also how your engineered solutions business is doing? Thanks.

Thanks, Ian. On the pricing as you had asked, over the course of this year we've seen pricing for electrodes trend up over the course of the year. There's been tremendous cost pressure and as you're aware, we've announced a number of increases on the selling price over the course of the year to try and offset some of those. And so over the course of this year, Ian, electrode prices has been on the upward trend.

'09 the book building process will start here in Q3, so we're at the front end of it. We really haven't starting building the '09 book but obviously we've been preparing on the price front to get ahead of what we expect to be some pretty heavy cost increases as we go into '09.

Engineered solutions, your last question, has benefited from some very nice growth industries that it participates in. Solar's been doing very well. We offer a number of tailored solutions into that industry as we do into some of the diamond drill bit and oil field service business and into some of the electronics industry business. Some of the latest generation electronics goods with higher line speeds, smaller hand held equipment is really starting to give our thermal management business some traction as those appliances and line speed type items demand stronger thermal management products. So the engineered solution team is off to a great start this year. Nice double digit year-over-year operating income margin expansion and we look forward a solid second half in that business as we do in the steel business we serve.

Okay. So I guess there's somewhat the -- your initial comments was that -- or when you answered my question -- is that it seems like pricing next year should at least offset the increases in raw materials you're seeing this year. Is that pretty much --?

That is absolutely our goal. Our goal has been to get ahead of large cost increases, as we've been successful the last few years. And so our goal will have us getting a fair price for our product. Supply/demand equation remains tight on graphite electrodes, and the cost pressures is drive -- are driving up the selling price.

And then just one final questions before I hop off. Is -- do you give us an idea of the receptivity of the surcharges that you announced? What are your customers saying about that? Obviously they probably don't want to pay a whole lot, but it is a very small cost of their product so I've got to believe that they're a little bit receptive to it at least, so if you could elaborate on that, that would be helpful too. Thanks.

Absolutely. Ian, yes. In July we raised the base price of our graphite electrodes for future orders and also put in a surcharge attribute to those orders. And as I said earlier, the '09 book building is just beginning, so I really don't have a lot of data points there and I think we just have to let some time go by. Let us build the book and obviously the marketplace will determine if we're successful in executing a surcharge.

We have seen unprecedented cost increase this year and to date we've been able to offset those with productivity improvements and price increases, but obviously in these types of markets, having a surcharge vehicle may help us further offset those in the future.

So Ian, we're just going to have to let us build the book and the marketplace will determine whether or not that surcharge feature holds.

Great. Thank you very much.

Thank you, sir.

Thank you. Next we'll go to Brett Levy with Jefferies.

Hey Craig. How are you guys? I wanted to ask you a little bit about the Seadrift transaction. Does that imply that you guys will have I don't know, more captive supply or is that going to be strictly on an arm's length basis going forward and if that's the case, are you guys looking to make additional share acquisitions or out and out acquisitions in the needle coke area?

Thanks, Brett. On Seadrift, our 18.9% holding does not entitle us to a claim on any coke, so all transactions with Seadrift are 100% arm's length, market price, et cetera. Time will tell what else comes to market. Obviously if some other needle coke assets came to market more of Seadrift or another producer, obviously we would have an interest in looking at that.

All right. And you noted that you did buy back another $35 million of the 10.25s, did you buy them below call price and at this point, what is your inclination to just call the rest of them at some particular call date?

Brett, we bought the $35 million right at the call price and so there's only $40 million outstanding and over the balance of this year we'll monitor our own cash flow and probably look to take those out before year-end.

Thanks very much, guys.

Thanks, Brett. Have a good day.

We'll take our next question from Asad Abedi with Merrill Lynch.

Good morning. Just one question for you. On your guidance for '08, I want to understand what had surprised you positively during the course of 2008 given you should have pretty good visibility on your costs and your pricing for needle coke and electrodes this year.

Asad, thanks for the question. I guess I wouldn't say anything's really surprised us. We knew and have monitored the oil situation, so we knew costs were going to be up significantly. I guess on the favorable side, prices have trended up over the course of the year and so whatever we've put in the book on the spot side generally has been at higher prices than the prior month or the prior quarter. So prices have continued up, demand remains very tight on the electrode side. Global steel is running well. There are some pockets where it's a bit slow, but globally steel looks very solid for us the balance of the year.

Great. Thank you.

Thanks, Asad.

Next we'll go to Charles Bradford with Bradford Research.

Hi. Good morning. I've got a couple of questions. First of all, the Seadrift deal. Is that purchase price all done and any debt already taken care of on the books?

Our acquisition is all done, closed, and so there's no open issues on that, Chuck. Seadrift has of course its own balance sheet and it has some debt on the balance sheet, but there's no open issues on that transaction. We are fully closed and done. And I was appointed to the Board. We get one Board seat, so I took the Board seat literally 48 hours after we closed.

Terrific. Another question. How much natural gas do you use? Because pretty clearly that's a price that's been coming down a lot and should be a significant benefit.

Well, Chuck, in the total cost to make a graphite electrode, natural gas is around 7%, so don't get me wrong, it's an important item, but it's only about 7% of our cost structure. So you're right, gas has come off nicely, down a single digit now and so we are getting a little benefit from that but it's only a 7% item in total.

Yeah. But $12 down to $9, 7% could go to a 5%.

Yeah it could. Could. So yes we are enjoying some benefit from that, but obviously when you go to bunker fuel and transportation charges, all those are on the increase. Metallurgical coke -- virtually everything else you touch is on the increase and yeah, we're getting a few bucks here on natural gas here for as long as it stays in single digit.

And then on the demand side, I've heard stories about a lot of mini mills, electric furnace mills being built in Russia and other places in Central Europe. Do you have any idea or can you tell us what you're looking for as far as demand growth in some of these areas that some of us aren't all that close to?

Well, Chuck you're right. Russia has built a lot of new furnaces and of course they're putting in the ground the largest available electric arc furnaces that they can find. These all demand large diameter high quality electrodes, so they play right to our sweet spot. So Russia, Middle East, China, the growth in new startups we're seeing there are absolutely dead center in our target zone. They play to our strengths in quality and customer tech service.

So we are seeing in total, as we've said earlier on calls, probably EAF growing at about 3% to 4% per year and obviously specific consumption on the electrode side does improve year after year and so net growth is probably somewhere around 2% to 3% net growth worldwide. In some pockets like Russia, China, obviously it's higher than those numbers. But we track this very closely. We are very good at new furnace startups. Our customer tech team is very, very well skilled and so literally we know where every new furnace is, the startup time, and usually we would participate in a good share of their electrodes.

Did you hurry the estimate for steel? Longer-term growth was closer to 5% now, yet everything -- every place I look, you're gaining market share. So seems like maybe you're being a little conservative.

Well, when we talk 3% to 4%, we look at absolutely the long cycle, and yes, if you go here the last few years and maybe what some people are forecasting for the next three to five years, it looks like we're in a very good period. We agree. And could it be higher than the 3% to 4% over the next five years? Absolutely a possibility. What we like to see is customers in those geographies putting in these large furnaces because they demand the highest quality of electrodes. And if you're going -- some of these old generation, small or medium sized furnace -- literally almost any electrode will work. But when you get into large furnaces going into the ground, you need a high quality electrode. It's usually large diameter and usually you want a lot of customer tech service around it.

Thank you very much.

Thanks, Chuck. Have a good day.

Thank you. We'll take our next question from Mark Parr with KeyBanc Capital Markets.

Hi. This is Phil Gibbs for Mark. How is everyone?

Hey, Phil. We're doing great. How are you today?

Good. Now this -- you had said you were on the front end of contract negotiations for 2009 and you typically talk about goal posts for your needle coke costs, and obviously it's becoming a greater percentage of the cost to produce an electrode. And I was wondering what your thoughts are on those goal posts, whether or not they've widened or narrowed given the change in oil pricing and the -- looks like continued tight supply/demand balance?

Phil, we're absolutely working on needle coke. We will get that all locked up and negotiated -- the full requirements we need for '09 and then we will start up the bid season. I would expect the bid season to get some momentum here in Q3, so you're spot on. We're working on the needle coke. We'll get all that fixed and then we will start to put together what for '09 we would expect to be a very good book.

Your ability to buy extra material going into 2009, has that -- has there been any change to that agreement because you typically can buy within the high end of your allocation band from Conoco. And do a lot of those things remain in place?

Yeah. That's all in place and I don't expect any problems securing the volume of coke that we need for '09. So on the volume side, because we are a very large buyer, I don't anticipate any problems on securing the volume that we need to support '09 and all we're doing now is putting the finishing touches on price negotiation to secure pricing for all of '09 on our critical needle coke. Obviously Seadrift investment will give us some hedge for a portion of that buy.

Okay. And can you also talk about some of your productivity improvements that you've made throughout the business and what you're looking to do going forward in the second half '08 CapEx budget and into 2009?

Well, we've had a number of them. Some of them are more obvious than others, some of them show up very clearly on the P&L. Obviously year-over-year we've improved on the overhead side. When you look at one overhead as a percentage of sales it's dropped dramatically from double-digit number to single-digit now. And then in absolute terms I think we're running $1 million to $2 million ahead per quarter versus last year. So some of it's very discernable.

Some of it in the production arena is less discernable on our P&L because obviously it's offsetting sometimes increasing raw material costs. But every one of our production facilities is involved in productivity improvement projects. We've been embracing very much a kind of a lean Toyota production process and system, and that's beginning to pay nice benefits. So I think perhaps over '09 we'll start to quantify some of these and maybe give a couple metrics around this as this initiative really starts to gain traction.

Yeah. I was just wondering if you had anything specific per any one of your plants in particular or any specific projects that you were working on or whether or not it was just broad based and by your answer it seems as though it's pretty much broad based at this point.

Yes, Phil. It's broad based, it's across the entire platform. And recall some of our increased capital expenditure for '08 is driven towards productivity initiatives. We have a number of great opportunities, and if you go back the last couple of years, we've been cash constrained. And so we have a team now that's been very anxious to get at these and that's what we're doing. And they're beginning to pay off nicely for us.

Okay. And then just lastly, can you remind us what your spot mix is? Is it still between less than 5%? Something like that?

Yeah. Generally when we build a book, the spot piece is going to be somewhere 5% to 8% at the front end of the year. And then as of course as you get towards the end of the year, that of course shrinks as people come in and eat up your capacity. So it generally runs 5% to 7%.

And by the second half of the year, I mean you pretty much have your book filled at this point on.

That's right. Now, we will get some key customers that will come in maybe an emergency requirement, maybe some change in their planning process or maybe they got let down by another supplier and they'll come in and get additional requirements from us. And obviously we'll do our best to serve them, but it's not at their contracted price. It's at the new prevailing price. And we've had some cases of that in Q1 and now in Q2, and so those have been at a much higher price than what the contract was booked at. And that's why as we said on the pricing [front], over the course of this year, we've seen prices come up.

Great. I appreciate that. And a great quarter.

Thank you, Phil. Have a great day.

Thank you.

Thank you. Next we'll go to Bob Richard with Longbow Research.

Good morning, and thanks for taking our call.

Morning, Bob. How are you doing today?

Good, sir. Just a little more elaboration on your CapEx. I appreciate the previous question. $40 million left to date and you're saying that's more for productivity enhancements than let's say maintenance CapEx in nature. What specifically do you target in the process, sir, with those capital dollars? Where's the bottleneck in the production?

Well, Bob, it varies by facility and obviously not all of that's productivity improvements. Our maintenance span might be closer to $35 million, $40 million kind of a maintenance spend. So the amount above that to the 75 would be productivity, sometimes quality, opportunities we have in the plant, and it varies by plant. Each plant has a different generation kind of period when it was built. Some of the newer plants have a different bottleneck than some of our older facilities, so really it's not one particular area by plant.

And so our initiatives are to look at each plant, and then we line up all of the opportunities and then the return on invested capital, payback period, and then we just work down that list. So the kind of the $25 million to $35 million above our maintenance spend is pretty much pointed at those productivity initiatives. And then there's one other bucket of on -- bucket on growth. Our engineered solution business obviously has been growing significantly and it needs more volume. It's sending an awful lot of great tailored solutions to solar and some of those other electronic industries. So we've been adding some capacity in those areas as the demand has gone up. So some of that addition above the maintenance capital is also for growth.

Okay. I appreciate that. That's very helpful. My follow-up is tax rate, you're still guiding to 27% and 29%. It's been a little higher here the first couple of quarters -- north of 31%. Is that initially -- is that anything to worry about or any color there?

Nothing to worry about and we should finish up the year 27%, 29%. Total year.

Okay. Thanks very much and a good quarter.

Thanks, Bob. Have a great day.

Next we'll go to Paresh Jain with Religare Securities.

Yeah. Thanks for taking my question. Just wanted to get a sense of what is the kind of capacity that has been added to graphite electrodes?

Sir, we're not adding any capacity to graphite electrodes.

What is the sense on globally?

Paresh, a couple of the competitors have announced some increases. I think a couple of the Indian competitors have announced some, but I would see it in the total global demand not material, and then also as we said earlier, constrained by the availability of quality needle coke.

Okay. Okay. So going forward, can we see where in probably steel manufacturers not adding additional electric (unintelligible) just because there's not available graphite electrode available with them because of a shortage of needle coke?

Paresh, I don't see that happening. What I see is the needle coke producers continuing to de-bottleneck their facilities, which will not in any way impede EAF growth. So I would expect the coke supply to be there and ready as the electrode demand and the ultimate EAF steel demand arises.

Thank you.

Thanks, Paresh.

Thank you. (OPERATOR INSTRUCTIONS) We'll go next to Sam Martini with Cobalt Capital.

Hi guys. How are you?

Hey, Sam, we're doing great. How are you today?

Good. Just to -- I think just a quick question for Mark. Two quick housekeeping questions. The debt balance for 303 to the kind of 180 total, I'm assuming that's taking out 225 to convert and the 100 for Seadrift. Is that basically the walk?

Yeah. That's basically the walk.

And so what's the -- Mark, what's the -- so fully drawn on the revolver, if I look at the 180, I've got 75 of the 10.25s going to 40. And the revolver -- what is it, 215 total size drawn with 100? Is that right?

Yeah, 215 the total size of which we drew about 100 of it to fund a portion of the Seadrift acquisition. Then we have a nominal amount of LCs that are drawn against that as well.

And that's LIBOR plus 200?

It's actually [left] plus 150.

Plus 150. And then, Mark, how do you think about the credit right now of just the total availability? We've been talking now for a while about the 10.25s -- they're basically gone. The converts are gone. When the 10.25s are retired to 40, you'll have -- you'll be a whopping one-third times levered and what are the other -- how do you envision the revolver? How do you envision recapitalizing this balance sheet?

Yeah. I mean I think we saw this before around the revolver capacity around 215, and we know given our liquidity requirements, coupled with the revolver, coupled with factory lines and other initiatives that we have in place, we're very comfortable with liquidity that we currently have available for us for working capital needs, as well as selective opportunistic transactions like we had with Seadrift, right? So I think from that standpoint we have sufficient liquidity to address both working capitals as well as our growth initiative that we've embarked on.

The -- talking about the credit and more or less evaluating it from a rating perspective. As you know, Sam, we've had two upgrades up this year and clearly we're positioning ourself for further upgrades as we continue to improve and the balance sheet strengthens itself the way it has and we continue to generate cash flow along the profile that we've done over the last year or so. So from that standpoint, we feel very comfortable with the balance sheet and the capacity that we have to grow this business.

(Inaudible) S&P need you to be at zero drawn debt to be greater than a double-D credit?

No. I think -- Sam, you know there's a number of things that they take in consideration when they're trying to assess the credit rating. And concentration into a particular industry is obviously one of the elements that they would look at. Size and scale of the company was another thing. So there's a number of elements that come into play. So if you look at it purely from the metric standpoint, clearly our metrics stand alone which say our ratings should be higher than where it currently is at.

Mark, if you were to -- do you think you have the ability right now, given the current credit markets, if you wanted to size up the credit facility and say you wanted to have $500 million credit facility, A, is it available and B, what would be the cost do you think? And C, would you want it?

Yeah. I mean clearly the credit markets where they are right now are not all that attractive for anyone to be in the market. Alls I would say is that in the market as it exists today, is we probably would be better positioned than most companies if they were trying to access the credit markets given our balance sheet and given our industry and the outlook for our business. So clearly at this point in time I would not be looking to access the credit markets. We believe we have sufficient liquidity to manage our business and as the credit markets would improve we would evaluate at that point in time.

And then just last housekeeping. Share account pro forma for the end of the quarter is what, about 121 fully diluted?

Well, we ended up the quarter at [119.5].

That was an average. Just cleaning up the convert?

Yeah. We'll see a little bit of pressure on that in terms of the timing. You've got to remember, the convert was already -- really doesn't have an impact because it's in the fully diluted. Whether it was there at the beginning as part of the basic count or at the end is -- after we converted it, right?

I just wanted to make sure I got the make whole right.

Yup. You got it right.

Thanks, guys.

Thanks, Sam. Have a great day.

Thank you. We'll go next to Don [Schimmel] with SCM LLC.

Good morning, Don. How are you today?

Good morning, gentlemen. Great. How are you?

Great, thanks.

My only question is where do we stand on development of sales force on the engineer's solution segment?

Well, Don, we have a global sales force in place for that business. Their numbers show you some of the traction they've been gaining. But as we look forward, obviously with the growth in that business, we are adding resources to that team. It's a global team today, and we are adding to that team on a regular basis as they build out their business and as their business model expands to those nice growth industries.

Don, anything further?

Oh no. That's it. Thank you.

Thank you, Don. Next question?

We do have a follow-up from Asad Abedi with Merrill Lynch.

Good morning. Just one full quick follow-up. Given the (unintelligible) steel, and given the lack of availability in some regions, do you see any risk to electric (unintelligible) production next year?

Asad, what we see is a very solid second half here this year. And then in all of our work with our customers, and recall we sell in 85 countries, our customer base is looking for a very solid '09. They do not see constraints in production because of scrap. They see cost pressures like all of us do, but none of our customers globally see them not being able to run because of scrap. And I think a couple things are at play here. One obviously as scrap prices have gone up, people are getting very creative and aggressive at getting at scrap.

And then the second thing -- and this is something we keep reminding people, kind of the medium longer-term for our business is China, Russia, Middle East are putting tremendous infrastructure steel into the ground. And China's putting 400 million plus tons of steel a year into the ground in China. They're developing what's going to be I think in the next five years a very nice automobile industry. And all of those are going to generate some tremendous amounts of scrap down the road. And so that's what has us very excited about the medium longer-term here. So we really don't see, nor do our customers see, any major constraint around global scrap preventing EAF from running hard.

That's great. Thanks a lot.

Thanks, Asad. Have a good day.

Thank you. And now with that, there are no further questions at this time. I'd like to turn the program back over to Craig Shular for any additional or closing comments.

Robbie, thank you very much. Ladies and gents, thank you very much for attending our call and I'll talk to you next quarter. Have a great day.

That does conclude today's call. You may disconnect your lines at this time.