GrafTech International Ltd (EAF) 2010 Q2 法說會逐字稿

Good morning, my name is Leigh and I will be your conference operator today. At this time I would like to welcome everyone to the GrafTech second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. (Operator Instructions). I would now like to turn the call over to Ms. Taylor. Ms. Taylor, you may begin your conference.

Thank you, Leigh. Good morning and welcome to GrafTech International's second quarter 2010 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, contact Marie Knorr at 216-676-2160 and she will be happy to fax or e-mail a copy to you.

As a reminder, some of the matters discussed during this call may include forward-looking statements as defined in the Private Securities Litigation Reform 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 time I would like to turn the call over to Craig.

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

Net sales were $255 million in the second quarter, a 62% improvement over the prior year. Gross profit improved 64% to $75 million or 29.3% of sales. Operating income more than doubled to $46 million, excluding $7 million in expenses associated with the announced acquisitions of Seadrift and CG. Excluding acquisition expenses and currency gains, net income was $37 million or $0.31 per share, more than triple the net income in Q2 last year on the same basis.

In our industrial material segment, sales increased to $209 million, a 61% increase over Q2 last year as a result of higher graphite electrode sales volume offset slightly by unfavorable currency movement and a lower year-over-year average graphite electrode selling price. Excluding the impact of acquisition-related expenses, operating income for the segment was $41 million, or nearly 20% of sales. We experienced improved electrode sales volumes as a result of increases steel and market demand. This was partially offsetting the favorable impact of -- partially offsetting the favorable impact of higher volumes in the quarter were increased raw material cost, namely needle coke.

In our Engineered Solutions segment, sales were $46 million the second quarter, an increase of $18 million as compared to Q2 2009. Operating income was $5 million. As discussed in the first quarter call, our Engineered Solutions business began to recover in the second quarter with sales improving 65% year-over-year, driven by strong demand in solar, gas and oil drilling, and electronics. In June, we received a $1.2 million grant from the Department of Energy to support our research and development in the area of solar power. We continue to utilize our core competencies in graphite materials science to commercialize products for rapidly growing industries such as solar.

Turning to our acquisitions. As discussed in April, we were very pleased to announce our acquisitions of both Seadrift and CG. We are in the process of responding to the previously announced second request for additional information concerning acquisitions from the antitrust division of the US Department of Justice. Completion of the acquisition is subject to compliance with applicable DOJ clearance procedures as well as other customary closing conditions. We expect both acquisitions to close in 2010. These acquisitions are components of our company's growth strategy and will allow us to better serve our global steel customers.

The acquisition of Seadrift secures a large portion of our key raw material, needle coke, which strategically positions GrafTech to participate in the broader graphite electrode value chain. On completion of the Seadrift acquisition, we are confident that our collective teams are scientists and engineers working together will propel the Seadrift operation into one of the most efficient and highest quality needle coke production facilities in the world.

The eventual joining together of CG and GrafTech will provide customers with benefits in the areas of quality, service and innovation. The combination of our technologies, process know how, and production capabilities will allow us to achieve several cost, quality, and lead time improvements. We are looking forward to welcoming the excellent Seadrift and CG team members to Team GrafTech.

Turning to outlook. Based on International Monetary Fund projections and other economic reports, the global economies began to recover in the first half of this year -- modestly in advanced economies and to a stronger degree in emerging economies. As previously discussed, the third quarter for us, which has historically been a weaker quarter, is expected to be lower than the second quarter, as GrafTech electrode sales volumes decline in response to weaker demand associated with the normal European holiday season.

In conclusion, excluding the impact of acquisitions and related costs, we are targeting full year operating income to be in the range of $170 million to $180 million and operating cash flow to be in the range of $100 million to $110 million.

That concludes our prepared remarks. And Leigh, if you could open it up for Q&A.

(Operator Instructions). Your first question comes from the line of Luke Folta, Longbow Research.

Good morning, guys. How are you doing?

Morning, Luke, how are you doing?

Not bad. First question -- I guess it's a typical question if the quarter -- but can you give us a sense of what the change in pricing was year-over-year that you realized in the second quarter, and then also some sense of what you are seeing as far as forward looking trends.

As we discussed in the last quarter wall, we expected graphite electrodes' selling price to drift downward slightly, and year-over-year it was down 6.5% for graphite electrode pricing. And as we said in the last call, we saw softness in graphite electrode prices which carried from Q2, Q3, Q4 as we built out the book and we saw lesser slippage over the course of this year with what we believe the total slippage is going be something single digit.

And looking forward, do you think this is kind of the bottom here and we start to look up because there has been some announcements in recent months about some actual price increases.

That is always hard to tell. I think it's going to be driven by supply and demand in our industry. What I can speak to is what is in our book and we saw it stabilize kind of in the back half of this year. So we saw the slippage in Q2 and Q3, Q4, still softness but to a much lesser extent. Time will tell. I think next year's supply/demand equation will really drive where prices go -- how hard does steel run, what do the global economies look like, those types of things will really drive where the price ends up as well as needle coke cost and other costs. How much cost inflation do we see for next year will be a key driver I think.

Can you give us a sense of what the sequential currency impact might have been for the second quarter. I was trying to see if trends reversed there and I'm just trying to get a sense of what that delta might be in the third quarter.

In the second quarter I can speak to for us currency on the selling price the top line had about a 4% negative impact on our selling price. Top line. You know, a lot of that was euro weakness that we have all seen over the last few months. Looking forward, hard to tell. Historically currency has not been a major or a material item for us one way or the other.

Just to verify that 4% was that a sequential impact or year-over-year.

Luke, this is Mark, that was actually a year on year.

Okay.

Sequentially it actually had an amount that was slightly lower than that.

Okay. All right. Guys. Just one more and I will get back in line. The utilization for the quarter, can you give us some feel for what that was?

I can, Luke. We came in at about a 76% operating rate in Q2 and if I put that kind of in our profile where we have come from, you will recall that last year full year was about an average of 40% operating rate in our graphite electrode facilities. We exited the year at 51% and then you will recall last quarter Q1 we did about 66%. Kind of a steady improvement, 51% Q4 last year, 66% OP Level Q1 and then about a 76% in Q2. We continue to see, you know, as we have discussed in this recovery, a slow, progressive recovery but we are running right about 76% in Q2.

Thanks, guys.

Thanks, Luke, have a good day.

Your next question comes from the line of Ian Zaffino with Oppenheimer.

Hi, guys. It's Brian Bittner in for Ian. How are you doing?

Hey Brian, doing great, how are you doing today?

Good, good. Just talked about a 76% operating rate in the second quarter. Where do you see that going in the second half?

Well, it is not an item we guide to so I would direct you to look at our full year operating income guidance and around that full year operating income guidance, as we said last quarter, virtually all that book is built so it is in the book. I think our risk on whether it be operating rate or volume or sales is more global economy. How does steel run? The orders are in our book and we will run the plants as hard as we need to meet the customers' orders.

Thanks. And then as far as the gross profit margin as far as how it changed sequentially went from 36.3 to 32 point -- well, excluding depreciation went to 36.3 to 32.7. How much of that is attributable to the higher needle coke?

Well, a good portion of it. You know, I can't give you exact percent, it is not an item we guide to but as you know, needle coke costs are up about 45%. And so for us, sales volume was up a nice positive. Coke costs were up. So a negative weight on us. And as we said, graphite electrode prices were down about 6.5%. Really the operating leverage and the higher volume along with productivity improvements helped us offset some of that coke cost increase.

Thanks -- and the last question it was really nice to see a big jump in the Engineered Solutions business. You know, how much -- do the trends there, how sustainable do you think they are?

Well, you know, last quarter I think we said that business generally lags 3 to 6 months our industrial materials and I think last quarter we mentioned new order rates were picking up so yes, it had a pretty solid quarter. Sales jumped up nicely. Baked in to our full year guidance is what we see in the Engineered Solutions. So it is starting to perform better and that is fully in our operating income guidance for the year.

All right, thanks, guys. Great quarter.

Thanks, Brian. Have a good day.

Your next question comes from Eric Prouty's line at Canaccord.

Hi, good morning.

Good morning, Eric. How are you today?

Great, thanks. I was wondering with you could talk about whether your customers have fully completed restocking of graphite electrodes I know you talked about how volumes would be down in the third quarter. But is there still restocking left to do and how much longer do you think that could continue?

I would look at it this way. Really, it's the other end and other situation that the supply chain had too many electrodes because of the steep dropoff in the global economies. As I look around the globe I would say virtually all that working off of excess electrodes is behind us. What they are ordering now is based on their current utilization. So they have worked off the excess and now they are running their shops very, very lean, very tight and what they are taking from us from what we see and what they are ordering from us is exactly what they need meet their demand today. Obviously their operating rates have come up also as you have seen over the last year, year and a half.

Okay, great. And you mentioned obviously needle coke costs are up but can you talk about the other primary components, cost components, that go into graphite electrodes and where those prices are trending?

They have all been trending up. Pitch. Electricity. Natural gas. Most of those the trend has been upward as the economies begin to recover. That is the trend on our entire cost picture with needle coke being the big one in size and in rate of increase.

Would you say that these cost increases have been within your expectations?

Yes, we knew about the 45% needle coke and I would say pretty much the others had been pretty much in our expectations for this year.

Okay, great, thanks.

Thanks, Eric. Have a good day.

Your next question comes from Mark Parr's line with KeyBanc Capital.

Good morning.

Good morning, Mark. How are you today?

Not too bad. Thanks for taking my call.

Our pleasure.

Good quarter.

Thank you, sir.

A couple of questions. You know, 90 days ago I think the world may have had a little bit different view of the world as far as the second half was concerned. And I think things may be at least, you know, we still aren't sure what the reality is yet but the view might be a little bit more subdued or maybe kind of more leveling off than we might have thought 90 days ago. And, you know, you have congratulations on being able to maintain your EBIT guidance for the full year in the face of that. I was wondering if you could give some color on, you know, perhaps how you have been able to do this given that maybe the world isn't quite as moving forward as much as we thought a little bit before?

Mark, it has been in a few areas. One, we put together and annual book and as you recall it started out quarter by quarter was kind of the customers' approach.

Right.

And then early in the second quarter, globally virtually all of our customers came in and really wanted to fill out their full book. So that gave us a relatively good line of sight to our year. So, in our guidance of $170 million to $180 million of operating income we have a book behind that. We also had some expectations that the Engineered Solutions business would pick up and it lagged industrial materials, and that has borne out well, as you see, in Q2.

For us, thus far the year played out pretty much the way we thought. In addition to that we worked hard on productivity improvements and efficiencies, so we have a very well delineated lean program here at the company and we have been deep into that program for the last three years plus and that is contributing some nice productivity improvements and driving continuous improvements. That, together with building the book, managing our costs very, very tightly, improving the quality, our quality is very, very good right now. Scrap rates are very, very low in our facilities. And when you add that up, it has helped us stay within our guidance range and deliver on our targets.

Okay. Terrific. Thanks for just reminding us of that and I appreciate that comment. I had another question, though, related to the currency situation for the second quarter. And you know, you had indicated that it is 4% on a year-over-year basis from a top line standpoint. I was wondering, Mark, can you give us any sense of what the potential bottom line impact might have been there from a reported EPS standpoint?

From the year on year standpoint, Mark, it actually had an EPS impact around $0.05 to $0.06. And really what happened, and historically as Craig has mentioned normally we are -- the currencies which we have exposure to normally move into essentially a basket relative to the dollar and so in second quarter as the euro weakened, significantly, while the other currencies we had exposure to strengthened and given our long position that we had in the euro it really had an adverse impact that we normally wouldn't see in the quarter. It was about $0.05 to $0.06 negative effect around the currency movement that happened discretely in the quarter.

Normally as they move in tandem to each other it is a nominal effect. Maybe $1 million to $2 million currency effect, assuming the depreciation of all the currency by 10%, that would probably impact our results by $2 million. Because of the direction which the currencies moved in the Q2, not moving in tandem as they historically had we did have a larger effect in the quarter than we would have seen normally.

It is fair to say that in addition to just kind of a weaker macro unfolding for the second half you have been able to maintain EBIT guidance in addition to greater than expected currency effect for the second quarter is that fair?

I would agree with that.

Looking out into the second half, you have seen the dollar weaken, you know, there are return I guess to a gradual trend weakening and I guess not quite halfway back but I guess the last time I looked it was $1.30 on the Euro. Based on what you are seeing now, if that currency relationship is maintained through the third quarter, would you see any, you know, a greater than expected or, you know, further degradation of earnings reports related to currency?

No, not in terms of our operating results, you know, because we obviously have entered into some forward-looking hedges for the third quarter. So largely our currency exposure is locked into at this point in time. So I wouldn't see any short-term effect of movement of the currency.

Just kind of that one hit in the second quarter and then pretty much mitigated it for the back half of the year?

Exactly.

Okay. All right. And all right, I will get back in queue. But I really appreciate all that color. Thank you very much.

Mark, our pleasure.

Your next question comes from the line of Chuck Murphy with Sidoti & Company.

Good morning, guys.

Good morning, Chuck, how is it going?

Doing all right. Just a couple of quick questions. I know you mentioned your utilization rate was about 76%. What would you guess your customers utilization rate was?

Well, when you look at global steel is a little bit above 80% globally. US customers I think were a bit below that.

That is why I was wondering.

US were around I think 70%, 72%, a little bit below the global number.

Okay. And what are you hearing in terms of third and fourth quarter utilization rates?

Pretty much paralleling what we are seeing for our Q3. Q3 will be a little bit softer. You have the European holiday effect. And that I think a number of them believe Q4 will come back and be a decent quarter. So softer in Q3 and then back up in Q4 is kind of the trend we hear.

Got you. And then my other question was just for 2011, do you think by then you will be back to mostly full year contracts for electrodes pricing or probably still going to have a lot of monthly and quarterlies?

Hard to tell. Our customer base drives that. If I look at how they managed electrodes by this year started out quarter by quarter and then once they seemed to see that the global economies were picking up and they had some reliability and their own operating rates got above 70%, I saw a pretty good interest from them to book the balance of the year of the requirements. It may work out that if we enter 2011 and things are still looking good, a slow, steady progressive recovery and their operating rates are where they are at today, maybe they are going to go for annual contracts again. I think that is a pretty strong possibility but time will tell. They have each got their own buying strategy and they drive it, we don't drive it. They drive it completely.

Got you. Okay. Thanks.

Thanks, Chuck, have a great day.

You, too.

Your next question from the line of Charles Bradford with Affiliated Research.

Good morning.

Good morning, Chuck. How are you today?

Hi, could you talk a bit about the Engineered Solutions? It is pretty clear the administration has been putting a lot of money into things like solar, just, a week or two ago, a couple billion-dollars project. Are you seeing any impact -- obviously what they it two weeks ago doesn't matter, but are you seeing much in the way of new construction of solar production facilities?

Yes we are, Chuck and it is a very global business. Part of improvement in Engineered Solutions in Q2 was directly related to solar. So we are seeing new facilities and new furnace locations coming up. We are seeing US government and some other governments putting some money behind it. You saw we got some R&D grant money to support our work in solar. So yes, we are seeing it. A lot of it is even in China. China has really embraced solar and a lot of our new customers are Chinese production facilities.

That was going to be my next question because China seems to be moving ahead very, very fast.

They are moving --

How much of that have you been able to pick off?

We have gotten a good share of that. We just opened our Shanghai office. We now have three offices in China, Hong Kong, Beijing, and most recently Shanghai. We have been adding to our team there and adding commercial people, technical people, and so China solar business for us has been very good.

On the oil and gas exploration side, obviously we hear a lot about cutbacks, suspensions, but that is mostly US-centric. What are you seeing outside of the US as far as exploration activities for oil and gas and how are you participating in that?

We are again like our solar business -- very global is our reach. And outside of the US, we are seeing increased business across the board. Recall our business there is oil and natural gas. And so the drilling of natural gas is also a good component of our product portfolio. So, we are seeing good business there. Trends -- the trend right now has been up in the demand for diamond drill bits.

On the electrodes side, we are hearing a lot of strength in places like Brazil but continued weakness in places like Europe. Are there any other markets that are really strong and leaving aside China for a minute?

Russia has been good. As you mentioned, Brazil has been good with the Olympics. So, you know, right now I would say yes, Europe is the one that is lagging a little bit. They are going to go into their summer holiday so that is going to be slower. But when I look across the world, I see their supply chain of electrodes is very, very leaned out. They buy just what they need and what they are using so I think that is very good for the overall picture. And, you know, no one knows where the global economies are going. But if I add it up it just looks like it is going to be a continued and slow progressive recovery and that looks like the most likely scenario here.

I'm pretty sure that you won't or can't tell us details of the second request from the Department of Justice but can you give us some idea like how many questions did they ask? How large a document was that? I have heard stories that it was a couple hundred pages. How bad is it?

What I can tell you is that we got what I think everyone would term a very normal second request. So nothing out of the ordinary. Nothing exceptional like you had asked. We got a very normal Department of Justice second request. We are completely cooperating on that. We are ahead of schedule with them. And I think when it is all done I think both acquisitions are going to be very good for our customer base. I think in the case of CG, we are going to be able to improve quality of electrodes, I think we are going to be able to improve cost structure and obviously with that facility combined with our Monterey facility we are going to be able to improve lead times and service to our customers. I think it is going to be a huge win for our customers.

When you look at innovation, GrafTech the last few years that has had all the innovation in electrodes. New electrodes. High performing electrodes. Apollo electrodes. And I think we bring all that to the table on the electrodes side. So I think that will play out that way and turn out to be good.

On the needle coke side, I think we bring tremendous things to the marketplace there. As we have talked on prior conference calls, you know, all of the other needle coke producers are a part of a very large refinery making unleaded gas or diesel oil. And for us, Seadrift's sole purpose will be to make exceptional quality needle coke to make a great graphite electrodes. At the refineries, the needle cokers a couple percent of the whole operation. It is an upgrade of a by-product and I tell you that is about the attention it gets. It gets an upgrade of a byproduct. The attention is to make diesel and unleaded gas. For us, this is our key raw material so our intention is to make Seadrift the number one location in the world.

We are going to invest money. We are going to improve the quality and when required, increase the size and the capacity. And so I think that is going to benefit our customer base. This will be the only needle coke facility on the planet whose sole purpose is to make superb quality needle coke to make the best possible graphite electrodes which in the hands of the customer base makes a more productive lower cost et cetera. We believe we will get through it. It is probably sometime the end of the year. But obviously, having said all that there is a risk. You never know how these are going to turn out and so we are completely cooperating with the DOJ and as we said, we're ahead of schedule in filing what they asked us to put together.

Thank you very much.

Thanks, Chuck, have a great day.

Your next question comes from the line of [Sutra Vendram], investor.

Thank you. The first was on the guidance that, you know, you all reiterated. From Q1 clearly it was backed up by a strong -- not a strong but it was strongly backed up by the order book. But orders do not translate into sales unless they are actually -- the clients are actually coming back and exercising their rights, right, to take supplies. So I was wondering what the sensitivity was at $170 million to $180 million, it must mean that you all have in some way have got the order book and I just wondering if you could discuss these qualitatively? (inaudible)

Sutra -- personally, thank you for your question. You are absolutely right. An order book has to translate into sales, and if we were to see a significant downturn in the global economies, some customers wouldn't take their full requirements. So there is definitely that risk. As far as our guidance, the $170 million to $180 million of operating income, built into that you are right, there is some conservatism and a range of variation built into that. So we don't price out in our earnings guidance the absolute full order book we have because of that very risk that you mentioned. So, we have some latitude within that. And I would say we feel very good about our guidance and that the risk to our guidance would be a significant global deterioration and that may call steel producers to significantly drop operating rates. Other than that, other than that I think our range is very good.

Okay. No, that is actually very helpful. Then the GrafTech electrode, the end markets that you all feed into, did the utilizations of steel mills that feed into those end markets, did that sort of reflect the 80% thereabout global steel rates, utilization rates that you mentioned earlier in the Q&A?

Yes, you know, our customer base, you know, if we kind of look over the last year and a half or so, kind of the first half of 2009, global steel kind of ran between 61% and 65% operating rate and then in the second half of 2009 they moved up to kind of the 72% to 76% operating rate range. And then, of course, here the first half of this year so far, they are above 80% in total global steel. So they have been coming up nicely. And that is what has triggered our operating rates also to follow and as I said earlier, we are up now to about 76% in Q2.

Yes. I guess I was under the impression that many of your clients are more leveraged to the construction market than perhaps some industrial users and I could be wrong about that. And I just wondered if that were the case, were those kind of seeing similar rates instead of the overall?

Depending on the geography what you say is, correct. Some of our US customers at a lower rate than the global number. Some would be 70% to 75%, to 76% versus maybe an 80% 81% for the global rate because of some of the construction impact that they are feeling. I think trend wise they have the same kind of trend that the global steel has, coming from the 60s to the 70s. They had the same march up which our business has benefited from and that is what has driven our volumes up in Q2 and that is what is built into our order book and guidance for this year.

Great. May I just, my last question is just on the CapEx increase. If you could just delineate where that extra money is going. I assume it was engineered materials and if it was, some color on that.

Yes, you are right. It is primarily in the Engineered Solutions. We have seen an uptick in a number of their businesses and as we look forward to next year, we believe solar and some of those alternative energy markets will continue to perform well. So that minor increase in our CapEx is really getting Engineered Solutions better positioned to service those markets as they continue to grow next year.

Okay. Great. Thank you so much and congratulations.

Thank you, Sutra, have a good day.

You, too.

You have a follow-up question from Mark Parr with KeyBanc Capital.

Thanks very much. I had a couple of things. One in looking at the second quarter, you know, the tax rate looked a bit lower than normal although if you look at the six months rate it is, you know, looks like it is more in line with normal historical levels. You know, Mark, could you give us an update on what your expectations are for the full year tax rate?

We did, Mark, we did lower our guidance. I think we are now in the range of 23% to 25%. So we did take it down a little bit. We are seeing some benefit in terms of the jurisdictional mix of income, so we took that into consideration and lowered the guidance to the 23% to 25%. There was a one-off benefit within the current quarter that resulted in the rate being a little bit lower. We did some restructuring of one of our jurisdictions and as a result of that we ended up benefiting from tax rate adjustment that impacted our deferreds and that benefit flowed into the rate so there is a one-off discrete item that impacted the rate for the quarter. Clearly when you adjust for that we are pretty much in line with the 23% to 25% that we guided to for the full year.

All right. I can do the math on that. One other thing, just wondering if you have any additional color that you might be able to give us at this point as far as the full level of the non-cash amortization charges associated with the acquisitions? Is there anything there you can share?

Well, this is some information that we had to put together, Mark, for the S4 filing that we did a few weeks ago, I guess. And we have done some preliminary estimates on what the purchase price accounting would be, the associated step up, the indication of the intangible assets, and then the amortization that we would derive from that. Right now, you know, again, Mark, this is preliminary. We have not engaged a third-party yet to complete the purchase price or valuation work. We will be doing that over the next coming quarters. Right now it looks like it will be in the range of around $35 million. I think what we actually have in the S4 is slightly lower than that. But I would just use $35 million at this point in time, and as we get better information we will know more about the actual number at the end of Q3 or the beginning of Q4.

So the underlying assumption there is and again I don't have the math all here with me, but I think that is about the number that we were looking at which would result in about a -- from an EPS standpoint about a neutral situation as far as the 2011 EPS was concerned based on the EBITDA guidance that you provided when you announced the acquisition. Is that about right? Am I in the right ballpark there?

I think based off your model, I remember looking at it, that is about what your estimate is. So we are not too far off of that.

Good. That is actually good news. I had another question about the acquisitions if I could. And if it is preliminary just please, you know, it's fine. But I'm just wondering if you have had a chance to assess the cost of commissioning the existing [desoft] capacity or the [desoft] equipment that is I guess theoretically on site and part of the acquisition. And also do you have any ballpark estimates about the capital cost of increasing or doing the brownfield expansion and moving the capacity up? I think you were talking about two difference tranches of capacity upgrades. Do you have in any idea of what it would cost yet

Mark, you're right. It would be premature for us to go through that. But I can speak to the general phases of capacity expansion and maybe the path. Our first investments will be to improve the quality. Obviously it is running at a low operating rate today because of the global economy. We are going use that time to improve the quality, add some good I think production process improvements to the facility. And the facility right now can do about 150,000 metric tons. The most we can use is about 100,000. So we will sell 50,000 to the marketplace and as I think as we improve the quality I think those third-party sales will go very well and that will help support the first phase expansion which will be 180,000, 200,000 metric tons kind of Phase one and then we would sell that out. Our intention is to run this facility at a very high operating rate. We have got a nice base load but we have to sell the balance to third parties.

And then the second phase would be about 240,000 metric tons. These have been laid out high level. The Seadrift team has done a lot of work before our acquisition on this. And so I think a lot of the mechanics and how this has to happen and whatnot are pretty well thought out. But I think it is premature to talk about any costs or CapEx.

We have sized up the facility and it has got plenty of land. One of the beauties of Seadrift is there is a lot of land there for expansion. We sized up the footprint that all sits there, the infrastructure can be upgraded and increased. so as I look forward, I think this can become really the premier needle coke facility in the world in quality and one of the largest on the planet. And the beauty of it for our customer base is we have a base load and we can now contribute to the efficiencies of that facility. Today we have no say or input into the efficiencies of our needle coke production. And as I said earlier it is like 2% of a refinery. It is an afterthought at the refinery.

Right.

And big picture when I look at the refineries and I look at what is going on in the Gulf Coast, I kind of think their focus is not going to be on the little tiny needle coke operation. They have a lot of other issues in the oil industry that is going drive a lot of their attention. So us having access to the needle coke and it being so key to us to upgrade and run it full I think will be very, very good for our customer base. Two phases. First one 180,000 to 200,000 metric tons. Second one to 240,000. Near term improve the quality. Sell it out. My team's mission will be sell that thing out. Sell it out in 2011 and that means about 90,000 to 100,000 tons that we use internally and another 50,000 or 60,000 to the external market.

All right. And I just had one last question. I appreciate all that color, Craig. Thank you very much. One last question on you had some acquisition related costs here in the second quarter. I am just wondering do you have any sense of what those costs might be over the back half of the year, the third and fourth quarter?

We had about $7 million in the quarter. $7 million in the quarter. But I would say that -- it is early to give you that number. We will give it to you in Q3. Obviously we are working very closely with the DOJ and that has got expenses attached to it. In our Q3 release we will give you the latest update on that.

Mark the guidance we gave on operating income as well as operating cash flow, just to make sure you caught it, we are excluding the effect of those related costs.

Okay. All right. So there will be additional costs and then we will just know to exclude those from the operations then?

Exactly.

Terrific. Thanks again. Congratulations on a great quarter.

Have a great day.

Thanks Mark.

Your next question comes from the line of Tim Hayes with Davenport and Company.

Hi, good morning.

Good morning, Tim, how are you doing?

I'm fine. Actually my question on that -- the acquisition costs whether that was excluded from the guidance that was already asked and answered. Thank you.

Thanks, Tim, have a good day.

Your next question comes from the line of Zahid Siddique with Gabelli.

Hi, Good morning.

Good morning, Zahid. How are you today?

Good, how are you?

Excellent, thank you.

A couple of questions. First on your book for 201,1 when do you started building that and what is your take on that?

Well, it is early now really very little to zero activity so far from the customer base. So I what expect some of that to start up here in the third quarter. And probably October, November, December we start to get a sense of that. And then that is usually finished up kind of February type period.

Okay and on the needle coke has the price been going up more and what is your expectation let's say towards the end of the year, where do you feel the price would be?

Well, as mentioned earlier, ours has gone up about 45% from our prior purchases I guess over a year ago now plus. And we have had no more pricing activity in that area. We are already booked for our needle coke requirements for this year. So that won't come up until kind of later in Q3, Q4.

And do you have an expectation of what that may be in Q3 or Q4, the prices?

Too early to tell. We look at global recovery and we look at oil prices but, Zahid, too early to tell. I really don't have a sense yet.

Okay. That's all I had. Thank you.

Thanks, Zahid. Have a good day.

(Operator Instructions). Your next question comes from the line of Ray Rund with Shaker Investments.

Thank you for taking my question.

Good morning, Ray, how are you today?

Fine, thank you. How are you?

Great, thanks.

On the Engineered Solutions side I was just curious, your operating margins declined a bit even though your revenue went up. Is there any particular, you know, is this a normal operating margin to expect in the future? Or do you expect the operating margins in the Engineered Solutions to go up as volume and revenue goes up?

Ray, let me get mark just to jump in to give you clarification because I think we have to look quarter over quarter versus year-over-year.

Yes, so one of the -- Ray, one of the things we need to continue to remember is that the manufacturing cycle in Engineering Solutions tends to be much longer than our normal core business. One of the challenges that we had as we started to ramp down production for ES and the latter part of 2009, it did drive some unfavorable fixed cost absorption. What that meant is that product was still carried in inventory ultimately until we started to ship some of the revenue until the second quarter.

So as the business volume started to ramp back up we were getting a little bit of a head wind against the margins associated with that unfavorable absorption that was sitting in inventory. Most of that has worked its way through in Q2. As we progress in the second half of the year, we would expect the operating margins to expand. We did see expansion first quarter to second quarter. We did see unfavorable year-on-year. But I would say is that we would start to see a much more favorable margin realization for ES in the second half of the year as a result of that unfavorable margin now largely being behind us.

Do you have any sort of target for operating margins in the Engineered Solutions segment?

Well, Ray, in the business, obviously, in 2008 was performing at a level in the low 20s, so we had ops margins in the 22%, 23%, 24%. Clearly, when you look at the end markets in which we are serving and unique solutions that we are providing to our customers, we would expect to start to reach the margins over time. Whether we start to see that in the second half the year, I would say it is probably too early for that. But clearly, we would see this business potentially having margins probably in the 20% change.

Okay. Thank you very much.

Thanks, Ray. Have a good day.

You, too.

At this time, sir, we have no further questions.

Leigh, thank you very much. Everyone thank you very much for joining our call and we look forward to talking to you later in the year to review Q3. Take care and have a good day.

Thank you. This concludes today's conference. You may now disconnect.