GrafTech International Ltd (EAF) 2013 Q2 法說會逐字稿

Good morning, my name is Jodi and I will be your conference operator today. At this time I would like to welcome everyone to the GrafTech second-quarter 2013 earnings conference call. All lines were placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session.

(Operator Instructions)

Thank you. I would now like to turn the conference over to Ms. Kelly Taylor, please go ahead ma'am.

Thank you, Jodi.

Good morning and welcome to GrafTech International second-quarter 2013 conference call. On the call today is GrafTech's Chief Executive Officer, Craig Shular, and our Chief Financial Officer, Lindon Robertson. We issued our earnings release this morning. If you didn't receive a copy please contact Marie Knorr at 216-676-2160 and she'll 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 are posted on our website at www.graftech.com in the investor relations section. For your reference, a replay of the call will be available on our website.

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 call today. Today we'll take you through our second-quarter results, provide commentary on our 2013 outlook and then open it up to questions. In Q2 total Company sales declined 5% to $301 million, EBITDA came in at $40 million, at the high end of our guidance range, net income was $4 million, or $0.03 per share. Our team delivered second-quarter results among with expectations in spite of a very challenging operating environment. Record sales in our Engineered Solutions segment and proactive cross management across the Company positively impacted these results.

Turning to our Industrial Materials segment, sales decreased 12% to $231 million, operating income for the segment was $8 million. As an update to our graphite electrode bookbuilding process, we currently have approximately 95% of our 2013 targeted book completed. This is up from the 80% level we highlighted in our last conference call at the end of April. The environment for our IM segment remains very difficult as steel production outside of China continues to decline year over year. This weaknesses is further exacerbated by over capacity in the graphite electrode industry.

In our Engineered Solutions segment sales increased 31% to $70 million in the second quarter. Operating income for the ES segment was $8 million, or 12% of sales. Our Engineered Solutions segment achieved record sales in the second quarter, accounting for nearly 25% of total Company revenue.

The majority of the sales growth has been driven by new products and solutions developed by our R&D team. Additionally, this segment delivered double-digit operating income margin performance, ramping from Q1 as the infrastructure investments to support growth are more effectively absorbed at a higher revenue level. As this business continues to gain traction, it is better positioned to provide a sustainable base for diversification in tough steel cycles.

Turning to outlook, in its July 9th report the IMF reduced its estimated 2013 global GDP growth to 3.1%, representing the third consecutive downward revision this year. The IMF also states that global growth has not accelerated as expected and has underperformed relative to its prior expectations due to several factors, including, one, protracted recessionary conditions in Europe; two, weaker than anticipated economic expansion in the US; and three, slower growth in emerging markets.

On July 22nd the World Steel Association reported that global steel production, ex China, declined 2.7% in the first half of this year as compared to the same period last year. Looking at a couple key steel markets for us, North American steel production is down 5.8% the first half of this year versus the first half last year, and the EU 27 is down 5.2%. As a result of the aforementioned economic factors, steel data and feedback from our customers we are reducing our targeted EBITDA range for the full year to $145 million to $165 million to reflect weaker than previously anticipated demand for our industrial material products. Consequently, we are also reducing our targeted operating cash flow guidance to $110 million to $130 million to reflect the reduction of profitability and higher than previously planned inventory levels.

It is important that 2013 marks the final year of a third-party wind down agreement triggered by the acquisition of Seadrift in which GrafTech is required to purchase minimum third-party needle coke quantities. Going forward this will provide us with increased flexibility to further optimize our vertical integration with Seadrift and reduce inventories.

Given the challenging operating environment we are also further reducing our targeted overhead expense to approximately $135 million. This compares to overhead expense of $155 million last year.

In the third quarter we are targeting EBITDA in the range of $30 million to $40 million. Continued growth and improvement -- improved profitability in the ES segment is expected to partially offset weakness in the Industrial Materials segment. Finally, we've built an advantaged, low-cost, back-integrated business model supported by a solid capital structure. We will continue to drive productivity and quality improvements while driving out cost. GrafTech as well emer -- positioned to emerge from this difficult part of the steel cycle stronger than we entered it.

That's the end of our prepared remarks, Jodi, let's open it up for Q&A.

(Operator Instructions)

Edward Marshall from Sidoti & Company.

Nice work navigating the challenging market. My first question was on pricing. As we get a first look this past week from SGL -- I don't know if you'll comment on this, but your competitor put out their indications on pricing for 2014.

Can you -- first, can you comment on what you're seeing from a pricing perspective? And secondly, does this confirm what you'd say is the bottom of the cycle?

On pricing you'll see what we've put out the Q, first-half price is down about 11%. So, yes, graphite electrode prices pretty much have slid over the course of this year and, obviously, we saw the announcement from our competitor. As far as looking forward on pricing, I think it's early to make any observations on that and at the end of the day, obviously, the marketplace is going to determine the price. So, price is down, costs are up in a number of areas and I understand it's a very tough market for all of the GE producers.

On the Engineered Solutions business, good job on both margin and then in particular I think the revenue. In the past this has been a very volatile quarter-over-quarter for you and has that stabilized and have you guys got a handle on that business? And is the July shipment similar to what you saw inside the June quarter, if you'd comment on those?

As the girth of that business grows into the of the structure investments we've made, yes, I think you'll see more stability quarter-to-quarter. Seasonally always Q1 in that business is a soft quarter, but I think what you'll see Q3 and Q4 this year will build on the success of Q2. Q2 operating income margin came in at around 12% and I would expect over the second half we'll build on that. Could it be 12%, 13%, 14%, it could. Volumes look good, the new products we've developed are performing very, very well.

If I take you out three-to-five years, as we've said before, we expect this business three-to-five years to be $500 million business. This year they should blow through $250 million. A majority of the sales and profits are new products, so our R&D team's done a great job and execution in these demanding customers has been very good in this market.

Luke Folta from Jefferies.

First question was on pricing, as well. I wanted to understand, it appears to me that the bottom fell out of the electrode pricing market at some point in the second quarter and you've that you're about 95% booked for this year. Can you give us some sense of where the offer price is today relative to what's in the order book on average this year?

Yes, I think you're pretty accurate. Q2 halfway through the quarter there was a step down. The volumes available out there for electrode producers are pretty small, if you will, at this stage of the cycle. Steel production is down in virtually every single country year-over-year.

It was pretty ferocious competition. Price came down in the quarter, that's really what's driven our guidance. I don't know if it's the bottom yet.

I know many producers are struggling, they're reporting their numbers. Chinese producers are losing a lot of money, the economics in the industry are very, very stressed. Time will tell.

I think big picture, EU looks like the rate of decline in the EU is starting to slow so it looks like the EU is trying to find a bottom. That is about 35% of our sales so that will be a key part to recovery.

US is better, for sure. There's been -- probably our best steel market has been in the US but that's not without challenges. And then, of course, you've seen -- everyone's seen the China slowdown.

I don't know if this is the bottom. I think bottoms we always see in the rear-view mirror and so our team has continued to drive productivity improvements, cost out the door. A lot of quality improvements. We've talked to a lot of them about what we've done on the Cedar needle coke, that's gone absolutely superbly for us.

Time will tell where we finally find this bottom. I think what we've worked hard here is, when we to emerge from this trough we've got four great acquisitions. They're integrated, our cost structure will be much better, our product offering will be much broader, ES will have the girth to be a nice profitable growth business. And I think what you see when the economies really do recover for the steel sector, EU picks up, et cetera, you'll see us well positioned to beat all of our historic financial numbers.

Can you give us some sense of just how much prices fell from -- they're down 11% in the first half, but I know they stepped down from there in 2Q, can you give us some sense of what that number was?

I'd say in the -- if you look quarter-over-quarter, Q2 over Q2, they're down about 15%, you'll see that in the Q. So yes, they took a step change down in the quarter halfway through and then, like I said, for first half down about 11%.

All right, that's helpful. SGL reportedly announced some price increases going forward. I get what they're -- I understand what's happening, no one's making money -- a decent amount of money at these price levels and there's areas that are losing a lot of money. Have you seen anything on the supply side that would indicate that things are turning a corner from that perspective? Has anyone shut down anything, or is capacity pulled back in anyway?

We haven't seen any of that, Luke, no, sir.

Okay. And then maybe can you just talk about where utilization rates are, where in the second quarter? Obviously, I think you said 80% was the target on the last-quarter's call for the year end -- exiting the year. I think that that's probably a lower number now. Can you give us your updated guidance there?

Yes, I can. Q2 came in right around 81%, 82% op level. And then on the full year you are right, I think we're going to be -- we'll definitely be under 80% so we may be around 76%, 77% -- 75%, 76%, 77% op level. So operating rates will be down in electrodes.

And then also on needle coke, the same thing you see in the electrodes triggered by the low steel demand and production levels translates all the way back, of course, to needle coke. So needle coke volumes and sales are down and so we've been running our coker at a very high level. We'll be bringing that down in the second half, too, and the needle coker will probably go down to 90%-type level versus full out. So that's been coming down just a response to the slowdown in the marketplace.

Just last question. For Seadrift into next year, what is the practical max amount of capacity that you could use internally from Seadrift next year now that your contracts with Conoco -- or your contracts with Philips have no minimums on them?

All of that heavy lifting we did around the quality of Seadrift on normal premium. And then the breakthroughs we had on super premium allow us to use all the Seadrift needle coke.

Our strategy has been to sell about half of it in the open market and use half. And then obviously, without the mandated contract buy that we've had the last three years, that finishing up 12/31 this year, obviously that will be up for review. There's no constraints to us using all that coke. And I would expect next year, with a little bit of market improvement Seadrift will run at a very high op level and most likely full out.

Chelsea Bolton from Goldman Sachs.

Just had a quick question on the Engineered Solutions business, obviously a strong quarter for those guys. Your long-term sales target has been $350 million assuming solar comes back, with the strengthening growth in advanced electronics do you think that number could ultimately be higher? How are you think about long-term performance for this business?

Yes, Chelsea, we're thinking this year will be over $250 million. You recall when we started this business several years ago it was about $80 million.

So we're through $250 million for this year and the way we think about it, three-to-five years we think this is a $500 million business. We've gained so much traction so far, we've put infrastructure in the ground, we've built the right team. And so we see this double-digit growth continuing next year and from building from this $250 million plus in sales.

Sal Tharani from Goldman Sachs.

I think Chelsea took my question so I don't have any more questions. Thanks.

Mark Parr from TVAC.

I'm not sure what TVAC is but --

You wear so many hats nowadays.

I guess so. I just -- grandpa's good enough, I'll take that one. One thing I'm curious about is, what -- on the electrode side is there any precedent in the industry for seeding share, cutting capacity, turning plants off for a period of time? I guess along those lines, could you give us some color on how much worse this market has to get before you would actively consider shutting some capacity?

Yes, if we go back, Mark, to the last really brutal trough before the crash at Q4 2008 and go back to the early 2000s and a number of plants got shut down, there were a couple of bankruptcies. So if you go back to the last trough before this, yes, there was that kind of activity.

Time will tell what happens here. Obviously, the economics in the electrode industry have gotten very, very challenging. Some of the players are losing money, they're reporting it. The Chinese, many of those producers are losing a lot of money.

Time will tell and maybe we'll see some of that. I know ultimately what happens is it gets tough with the bank groups for some of the players and then sometimes that is what forces some of the restructuring.

Than they don't have any choice, yes.

Yes, exactly, so time will tell. All we've tried to do -- and you know us well -- is during this trough improve our business model, so we made the acquisitions, we've back integrated, delighted with the back integration. We bought the St. Mary's Electrodes, we picked up two ES companies, so we've tried to really improve our business model.

We're going to have, probably, our second the sales ever this year. So the size is bigger, the breath of the technology. We've improved the cost structure, I think it dramatically vis-a-vis our competition because of the back integration, because of our very strong and active Lean Six Sigma program, and so time will tell. I think there's some others that are suffering and some rationalization they may be driven to.

Clearly suffering than you guys are. If I could follow on to that just real briefly. You said that you operated 81%, 82% in electrodes in the second quarter?

That's right.

And then the -- I guess Luke was asking you and I missed it, did you give some thought about where you might be for the full year?

Yes, the full year we think will come in around 77%, 76%, 75% right in there. We were thinking we were going to be 80%, maybe a little over 80%, but obviously with the slowdown we're going to be a little bit less than that. So we've slowed down the electrodes and like I said, we've also slowed down the needle coker because ultimately this translates into less needle coke demand out there from third-party sales.

Now given the fact that the industry is going to be operating well below full capacity, figuring you guys are probably going to be operating higher than average would be my guess. But how does pitch-based coke potentially help some of these other players to lower their cost given that their capacity -- their graphitization facilities are not running flat out?

Well, remember, pitch -- high-quality pitch needle coke can make a good electrode. It starts off when you buy it a little bit lower cost. But the challenge is to make it graphite you have to process the pitch needle coke much slower so you end up in furnaces longer and it accumulates, obviously, more cost. So when you add all of that up, pitch-based coke doesn't have an advantage. Whatever you start out with a lower price in the beginning, you give up in more furnace time, more power into the furnace, et cetera.

So having available furnace time does not change that equation. It has to stay in there longer to be graphite and that's just the material science around starting with pitch base.

Right, okay. I appreciate that, good luck in the third quarter and it's exciting what you guys have accomplished at ES. Congratulations on that.

Chris Haberlin from Davenport.

Can you talk a little bit about the supply/demand dynamics in needle coke? I think earlier -- on an earlier call you had mentioned that there was some increase supply in 2013. What is the outlook there going forward?

There is some increased supply coming on, not in 2013 but down the road in another 18- to 12-months. What we have today is, because of the low steel demand and hence the low electrode demand, you have a lot of the current players in needle coke running at low operating rates and so you have excess capacity.

There is some new capacity coming on in I think it is about 18 months or so and it's one of the existing players. Obviously there's only a few players that have this technology. And so that's slated to come on -- the production schedule's have changed a few times, but I think that might be the end of 2014 or some time in 2015. So think of that maybe about 18 months once they finally get it running and good quality.

Earlier I think -- and I could have misheard you, but I think you mentioned that costs were up for electrodes. And just trying to understand if there's been no real change in needle coke here what costs are increasing? Is that just a function of operating rates across the industry, or how are you looking at the cost picture?

One is -- well point taken. One operating rates are lower and as we said because of the slowdown our operating rates are going to be even lower this second half than anticipated. So I think everyone in the industry has some optimal operating rate, so that's one bucket of cost and that's the cost increase for us the second half of this year.

Another one is energy. Oil is up. As you see it's $105, $106 now and it's been staying over $100 now for a while, so it is up. Natural gas is up in some regions around the world. We're a global producers so we buy gas in many locations.

Then in some regions electricity is up also. There are some cost pressures that different parts of the world are feeling on producing electrodes.

I'm sorry, jump back to needle coke here. Can you just remind us how the annual contracting for needle coke plays out? Is that something that's typically determined during the fall and then does it normally received your beginning of contracting season for electrodes?

That's correct, Chris. Needle coke contracts would usually get let first and they would start up usually in late August, September time period in a typical year and then electrodes would be after that. Most producers try and line up their needle coke requirements, get their quantities, get the pricing in so they know their cost structure. And then GE producers would go ahead and start doing contracts with the steel industry.

Last one for me. Can you give us an update on the impact of the dollar here on both your realization and your cost and then on the overall competitive environment in the industry?

Yes. One let's talk about our book first and then I'll talk maybe about, perhaps, some of our competitors from a vantage point. For us we're a global producer so we produce in many geographies and so historically and also this year, currencies aren't a major impact for us. In some countries, we've got sales and cost in the local currency so there's puts and takes for us.

Year-to-date currency's been a little bit of a positive impact for us and it is probably around $800,000, $900,000 net, all geographies a positive to us. So it's not a major one. Some six months it can be a minus $800,000.

So for us, think of us as -- because a global producer many geographies cost in some local currencies -- and we have a hedging, a proactive hedging programs, so cost had not -- and currency's not a big factor for us. Now for some of our competitors, obviously we've seen a big weakness in the yen and so that has help some of the Japanese electrode producers to some extent. Remember they buy needle coke and needle coke is a dollar denominated or a dollar driven because the oil starts out in dollars, so there's some puts and takes for them.

But net-net I would say for our Japanese competitors a weaker yen has helped them out. They get a benefit from that and that may be driving some of the pressures we see in the marketplace, too. I'm sure that's a slice of it.

And then last one for me. You had some phenomenal revenue growth in the Engineered Solutions segment. Is that type of level sustainable going forward over the next several quarters? I know you've talked about getting to the $500 million, but as we look into 2014 could we still be seeing mid-teen revenue growth from that business? Or might it be higher, something closer to the 30% that was we saw in the second quarter?

Well, double digit, I don't -- I wouldn't plan on the 30%, 31%, no, sir. I would look at double digit, so 10%, 12%, 15%, yes, and that's with our expectation would be next year barring any major collapse in the global economies. ES has developed some great solutions for some very tough applications. And as you know, it's everything from the heatshield on the Mars Rover to the latest generation smartphones, and so it has a wide range of applications and many, many different industries.

When solar starts to come back some, when some of the manufacturing comes back, remember the EU is a major part of ES sales. They have a lot of for blocking-and-tacking applications in industry that the sales are anemic now. Solar, virtually zero.

So when those come back over the 2014 and 2015, those will also be additive. But for planning purpose I would look next year. 10% to 15% a quarter-type double-digit growth is probably pretty good to plan on for our Engineered Solutions business.

(Operator Instructions)

Charles Bradford, Bradford Research.

We've been compiling some data on electric furnace output for about 50 countries on a monthly basis. And it looks like it peaked up pretty significantly in the in March to July period last year and has been going downhill almost every month since where the BOF has held flat. Big countries, as you know, obviously a China, India, US and what have you. Are you seeing any place where there's a pickup in electric furnace usage that could turn this trend around?

No, Chuck, we would agree directionally with your numbers. I think you're spot on.

EF operating rates and production rates have been below all of the total steel numbers that get reported. So EF is right smack in the middle of the worst part of the trough. I think the turn will probably be driven by some of the factors we've talked about.

Here locally in the US, improvement in nonresidential construction, that will be a big part of the turn. And obviously there everyone follows the ABI index. And the last 10 months ABI numbers have looked very encouraging and they tend to portend, as everyone knows, 12- to 18-months out. So there's some positive data points, but the turn of nonresidential construction numbers in the US will be a key part.

The other one, of course, is the EU. The EU appears to be trying to find a bottom. The rate of decline in most of the markets, most of the countries has slowed.

There's been a couple little signs of positive, but really a turn in the EU will be another key milestone. And we will start -- the EU will have to start putting some positive numbers on the board and for us that's of 35%,some quarters more than 35% of our sales. Those would be the two that we're looking for and I really think, Chuck, until those really turn significantly we're not going to get a major up-tick in EAF.

We have been waiting for the Europeans to do more of a switch to electric furnaces because of carbon capture legislation and so on and carbon pricing. But now I understand there's some new technology that may allow them to use other things in a blast furnace to reduce the carbon emission, which might put off the electric furnace switch, forced [subpoena] as an example of that. What are you seeing in that kind of an area as far as electric furnace attractiveness?

Chuck, when we look at some of the blast furnaces in Europe, some of them are very old and challenged. Eight European companies have already gone into either Chapter 11 or full bankruptcy proceedings since 2009, since the trough years. So things are -- some of those just are not advantaged.

You're right, they have huge carbon footprints and some of those won't come back and some need not to come back. I think another data point we may see in the EU is some more rationalization of some of these large old blast furnaces and then that'll be another part of the turn in the EU. Some of those they just -- they're not advantaged on the environment, they need hundreds of millions of dollars to get compliant. And they can't afford the carbon taxes that are coming down the road, and then finally the economics just aren't good. They're not competitive.

I think that will be part of this the bottoming process and we've seen that before if I take you back to the last trough in the early 2000's, and so we've seen some of that already. You've seen some of the big steel producers working on it. Some of them are in discussions with local governments to try and make some of that happen. I think we're in that bottoming process and when we start to get some positive numbers out of the EU then I think you'll start to see the EAF pick up.

I just worry about what they're doing on electric prices with Germany closing all their nukes, but that's a different issue. Thank you for your time.

Sal Tharani from Goldman Sachs.

Just a housekeeping first, what's your tax rate we should look in the second half because it was pretty low this second quarter?

We had a -- on a year-to-date basis we had about a 30% tax rate and we're guiding for the full year 35% to 40%. So you can see that the second-half tax rate will be a little higher. First half had a couple of discrete items but -- so I would expect the second half to be in that higher end of our range that we referenced for the full year to average out.

You mentioned about the weakness in the capital market, which we are seeing, and also you have reduced your guidance. I'm just wondering, how should we think about next year if you're going to order -- start building the order book in a weak environment should we expect that prices actually could be down next year?

Sal, I really think it's too early to tell. We're just finishing up mid year here so I think that's too early to tell. Our next report out, Q3 may be a better time just to give some color, but I just think we're way too early to look into 2014 right now.

When do you start building your order book, by the way?

Yes, the needle coke will come first and the needle coke usually kind of the end of August, September I would expect this year. And then electrodes would be after that and that seems to be the timeframe this year.

Kenneth Hemphill, a private investor.

I have two questions, first one is the Affordable Healthcare Act. Is that going to have any impact on your cost structure?

Ken, excellent question. I think we, like a lot of other manufacturers in the US, are concerned what it may mean to the cost structure. We've run a very, very good healthcare program for our teammates here in the US.

It's company run, it's had always below market increases and it's been very competitive. We run it ourselves, we have wellness centers in our facilities, we've got proactive health maintenance and preventive care. So we, like a lot of US employers, we're most concerned about our own teammates, right, and we take great care of them.

I think Affordable Care a lot of unknowns. I think even some folks in the government are still trying to understand it and when we ask questions about it from the government officials, there seems to be a lot of uncertainty. Ken, time will tell, but I share your concern. I'm worried that this government-run thing will increase costs somewhat and right now all we hear from it is it's being delayed. It's so good that we're going to delay it, it's one of those.

Let's say we're concerned. We're watching very closely, we've been very happy with the program we've set up. All of our US teammates are on the exact same programs and so we're watching that Affordable Care very cautiously.

My second question, I read an awful lot about this new product called graphene. And what is your -- how are you making out with that project?

We are one of the early producers of graphene. I think we have one of the earliest patents that was posted on graphene. And so our teammates have been at the front end of this and so our R&D facility here in Parma very involved in graphene.

I think the day will come when graphene has a very significant role in a number of unique applications, very challenging applications where it has to be very lightweight, very strong and with tremendous electric conductivity properties. But I stress we're at the front end, I think graphene as an industry is at the front end and so is it five-years out, seven-years out, yes it could before it really becomes significant.

We are very excited about it and there's not a day, not a week here that our PhD's aren't working with graphene. We've got a lot of papers my teammates have published here and we look forward to good commercial developments in graphene.

Richard Remey from [Isbalt]

In regards to graphene, what are your views about the molybdenum disulfide, which is the same idea as the graphene to the dimensional material much easier to print circuits on, what are your views about it?

Some of my teammates may be much better positioned to answer that, some of our PhD's, but what I will say is, our team is working in a number of different applications. I wouldn't want to comment on a specific application this early in the process. Obviously I think many companies are chasing solutions and applications here in different industries and I think at this early foundation stage it's not good to play any cards.

Like we've done and you've seen us commercialize many products in Engineered Solutions and obviously graphene and its future resides in our Engineered Solutions business. But you've seen us play these cards very close to our vests. We develop their product, we take it to our customers, we get engineered into our customers product to become a great solution and then we tell the marketplace about it. Often before that we've done a lot of IP to protect our technology.

So I'm hesitant, Richard, to comment on any specific one other than to say we share your enthusiasm. This is a unique product and has unique attributes and five years, seven years down the road will be, I think, commercialized in some very good market segments.

Thank you. There are no further questions at this time. I will turn it back over to Management for closing remarks.

Thank you very much, everyone, thanks for joining our call and have a great week. Take care.

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