GRAFTECH INTERNATIONAL LTD - Quarter Report: 2010 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

for the quarterly period ended March 31, 2010

OR

for the transition period from              to             

Commission file number: 1-13888

GRAFTECH INTERNATIONAL LTD.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (216) 676-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  x    Accelerated Filer  ¨    Non-Accelerated Filer  ¨    Smaller Reporting Company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).    Yes  ¨    No  x

As of April 19, 2010, 124,474,769 shares of common stock, par value $.01 per share, were outstanding.

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TABLE OF CONTENTS

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PART I. FINANCIAL INFORMATION

GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

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PART I (CONT’D)

GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share amounts)

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

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PART I (CONT’D)

GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

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PART I (CONT’D)

GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) Interim Financial Presentation

These interim Consolidated Financial Statements are unaudited; however, in the opinion of management, they have been prepared in accordance with Rule 10-01 of Regulation S-X and in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted or condensed. These interim Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements, including the accompanying Notes, contained in our Annual Report on Form 10-K for the year ended December 31, 2009 (the “Annual Report”).

The unaudited consolidated financial statements reflect all adjustments (all of which are of a normal, recurring nature) which management considers necessary for a fair statement of financial position, results of operations and cash flows for the interim periods presented. The results for interim periods are not necessarily indicative of results which may be expected for any other interim period or for the full year.

(2) New Accounting Standards

Recently Adopted Accounting Standards

Consolidation

In June 2009, the FASB amended the consolidation accounting guidance. We are required to qualitatively assess the determination of our being the primary beneficiary (“consolidator”) of a variable interest entity (“VIE”) on whether we (1) have the power to direct matters that most significantly impact the activities of the VIE, and (2) have the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. It also requires an ongoing reconsideration of the primary beneficiary and amends events that trigger a reassessment of whether an entity is a VIE. The new model is applicable to all new and existing VIE’s. The prospective adoption of this new guidance on January 1, 2010, had no impact on our consolidated financial position or results of operation.

Transfers of Financial Assets

In June 2009 the FASB amended the accounting guidance for determining whether a transfer of a financial asset qualifies for sale accounting. The amended guidance also provided four broad disclosure objectives designed to provide users of the financial statements with an understanding of:

The prospective adoption of this guidance to our accounts receivable factoring arrangement beginning January 1, 2010 had no impact on our consolidated financial position or results of operation.

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GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3) Stock-Based Compensation

For the three months ended March 31, 2009 and 2010, we recognized stock-based compensation expense totaling $0.5 million and $1.8 million, respectively. A majority of the expense, $0.5 million and $1.6 million, respectively, was recorded as selling and administrative expenses in the Consolidated Statement of Operations, with the remaining expenses incurred as cost of sales and research and development.

At March 31, 2010, the total compensation cost related to non-vested restricted stock, performance shares and stock options not yet recognized was $12.4 million, which will be recognized over the weighted average life of 1.5 years.

Restricted Stock and Performance Shares

Restricted stock and performance share awards activity under the plans for the three months ended March 31, 2010 was:

Stock Options

Stock option activity under the plans for the three months ended March 31, 2010 was:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(4) Earnings Per Share

The following table shows the information used in the calculation of our share counts for basic and diluted earnings per share:

Basic earnings per common share are calculated by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share are calculated by dividing net income by the sum of the weighted average number of common shares outstanding plus the additional common shares that would have been outstanding if potentially dilutive securities had been issued.

The weighted average common shares outstanding for the diluted calculation excludes consideration of stock options covering 1,190,703 and 227,000 shares at March 31, 2009 and 2010, respectively, because the exercise prices were greater than the weighted average market price of our common stock for each of those periods.

(5) Segment Reporting

Our businesses are reported in the following reportable segments:

Industrial Materials. Our Industrial Materials segment manufactures and delivers high quality graphite electrodes and refractory products. Electrodes are key components of the conductive power systems used to produce steel and other non-ferrous metals. Refractory products are used in blast furnaces and submerged arc furnaces due to their high thermal conductivity and the ease with which they can be machined to large or complex shapes.

Engineered Solutions. Engineered Solutions include advanced graphite materials products for the transportation, solar, and oil and gas exploration industries, as well as natural graphite products.

We continue to evaluate the performance of our segments based on segment operating income. Intersegment sales and transfers are not material and the accounting policies of the reportable segments are the same as those for our Consolidated Financial Statements as a whole. Corporate expenses are allocated to segments based on each segment’s percentage of consolidated net sales.

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GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following tables summarize financial information concerning our reportable segments:

(6) Investment in and Loan to Non-Consolidated Affiliate

Acquisition

On June 30, 2008, we acquired 100% of the common stock of Falcon-Seadrift Holding Corp., now named GrafTech Seadrift Holding Corp. (“GTSD”). The principal asset of GTSD is limited partnership units constituting approximately 18.9% of the equity interests of Seadrift Coke L.P. (“Seadrift”), a privately-held producer of needle coke, the primary raw material used in the manufacture of graphite electrodes. Seadrift is one of the four main producers of needle coke. Needle coke is a critical raw material, without substitutes, required to produce a graphite electrode and represents approximately 40% of our total cost to produce. At the time of the acquisition, industry sales of graphite electrodes were at an all-time high and needle coke production was at or near full capacity. The availability and rising cost of needle coke was creating a compelling threat to the profitability and growth of our business model. In order to partially hedge the impact of rising needle coke cost and, more importantly, to potentially position ourselves to gain a controlling interest, we purchased our 18.9% ownership interest in Seadrift.

The substance of the transaction was the acquisition of an asset, the limited partnership units. The cost of our acquisition was $136.5 million (net of $0.4 million cash received) of which $135.0 million cash was paid to the prior sole shareholder of GTSD.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

In addition to the limited partnership units of Seadrift, we obtained certain rights associated with these interests. These include: the right to one of five seats on Seadrift’s board of directors (or, at our election, board observation rights in lieu thereof); the right of approval with respect to certain mergers and other transactions; and the right to veto Seadrift’s repurchase of its own equity (other than from former employees). There are also customary rights permitting or requiring us to sell our interests on the same terms and conditions if the majority owners sell their interests. Beginning May 1, 2011, we have the right to require Seadrift to purchase our interests (a “put” to Seadrift) at the then fair market value (determined by a third-party assuming a sale of Seadrift as a going concern and without applying a discount for lack of liquidity, marketability, or lack of control).

We accounted for the acquisition of GTSD as the acquisition of an asset – limited partnership units in Seadrift – rather than as a business combination. Because the amount we paid for the limited partnerships units exceeded their tax basis accounting required us to recognize a deferred tax liability for this difference. We increased the purchase price by $41.8 million to recognize the deferred tax liability applicable to the difference between the amount we paid and the tax basis of the Seadrift limited partnership units. At the time of the acquisition we had a deferred tax asset valuation allowance. The accounting for the acquisition of Seadrift resulted in a taxable temporary difference that is expected to reverse during the same period that our deferred tax assets are expected to reverse. Accounting guidance required us to reduce our preexisting valuation allowance and decrease the purchase price of Seadrift by $22.4 million. The net result was an increase in the initial carrying amount for the investment in Seadrift of $19.4 million.

Equity in (Earnings) Losses and Summarized Financial Information

Seadrift is a pass-through entity. We account for our investment in Seadrift using the equity method of accounting. Our equity in (earnings) losses is based on Seadrift’s results of operations with a one-month lag because its accounting close and financial statement preparation cycle occurs subsequent to our reporting deadline for our corresponding cycle. We include material intervening events and an estimate for the effect of Seadrift’s LIFO inventory accounting on interim periods. The equity (earnings) in losses reflected in our statements of operation includes the amortization of the difference between our cost of the investment and the net assets of Seadrift assigned to the long-lived assets ($1.3 million and $0.5 million expense in the three months ended March 31, 2009 and 2010, respectively).

The following table shows summarized financial information for Seadrift, including adjustments for material intervening events, for the three months ended March 31, 2009 and 2010 (dollars in thousands):

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(Unaudited)

Write-down of Investment to Its Fair Value

We perform an assessment of our investment in Seadrift for impairment whenever changes in the facts and circumstances indicate that a loss in value has occurred, which is other than temporary. Because Seadrift is privately-held, we determine the fair value using an income approach (based upon the present value of expected future cash flows, using discount rates commensurate with the risks of the investment), a “Level 3” value in accordance with the definition in ASC 820, Fair Value Measurements and Disclosures. Our valuation method uses a discounted cash flow model in which cash flows anticipated over several periods, plus a terminal value at the end of that time horizon are discounted to their present value using an appropriate rate of return. We used the constant growth method to determine the terminal value.

At December 31, 2008, we determined that the fair value of the investment was less than our carrying value and that the loss in value was other than temporary. We recorded a $34.5 million noncash impairment to recognize this other than temporary loss in value. Because the impairment reduced the difference between the cost of our investment and its tax basis, we reduced the deferred tax liability recognized at the acquisition by $12.1 million. The reduction of the valuation allowance at the acquisition was not affected by the impairment.

At June 30, 2009, we determined that the fair value of the investment was less than our carrying value and that the loss in value was other than temporary. We recorded a $52.8 million noncash impairment to recognize this other than temporary loss in value. Because the impairment reduced the difference between the carrying amount of our investment and its tax basis, we recorded a net tax benefit of $7.4 million representing the net change of the deferred tax liability and the restoration of the valuation allowance recognized at the acquisition.

Given the current economic environment and the uncertainties regarding the impact on steel producers and their suppliers, including Seadrift, there can be no assurances that our estimates and assumptions regarding the fair value of Seadrift will prove to be accurate. If the assumptions regarding forecasted revenue, growth rates, and expected profitability are not achieved, we may be required to record additional impairment charges in future periods.

Loan to Seadrift

In late June and early July 2009, Seadrift entered into agreements to borrow up to $17.0 million from certain of its shareholders, which includes GrafTech. We agreed to loan up to $8.5 million and on July 2, 2009, we loaned Seadrift $6.0 million. We recorded the loan at its face amount, which reasonably approximated the present value of the note.

On March 31, 2010 Seadrift fully repaid the $6.0 million Demand Notes to us and the obligation to make any further loans or advances had ceased and terminated.

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GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(7) Other (Income) Expense, Net

The following table presents an analysis of other expense (income), net:

(8) Benefit Plans

The components of our consolidated net pension cost are set forth in the following table:

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(Unaudited)

The components of our consolidated net postretirement cost are set forth in the following table:

(9) Long-Term Debt and Liquidity

The following table presents our long-term debt:

We have a $215 million Revolving Facility that expires on July 15, 2010 of which we have no borrowings outstanding at March 31, 2010. We have completed the refinancing of our senior secured revolving credit facility effective April 29, 2010, see footnote 17, “Subsequent Events” on page 18 for a further discussion.

On September 30, 2009, our Spanish subsidiary received a $1.8 million economic stimulus loan from the Ministry of Industry, Government of Spain. The loan is non-interest bearing and matures in October 2024. Repayment in 10 annual installments commences in October 2015. The loan is to be used for costs associated with a capital project. We must return a proportionate amount of the loan if we do not spend the amount budgeted for the capital project prior to June 10, 2010. Since we have spent approximately 92% of the required amount as of March 31, 2010, the remaining 8% of the cash received is reported as restricted cash in our consolidated balance sheet. Because the loan is non-interest bearing, we are required to record the loan at its present value of $1.1 million (determined using an interest rate of 4.33%). The difference between the proceeds received and the present value of debt is recorded as debt discount and deferred expense. The discount will be amortized to income using the interest method; the deferred charge will be amortized to income using the same basis and over the same period as the capital projects are depreciated. The loan balance, net of unamortized discount, was $1.1 million at March 31, 2010.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(10) Inventories

Inventories are comprised of the following:

We recognize abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) as current period charges. We are required to allocate fixed production overheads to the costs of conversion based on normal capacity of the production facilities. The unabsorbed costs were attributable to adjustments of fixed production overheads to the costs of conversion based on normal capacity versus actual levels, due to production levels at certain facilities being below normal capacity for the quarters ended March 31, 2009 and 2010. Costs in excess of normal absorption at March 31, 2009 and 2010 were $7.2 million and $2.5 million, respectively.

(11) Interest Expense

The following table presents an analysis of interest expense:

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(Unaudited)

(12) Other Comprehensive (Loss) Income

Other comprehensive (loss) income consisted of the following:

(13) Supply Chain Financing

During the third quarter of 2008, we entered into a supply chain financing arrangement with a financing party. Under this arrangement, we essentially assign our rights to purchase needle coke from our supplier to the financing party. The financing party purchases the product from our supplier under the standard payment terms and then immediately resells it to us under longer payment terms. The financing party pays the supplier the purchase price for the product and then we pay the financing party. Our payment to the financing party for this needle coke includes a mark up (the “Mark-Up”). The Mark-Up is a premium expressed as a percentage of the purchase price. The Mark-Up is subject to quarterly reviews. This arrangement helps us to maintain a balanced cash conversion cycle between inventory payments and the collection of receivables. Based on the terms of the arrangement, the total amount that we owe to the financing party may not exceed $49.3 million at any point in time.

We record the inventory once title and risk of loss transfers from the supplier to the financing party. The amount recorded as a liability to the financing party was $14.4 million and $39.1 million at December 31, 2009 and March 31, 2010, respectively. The financing party invoiced us $25.4 million and $51.2 million for the three months ended March 31, 2009 and 2010, respectively, for purchases of inventory under this arrangement. We recognized Mark-Up of $0.3 million and $0.4 million for the three months ended March 31, 2009 and 2010, respectively as interest expense.

(14) Contingencies

We are involved in various investigations, lawsuits, claims, demands, environmental compliance programs and other legal proceedings arising out of or incidental to the conduct of our business. While it is not possible to determine the ultimate disposition of each of these matters, we do not believe that their ultimate disposition will have a material adverse effect on our financial position, results of operations or cash flows.

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(Unaudited)

Product Warranties

We generally sell products with a limited warranty. We accrue for known warranty claims if a loss is probable and can be reasonably estimated. We also accrue for estimated warranty claims incurred based on a historical claims charge analysis. Claims accrued but not yet paid amounted to $1.2 million at December 31, 2009 and $1.4 million at March 31, 2010. The following table presents the activity in this accrual for the three months ended March 31, 2010 (dollars in thousands):

(15) Income Taxes

We compute an estimated annual effective tax rate on a quarterly basis, considering ordinary income and related income tax expense. Ordinary income refers to income (loss) before income tax expense excluding significant, unusual, or infrequently occurring items. The tax effect of an unusual or infrequently occurring item is recorded in the interim period in which it occurs. These items may include the cumulative effect of changes in tax laws or rates, impairment charges, adjustments to prior period uncertain tax positions, or adjustments to our valuation allowance due to changes in judgment of the realizability of deferred tax assets.

The provision for income taxes for the three months ended March 31, 2009 and 2010 was a tax expense of $5.2 million on pretax income of $13.6 million, and a tax expense of $11.7 million on pretax income of $45.2 million, respectively. The effective tax rates were 37.9% and 25.8% for the three months ended March 31, 2009 and 2010, respectively. The decrease in the effective tax rate is primarily due to jurisdictional shifts of income, currency fluctuations, and changes in the utilization of attributes and related valuation allowances.

Our cumulative year-to-date unrecognized tax benefits have increased by $14.9 million, primarily as a result of tax positions taken in a prior period. This has an unfavorable impact on our effective rate of $3.4 million. We are able to utilize attributes and release related valuation allowances against the remainder of this amount. As of March 31, 2010, we had unrecognized tax benefits of $35.6 million, which would have a favorable impact on our effective tax rate. It is reasonably possible that a reduction in a range of $1.0 million to $2.0 million of unrecognized tax benefits may occur within 12 months as a result of the expiration of statutes of limitation.

We file income tax returns in the U.S. federal and state jurisdictions and various non-U.S. jurisdictions. We are currently under federal audit by the Internal Revenue Service for tax year 2007. All U.S. tax years prior to 2006 are closed by statute or have been audited and settled with the U.S. tax authorities. We are also under audit in Italy for our 2006 tax year. All other jurisdictions are still open to examination beginning after 2003.

Our tax provision for the three months ended March 31, 2009 and 2010 were primarily for taxes on our international income. We continue to adjust the tax provision rate through the establishment, or release, of non-cash valuation allowances attributable to the U.S. and certain non-U.S. taxing jurisdictions, including U.S. foreign tax credit utilization. We weigh both positive and negative evidence in determining whether a valuation allowance is required. Examples of positive evidence would include a strong earnings history, an event or events that would increase our taxable income through a continued reduction of expenses, and tax planning strategies that would indicate an ability to realize deferred tax assets. The balance of significant positive evidence does not yet outweigh the negative evidence in regards to whether or not a valuation allowance is required.

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GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

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(Unaudited)

(16) Derivative Instruments

We use derivative instruments as part of our overall foreign currency and commodity risk management strategies to manage the risk of exchange rate movements that would reduce the value of our foreign cash flows and to minimize commodity price volatility. Foreign currency exchange rate movements create a degree of risk by affecting the value of sales made and costs incurred in currencies other than the US Dollar.

Foreign currency contracts

We enter into foreign currency contracts from time to time to attempt to manage exposure to changes in currency exchange rates. These foreign currency instruments, which include, but are not limited to, forward exchange contracts and purchased currency options, attempt to hedge global currency exposures, net, relating to non-dollar denominated debt and identifiable foreign currency receivables, payables and commitments held by our foreign and domestic subsidiaries. Forward exchange contracts are agreements to exchange different currencies at a specified future date and at a specified rate. For the three months ended March 31, 2010, there was no ineffectiveness on these contracts.

In 2009 and 2010, we entered into foreign forward exchange contracts where we sold currency forward as economic hedges of anticipated cash flows denominated in the Mexican peso and Brazilian real. These contracts were entered into to protect the risk that the eventual cash flows resulting from such transactions will be adversely affected by changes in exchange rates between the US dollar and either the Mexican peso or Brazilian real. As of March 31, 2010, we had outstanding Mexican peso and Brazilian real forward exchange contracts, with aggregate notional amounts of $14.3 million. The forward exchange contracts outstanding as of March 31, 2010 have several maturity dates ranging from June to December 2010.

Commodity forward contracts

We periodically enter into commodity forward contracts to purchase natural gas and short duration fixed rate purchase contracts to effectively fix some or all of our natural gas cost exposure. These contracts were entered into to protect against the risk that eventual cash flows related to purchases of natural gas will be adversely affected by future changes in prices. For the three months ended March 31, 2010, there was no ineffectiveness on these contracts.

In 2009 and 2010, we entered into commodity forward contracts as economic hedges of exposure to variability of commodity prices for natural gas. These contracts were entered into to protect against the risk that the eventual cash flows related to purchases of natural gas will be adversely affected by future changes in prices. As of March 31, 2010, we had outstanding natural gas commodity forward contracts with an aggregate notional amount of $2.4 million. The commodity forward contracts outstanding as of March 31, 2010 have several maturity dates ranging from April to December 2010.

None of our derivative contracts contain provisions that would require us to provide collateral. Derivative contracts that we may enter into in the future may contain such provisions. Since the counterparties to these financial instruments are large commercial banks and similar financial institutions, we do not believe that we are exposed to material counterparty credit risk, despite the current worldwide economic situation. We do not anticipate nonperformance by any of the counter-parties to our instruments.

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GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The fair value of all derivatives is recorded as assets or liabilities on a gross basis in our Consolidated Balance Sheets. At December 31, 2009 and March 31, 2010, the fair values of our derivatives and their respective balance sheet locations are presented in the following table:

The location and amount of realized (gains) losses recognized in the Statement of Operations for derivatives are as follows for the three months ended March 31, 2009 and 2010:

Certain of our foreign currency contracts and all of our commodity contracts are treated as hedges under ASC 815, Derivatives and Hedging and are required to be measured at fair value on a recurring basis. With respect to the inputs used to determine the fair value, we use observable, quoted rates that are determined by active markets and therefore, classify the contracts as “Level 2” in accordance with the definition in ASC 820, Fair Value Measurements and Disclosures.

(17) Subsequent Events

Credit Agreement Refinancing

On April 29, 2010, we announced the successful completion of the refinancing of our senior secured revolving credit facility (“Facility”) that was due to expire on July 15, 2010. Borrowers under the Facility are GrafTech Finance Inc. (“Graftech Finance”) and GrafTech Switzerland S.A. (“Swissco”), both wholly-owned subsidiaries.

As amended and restated, the Credit Agreement provides for, among other things, an extension until April 29, 2013 of the maturity of the senior secured revolving credit facility in the initial amount of $260 million (the “Revolving Facility”), additional flexibility for investments and acquisitions and, subject to certain conditions, an “accordion feature” that permits GrafTech Finance and Swissco to establish additional credit facilities thereunder in an aggregate amount, together with the Revolving Facility, of up to $390 million.

The Revolving Facility provides for revolving loans (and for swingline loans in aggregate principal amount at any time not to exceed $25 million) to GrafTech Finance and Swissco in an aggregate principal and stated amount not to exceed $260 million at any time. The Revolving Facility also provides capacity for issuance of letters of credit for the accounts of GrafTech Finance, Swissco and other designated subsidiaries for an amount not exceeding $35 million. Revolving and swingline loans and letters of credit may be denominated in dollars, euros and certain other currencies and are available for working capital and other general corporate purposes.

The Credit Agreement provides for the lenders to terminate their commitments in the event of a default (as defined in the Agreement) or if there has been a material adverse change in our consolidated assets, liabilities (including contingent liabilities), business, properties, financial condition, or results of operations.

The interest rate applicable to the Revolving Facility is, at GrafTech’s option, either LIBOR plus a margin ranging from 2.50% to 3.50% (depending on our total net leverage ratio and/or senior unsecured rating) or, in the case of dollar denominated loans, the alternate base rate plus a margin ranging from 1.50% to 2.50% (depending upon such ratio or rating). The alternate base rate is the highest of (i) the prime rate announced by JP Morgan Chase Bank, N.A., (ii) the federal fund effective rate plus 0.50% and (iii) the London interbank offering rate (as adjusted) for a one-month interest period plus 1.00%. GrafTech Finance and Swissco pay a per annum fee ranging from 0.375% to 0.750% (depending on such ratio or rating) on the undrawn portion of the commitments under the Revolving Facility.

The financial covenants require us to maintain a minimum interest coverage ratio of 1.75 to 1.00 and a maximum net senior secured leverage ratio of 2.25 to 1.00, subject to adjustment for certain events. The Revolving Facility also contains a number of covenants that restrict certain corporate activities including annual capital expenditures and the payment of dividends and repurchases of our common stock.

Acquisitions and Reorganization

On April 29, 2010, we, and certain of our subsidiaries, entered into an agreement and plan of merger with Seadrift Coke, L.P., a Delaware limited partnership (“Seadrift”), and certain of its partners, to acquire all of the equity interests of Seadrift that we do not already own. We currently own limited partnership units constituting approximately 18.9% of the equity interests in Seadrift. Seadrift is the world’s second largest producer of petroleum-based needle coke, the primary raw material used to manufacture graphite electrodes. At the same time, we, and certain of our subsidiaries, entered into an agreement and plan of merger with C/G Electrodes, LLC, a Delaware limited liability company (“C/G”), and certain of its members. C/G is the only U.S. owned and operated manufacturer of large diameter UHP graphite electrodes used in the electric arc furnace steel making process.

The consideration to be paid for Seadrift will consist of $78.5 million in cash less debt (subject to working capital adjustments), 12 million New GTI Shares (subject to adjustments for stock splits, reverse stock splits or similar transactions) and non-interest, senior subordinated promissory notes in an aggregate face amount of $100 million due in 2015. The consideration to be paid for C/G will consist of $152.5 million in cash less debt (subject to working capital adjustments), 12 million New GTI Shares and non-interest bearing, senior subordinated promissory notes in an aggregate face amount of $100 million due in 2015. Approximately $185 million of the cash consideration to be paid in connection with the transactions will be funded through borrowings under our principal revolving credit facility, as amended and restated on April 29, 2010. The balance of the cash portion of the purchase price will be paid from cash on hand. The New GTI Shares delivered to the former owners of Seadrift and C/G will not be registered under the Securities Act. The New GTI Shares will be delivered on the respective dates that the acquisitions of Seadrift and C/G are completed.

In connection with the acquisitions, GrafTech will reorganize into a new holding company structure (the “Reorganization”) pursuant to agreements and plans of merger and Section 251(g) of the General Corporation Law of the State of Delaware. The new holding company will be identical to our existing holding company, GrafTech, in all material respects, including its Board of Directors, management and capital structure. At the closing of the mergers, all outstanding shares of our common stock will automatically be converted into identical common stock representing the same percentage ownership of and voting rights in the new holding company, which will also be a Delaware corporation.

To effect the Reorganization GrafTech formed the new Delaware holding company as a wholly owned subsidiary, which in turn formed a wholly owned subsidiary, GrafTech Delaware I Inc., (“Acquisition Sub”), and two other wholly owned subsidiaries which will merge with and into C/G and Seadrift, respectively. Pursuant to the agreements and plans of merger, GrafTech will then merge with and into Acquisition Sub (the “Merger”), with GrafTech being the surviving entity. In the Merger, each share of the common stock of Acquisition Sub issued and outstanding immediately prior to the Merger and held by the new Delaware holding company will be converted into and exchanged for a share of GrafTech’s common stock (each, an “Old GTI Share”), Acquisition Sub’s corporate existence will cease and GrafTech will become a wholly-owned subsidiary of the new holding company. Each Old GTI Share issued and outstanding immediately prior to the Reorganization will convert into and be exchanged for one share, par value $0.01 per share, of common stock of the new Delaware holding company (each, a “New GTI Share”), having the same rights, powers, preferences, qualifications, limitations and restrictions as the Old GTI Shares. Immediately after the Merger, the new Delaware holding company will be renamed GrafTech International Ltd. and the name of GrafTech will be changed to GrafTech Holdings Inc.

The certificate of incorporation and bylaws of the new Delaware holding company will be identical to those of GrafTech, and the directors and officers of the new holding company will be identical to the directors and officers of GrafTech immediately prior to consummation of the Merger. GrafTech’s stockholders will not recognize gain or loss for United States federal income tax purposes upon the Reorganization. Stockholder approval is not required to effect the Reorganization. Stockholders do not and will not have dissenters’ rights or appraisal rights in connection with the Reorganization. The New GTI Shares to be issued to GrafTech’s stockholders in connection with the Reorganization will be registered pursuant to a registration statement on Form S-4.

The agreements and plans of merger will contain customary representations and warranties, most of which will not survive the effective time of the relevant mergers.

The acquisitions are subject to customary conditions, including expiration of the waiting period under the Hart-Scot-Rodino Antitrust Improvements Act of 1976. The C/G acquisition is also subject to the consummation of the Seadrift acquisition. The owners of Seadrift and C/G receiving New GTI Shares will enter into a registration rights and stockholder agreement (the “Stockholder Agreement”) as a condition of the closing that will subject them to customary standstill provisions and certain restrictions on the sale of their New GTI Shares in addition to the limitations provided by applicable securities laws. Following the consummation of both the Seadrift and C/G acquisitions, the current controlling owners of Seadrift and C/G will have the right to nominate a director for the Board of Directors of the new Delaware holding company so long as such stockholders continue to own 12 million or more New GTI Shares.

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Introduction to Part I, Item 2, and Part II, Item 1

Important Terms. We define various terms to simplify the presentation of information in this Report. These terms, which definitions are incorporated herein by reference, are defined in “Part I – Preliminary Notes – Important Terms” of the Annual Report.

Presentation of Financial, Market and Legal Data. We present our financial information on a consolidated basis.

Unless otherwise noted, when we refer to dollars, we mean U.S. dollars.

Unless otherwise specifically noted, market and market share data in this Report are our own estimates or derived from sources described in “Part I – Preliminary Notes – Presentation of Financial, Market and Legal Data” in the Annual Report, which description is incorporated herein by reference. Our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under “Forward Looking Statements and Risks” in this Report and “Forward Looking Statements” and “Risk Factors” in the Annual Report. We cannot guarantee the accuracy or completeness of this market and market share data and have not independently verified it. None of the sources has consented to the disclosure or use of data in this Report.

Reference is made to the Annual Report for background information on various risks and contingencies and other matters related to circumstances affecting us and our industry.

Neither any statement made in this Report nor any charge taken by us relating to any legal proceedings constitutes an admission as to any wrongdoing.

Forward Looking Statements and Risks. This Report contains forward looking statements. In addition, we or our representatives have made or may make forward looking statements on telephone or conference calls, by webcasts or emails, in person, in presentations or written materials, or otherwise. These include statements about such matters as: expected future or targeted operational and financial performance; growth rates and future production and sales of products that incorporate or that are produced using our products; changes in production capacity in our operations and our competitors’ or customers’ operations and the utilization rates of that capacity; growth rates for, future prices and sales of, and demand for our products and our customers products; costs of materials and production, including anticipated increases or decreases therein, our ability to pass on any such increases in our product prices or surcharges thereon, or customer or market demand to reduce our prices due to such decreases; changes in customer order patterns due to changes in economic conditions; productivity, business process and operational initiatives, and their impact on us; our position in markets we serve; financing and refinancing activities; investments and acquisitions that we have made or may make in the future and the performance of the businesses underlying such acquisitions and investments; employment and contributions of key personnel; employee relations and collective bargaining agreements covering many of our operations; tax rates; capital expenditures and their impact on us; nature and timing of restructuring charges and payments; strategic plans and business projects; regional and global economic and industry market conditions, the timing and magnitude of changes in such conditions and the impact thereof; interest rate management activities; currency rate management activities; deleveraging activities; rationalization, restructuring, realignment, strategic alliance, raw material and supply chain, technology development and

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collaboration, investment, acquisition, venture, operational, tax, financial and capital projects; legal proceedings, contingencies, and environmental compliance including any regulatory initiatives with respect to greenhouse gas emissions which may be proposed; consulting projects; potential offerings, sales and other actions regarding debt or equity securities of us or our subsidiaries; and costs, working capital, revenues, business opportunities, debt levels, cash flows, cost savings and reductions, margins, earnings and growth. The words “will,” “may,” “plan,” “estimate,” “project,” “believe,” “anticipate,” “expect,” “intend,” “should,” “would,” “could,” “target,” “goal,” “continue to,” “positioned to” and similar expressions, or the negatives thereof, identify some of these statements.

Our expectations and targets are not predictors of actual performance and historically our performance has deviated, often significantly, from our expectations and targets. Actual future events and circumstances (including future results and trends) could differ materially, positively or negatively, from those set forth in these statements due to various factors. These factors include:

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Occurrence of any of the events or circumstances described above could also have a material adverse effect on our business, financial condition, results of operations, cash flows or the market price of our common stock.

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No assurance can be given that any future transaction about which forward looking statements may be made will be completed or as to the timing or terms of any such transaction.

All subsequent written and oral forward looking statements by or attributable to us or persons acting on our behalf are expressly qualified in their entirety by these factors. Except as otherwise required to be disclosed in periodic reports required to be filed by public companies with the SEC pursuant to the SEC’s rules, we have no duty to update these statements.

For a more complete discussion of these and other factors, see “Risk Factors” in the Annual Report.

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Global Economic Conditions

We are impacted in varying degrees, both positively and negatively, as global, regional or country conditions fluctuate. Our discussions about market data and global economic conditions below are based on or derived from published industry accounts and statistics.

Based on current International Monetary Fund (IMF) projections and other global economic forecasts, world output is projected to rise in 2010 in both advanced and emerging economies, although to varying degrees. Recovery in advanced economies is anticipated to be weak by past standards while emerging economies are poised for a quicker and stronger recovery given robust internal demand. While recovery has begun in certain regions, electric arc furnace steel end market demand is anticipated to remain below pre-crisis levels.

Global steel operating rates continued to rise in the first quarter of 2010, due to the improving global economic situation, lower steel inventories, and slowly improving demand from key steel end-markets, such as automotive, construction, and appliances.

According to published reports, global steel capacity utilization was approximately 80% for the three months ended March 31, 2010, an estimated increase of 15 percentage points compared to the same period last year. The United States steel industry operated at approximately 68% for the three months ended March 31, 2010 compared to 43% utilization for the three months ended March 31, 2009. For the United States, this is an estimated increase of 25 percentage points.

Industrial materials demand is primarily linked with the global production of steel in an electric arc furnace and, to a lesser extent, with the total production of steel and certain other metals. During the three months ended March 31, 2010, global steel production, excluding China, increased by 33% compared to the same period last year. China’s steel production increased by 24% during the three months ended March 31, 2010, contributing to global steel production increase of 29%. Based on industry projections, the total steel production for the second quarter 2010 will be approximately 343 million metric tons, an increase of approximately 20% compared to the same period last year and slightly higher than the first quarter of 2010.

EAF steel production has followed a similar trend as overall steel production. During the three months ended March 31, 2010, estimated EAF steel production, excluding China, increased by 22% compared to the same period last year. China’s estimated EAF steel production increased by 24% during the three months ended March 31, 2010, contributing to an estimated global EAF steel production increase of 22%. EAF steel production for the second quarter of 2010 will be approximately 96 million metric tons, an estimated increase of approximately 14% compared to the same period last year and slightly higher than the first quarter of 2010.

Generally, changes in graphite electrode demand have tracked changes in EAF steel production. Graphite electrode industry recovery is anticipated to be slow as operating rates remain subdued as compared to historical standards. Weak end market demand remains a risk to price realization as we work to complete our 2010 graphite electrode order book. We expect 2010 results to benefit from improved volumes in our graphite electrode business. However this favorable impact from increased volumes will be essentially offset by significantly higher raw material costs.

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Outlook

Based on IMF projections and other economic forecasts, the global recession has largely concluded in most regions and recovery is underway in advanced and emerging economies, although to varying degrees. The recovery is expected to continue however risks to global economic stability remain. Accordingly, steel producers have raised operating rates to respond to current market demand and have begun to extend their graphite electrode buying patterns.

Customers in several geographic regions largely completed destocking initiatives and began reordering in the third quarter of 2009. This more favorable environment for our Industrial Materials business segment continued into the first quarter of 2010 and we expect a similar scenario for the second quarter.

If in 2010 the IMF projections and other economic forecasts described above were to materialize, we would then expect the following results:

Our outlook could be significantly impacted by, among other things, factors described under “Preliminary Notes – Forward Looking Statements and Risk Factors” in this Report. For a more complete discussion of these and other factors, see “Risk Factors” in the Annual Report.

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Results of Operations and Segment Review

Three Months Ended March 31, 2009 as Compared to Three Months Ended March 31, 2010.

The tables presented in our period-over-period comparisons summarize our consolidated statements of operations and illustrate key financial indicators used to assess the consolidated financial results. Financial information is presented for the three months ended March 31, 2009 and 2010. Throughout our MD&A, percentage changes that are deemed to be not meaningful are designated as “NM”.

(in thousands, except per share data and % change)

Net sales. Net sales by operating segment for the three months ended March 31, 2009 and 2010 were:

(in thousands, except per share data and % change)

We experienced higher sales for both of our operating segments led by a significant increase in our Industrial Materials operating segment due to the slow economic recovery that began in the third quarter of 2009 and has continued through the first quarter of 2010 because of the completion of our customer inventory destocking. We experienced increased demand

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across most of our products lines, in both of our operating segments, as our customers, especially those in the Industrial Materials segment, started the reordering process and shipments began to increase in response to increasing orders and production.

Our analysis of the percentage change in net sales for Industrial Materials and Engineered Solutions is set forth in the following table:

Net sales. For the industrial materials segment increased significantly in the three months ended March 31, 2010 compared to the three months ended March 31, 2009 due to higher graphite electrode sales volume. We experienced increased demand for our products as the destocking activity witnessed in 2009 came to an end and EAF steel operating rates improved significantly year-over-year. The weighted average selling price of our melter and non-melter graphite electrodes has increased by approximately 5.2% from the three months ended March 31, 2009 to in the three months ended March 31, 2010. Looking forward however, we expect lower graphite electrode market prices to negatively impact our revenue in subsequent quarters. Higher electrode sales volumes will mitigate, in part, softer electrode pricing recognized in future quarters.

Cost of sales. The two primary drivers of the increase in cost of sales period over period were increases in shipments of our products of $23.2 million and currency impacts of $17.5 million across both of our segments. The global recession led to a dramatic decline in the demand for, and corresponding production of, graphite electrodes during the three months ended March 31, 2009. Our production volume increased throughout the second half of 2009 and continued in the first quarter of 2010 as our customers ramped up production from the low levels experienced during the first quarter of 2009.

Needle coke is the primary raw material in the manufacture of graphite electrodes. We usually purchase 70% to 80% of our needle coke requirements from one supplier under contracts with one-year fixed price per metric ton schedules. For 2010 needle coke purchases, we have completed the negotiations with our largest supplier and the 2010 cost per metric ton is flat with the 2009 cost per metric ton. Our production in 2010 has begun to use the higher cost needle coke purchased in the fourth quarter of 2009, which was approximately 50% higher than the cost of needle coke used in production during the first quarter of 2009 and continuing throughout 2009. The inventory flow through of the higher cost raw material has increased our cost of goods sold in the three months ended March 31, 2010 when compared to the same period in 2009. Our ability to pass this increased cost to customers depends to a large extent on the strength of the global economic recovery. Higher volumes have diluted our fixed costs in the three months ended March 31, 2010 partially offsetting the higher coke cost.

Selling and administrative expenses. Higher sales commissions as a result of increased sales contributed to the increase in selling and administrative expenses. We experienced a decrease in bad debt expense from $2.6 million for the period ended March 31, 2009 to $0.1 million for the period ended March 31, 2010.

Equity in (earnings) losses of non-consolidated affiliate. During the period ended March 31, 2009 our equity in earnings of our non-consolidated affiliate was $1.2 million as compared to equity in losses of $0.8 million in the period ended March 31, 2010. The losses were due in large part to the effect of the recession on Seadrift’s operations.

Other (income), net. Other (income), net decreased in the period ended March 31, 2010 as compared with March 31, 2009 due in large part to more stable exchange rates for the euro in the first quarter of 2010 which led to lower favorable gains on remeasurement of inter-company loans. During the three months ended March 31, 2009 currency gains recorded were $6.4 million as compared to $3.7 million during the three months ended March 31, 2010.

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Segment operating income. Corporate expenses are allocated to segments based on each segment’s percentage of consolidated sales. The following table represents our operating income by segment for the three months ended March 31, 2009 and 2010: