GrafTech International Ltd. — 2022 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended December 31, 2022. GrafTech manufactures graphite electrodes used primarily in electric arc furnace (EAF) steelmaking and petroleum needle coke, a key electrode input. It operates one reportable segment, Industrial Materials, and is substantially vertically integrated through its Seadrift needle coke facility. Its results are exposed to cyclical steel demand, electrode pricing, raw-material and energy costs, and global operations.
Key financial and operating metrics
| Metric | 2022 | 2021 |
|---|---|---|
| Net sales | $1,281.3 million | $1,345.8 million |
| Gross profit / gross margin | $554.9 million / 43.3% | $644.5 million / 47.9% |
| Operating income / operating margin | $474.3 million / 37.0% | $508.1 million / 37.8% |
| Net income / diluted EPS | $383.0 million / $1.48 | $388.3 million / $1.46 |
| Adjusted EBITDA (non-GAAP) | $536.5 million | $669.9 million |
| Cash from operating activities | $324.6 million | $443.0 million |
| Capital expenditures | $72.2 million | $58.3 million |
| Cash and cash equivalents at year-end | $134.6 million | $57.5 million |
| Total debt at year-end | Approximately $921.8 million | Approximately $1.03 billion |
Sales volume was 149.1 thousand metric tons (MT), down 11%; production volume was 157.1 thousand MT, down 5%. Capacity utilization was 68%, versus 72%. The average realized LTA electrode price was about $9,500/MT in both years; the non-LTA average increased 34%, to about $6,000/MT. LTA sales were 68% of net sales, compared with 77% in 2021. The filing reports no single customer at 10% or more of sales.
Year-end liquidity was $461.6 million, comprising $134.6 million of cash and $327.0 million available under the revolving facility, net of letters of credit. Operating cash flow remained positive, but declined as inventory investment increased; inventory rose to $447.7 million from $289.4 million. The company repaid $110 million of term debt and repurchased $60 million of shares during 2022. It paid a quarterly dividend of $0.01 per share. Debt includes a $433.7 million term loan due in 2025 and $500 million of 4.625% secured notes due in 2028. The company reported compliance with debt covenants.
Material changes versus 2021
- Sales fell 5%, mainly from lower electrode shipment volume and a shift toward non-LTA sales, partly offset by higher non-LTA prices.
- Gross profit fell 14%. Excluding the 2021 Change-in-Control charge, cost of sales increased 8%, reflecting inflation in carbon-based inputs, energy and freight, as well as approximately $16 million of excess fixed manufacturing costs associated with the Monterrey interruption.
- Adjusted EBITDA declined about 20%; GAAP net income decreased about 1%. The 2021 comparison included substantial one-time Change-in-Control compensation charges and an $11.5 million Brazilian VAT credit gain.
- Operating cash flow declined about 27%, with $153.6 million used for inventory in 2022. Liquidity nevertheless increased, aided by retained cash flow and a larger revolving commitment.
- Interest expense declined 47%, to $36.6 million, partly due to debt repayments and gains associated with interest-rate swaps. Total debt decreased year over year.
Outlook, risks and contingencies
- Management expected soft electrode demand in early 2023 amid economic uncertainty and geopolitical conflict. It forecast first-half 2023 sales volume at approximately half the comparable 2022 level, with the greatest effect in Q1; Q1 volume was estimated at 15–18 thousand MT. It expected second-half volumes to recover gradually.
- For 2023, management projected cost of goods sold per MT to rise 17%–20%, due to lower production volume over which to absorb fixed costs and higher-cost raw materials. It expected Q1 non-LTA pricing to be comparable to the 2022 full-year average of about $6,000/MT. Expected 2023 capex was $55–$60 million; management anticipated positive operating cash flow and no need to draw on the revolver.
- Management estimated remaining LTA revenue of $235–$275 million in 2023 and $100–$135 million in 2024, including expected termination fees. Realization may vary with customer performance, force majeure notices, arbitration, credit risk and volume ranges. The company expects its business mix to shift further away from LTAs as older contracts expire.
- Monterrey operations were temporarily suspended in 2022 following a Mexican environmental and operating-permit inspection. Operations resumed after the suspension was conditionally lifted, subject to agreed activities. The interruption affected 2022 production and was expected to weigh materially on first-half 2023 sales. Monterrey also produced all connecting pins, creating a single-site supply exposure.
- In customer arbitrations concerning fixed-price LTAs, claimants increased their damages calculation to approximately $178.9 million, including interest. GrafTech says it has valid defenses and intends to enforce the contracts. Certain Russia/Ukraine-related force majeure notices and customer challenges also affect LTA estimates.
- Mexican tax authorities confirmed a VAT assessment of approximately $23.5 million for 2019 and notified the company of a proposed $51 million assessment for 2018 involving similar VAT treatment. GrafTech disputes the assessments and says it does not believe a loss is probable. A separate Brazilian employee litigation has an unquantified potential loss that the company could not assess at year-end.
- Other key risks include cyclical EAF steel demand and electrode prices, Chinese capacity and imports, needle coke and energy availability and costs, inflation, foreign exchange, environmental compliance, litigation, customer credit and debt/covenant constraints. Environmental remediation and compliance expense was $22.4 million in 2022; accrued environmental remediation liability was $4.4 million.
The financial statements received an unqualified audit opinion, and the auditor and management concluded internal control over financial reporting was effective at December 31, 2022. Goodwill of $171.1 million was not found more likely than not impaired in the annual qualitative assessment.
Important facts for investors to verify
- Whether Monterrey completes the required environmental and permit-related actions and sustains production, including reliable alternative connecting-pin sourcing.
- Actual 2023 shipment recovery, non-LTA pricing, unit costs and cash generation versus management’s projections.
- Collections and enforceability of LTAs, including arbitration outcomes, force majeure determinations and the assumed termination-fee revenue.
- Developments and potential financial exposure in the Mexican VAT matters, Brazilian employee litigation and other contingencies.
- Debt reduction, interest-rate exposure, revolver availability and covenant headroom as operating conditions change.
- Inventory levels and cash conversion, given the large 2022 inventory build and its effect on operating cash flow.