GrafTech International Ltd. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. GrafTech manufactures graphite electrodes and petroleum needle coke, with one reportable segment. Financial figures below are in U.S. dollars; dollar amounts are in millions unless noted.
Financial results and position
| Metric | Q2 2019 | Q2 2018 | H1 2019 | H1 2018 |
|---|---|---|---|---|
| Net sales | $480.4 | $456.3 | $955.4 | $908.2 |
| Gross profit / margin | $283.3 / 59.0% | $290.4 / 63.6% | $562.8 / 58.9% | $597.2 / 65.8% |
| Operating profit / margin | $267.2 / 55.6% | $273.6 / 59.9% | $530.8 / 55.6% | $564.0 / 62.1% |
| Net income | $196.4 | $201.4 | $393.8 | $425.1 |
| Diluted earnings per share | $0.68 | $0.67 | $1.36 | $1.41 |
| Adjusted EBITDA (non-GAAP) | $284.4 | $292.0 | $568.2 | $602.3 |
| Operating cash flow | Not separately stated | Not separately stated | $359.0 | $377.7 |
| Capital expenditures | Not separately stated | Not separately stated | $29.2 | $28.7 |
At June 30, 2019, cash was $205.3 million, total debt was $2.035 billion (including $43.5 million short-term), and reported liquidity was $452.2 million: cash plus $246.9 million of revolving-facility availability. Net debt was approximately $1.83 billion. GrafTech repaid $125 million of term debt during the first half. The term loan’s effective interest rate was 5.90%.
First-half operating cash flow was below net income, in part because working capital used $102.5 million, including $65.1 million from receivables, $16.1 million from inventory, and $27.6 million from lower income taxes payable. Financing cash outflow was $174.4 million, primarily debt repayment and dividends.
Changes versus prior comparable periods
- Q2 sales rose 5%, reflecting 6% higher electrode sales volume and a higher realized price: $10,014 per metric ton versus $9,783. First-half sales also rose 5%, driven primarily by 7% higher volume; realized price was $9,984 per ton versus $9,885.
- Profitability weakened despite higher sales. Q2 cost of sales increased 19%, chiefly because sold inventory contained higher-priced needle coke; first-half cost of sales rose 26%, reflecting higher needle-coke costs and volume growth. Gross profit declined 2% in Q2 and 6% in H1.
- Net income declined 3% in Q2 and 7% in H1. The 2018 comparisons included a $61.8 million tax receivable agreement expense, while 2018 tax expense was reduced by a partial release of a valuation allowance. These items complicate year-over-year comparisons.
- Cash increased from $49.9 million at year-end 2018 to $205.3 million at June 30, 2019. Total debt decreased from $2.157 billion to $2.035 billion.
Outlook, management commentary, risks and unusual items
- GrafTech reported take-or-pay contracts covering approximately 65–70% of production capacity, with contracted sales volumes of about 148,000 metric tons in 2019, 145,000 in 2020, 128,000 in 2021 and 120,000 in 2022. Remaining performance obligations under these longer-term contracts totaled $4.525 billion at June 30, 2019. Contract protections include termination payments, typically 50–70% of remaining contracted revenue.
- Management said spot electrode prices had fallen from historic highs but remained above historical averages. It cited slower near-term steel-production growth in some regions, especially Europe, and lower steel-demand growth forecasts outside China. U.S. EAF capacity expansions could increase electrode demand, but are not assured.
- Needle-coke demand from electric-vehicle batteries is tightening supply and raising prices. Vertical integration mitigates exposure, but GrafTech expects to buy about one-third of its needle-coke supply from third parties and said higher costs will continue to affect earnings.
- Management said it believed liquidity was adequate and targeted returning approximately 50–60% of 2019 cash flow after capital expenditures to stockholders, with the remainder for debt repayment. This is a target, not a guarantee. The board declared a $0.085-per-share quarterly dividend and authorized a share-repurchase program of up to $100 million on July 30, 2019, after quarter-end; repurchases depend on liquidity, price, market conditions and other factors.
- Key exposures include floating interest rates, foreign currency, energy and commodity costs, steel-industry cyclicality, customer credit, raw-material supply and debt covenant compliance. A 100-basis-point interest-rate increase would have increased first-half interest expense by an estimated $10.5 million. The company reported no interest-rate hedges outstanding.
- Brazilian employee wage litigation could be material, but the company said it could not estimate potential loss because claimants and damages were unspecified. A separate environmental administrative proceeding concerning emissions at the Monterrey facility requires corrective measures; the company said it was cooperating. Management stated that other proceedings were not expected to have a material adverse effect.
- The company estimated a potential $65–90 million LTIP payout upon a qualifying change in control, assuming full vesting; awards were 60% vested at June 30, 2019. A $23.9 million current and $62.6 million long-term related-party tax receivable agreement payable were recorded at quarter-end.
Important facts for investors to verify
- Whether electrode pricing, needle-coke costs and margins stabilize or deteriorate, particularly as spot prices and steel-market conditions change.
- Execution and collectability of the take-or-pay contracts, including the contracted volume schedule, customer credit protections and remaining obligations.
- Cash conversion and working-capital needs, alongside the company’s ability to fund dividends, share repurchases and debt reduction while maintaining liquidity and covenant compliance.
- Floating-rate debt exposure and the effect of interest-rate changes on interest expense and free cash flow.
- Developments and any quantified exposure from the Brazil litigation and Monterrey environmental proceeding.
- The assumptions underlying the 2019 capital-return target and the timing and amount of any share repurchases; the board’s authorization does not require purchases.