GRAFTECH INTERNATIONAL LTD quarterly report, Q1 FY2018

GrafTech International Ltd. — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018; unaudited consolidated results. GrafTech manufactures graphite electrodes and needle coke, with Industrial Materials as its sole reportable segment. The prior-year comparison excludes the Engineered Solutions business from continuing operations. ASC 606 adoption had no reported effect on Q1 2018 financial statement amounts.

Financial and operating performance

Metric	Q1 2018	Q1 2017
Net sales	$451.9 million	$104.7 million
Gross profit / gross margin	$306.8 million / 67.9%	$1.3 million / 1.2%
Operating profit (loss)	$290.4 million	($11.2 million)
Net income (loss)	$223.7 million	($26.3 million)
Net income (loss) per share	$0.74	($0.09)
Operating cash flow	$140.6 million	$1.8 million
Capital expenditures	$14.0 million	$8.0 million

Sales rose 331%, driven principally by a 332% increase in graphite-electrode weighted average realized price to $10,124 per metric ton; sales volume increased 4.9%. Favorable foreign-exchange effects added $10.3 million to sales.
Cost of sales increased 40% to $145.1 million, chiefly from higher raw-material costs; unfavorable currency effects added $7.1 million and higher volume added $4.4 million. The resulting gross margin was about 67.9%.
Interest expense was $37.9 million, up $30.3 million, including $18.7 million of accelerated accretion on the redeemed Senior Notes and a $4.8 million redemption premium. The effective tax rate was 11.4%, versus (1.6)% in Q1 2017.
Adjusted EBITDA from continuing operations, a non-GAAP measure, was $310.3 million versus $4.2 million. It excludes specified items and should be considered alongside GAAP results.
Operating cash flow included a $150.5 million working-capital cash use, primarily a $132.8 million increase in receivables and $28.7 million increase in inventory, both associated largely with higher prices and activity.

Balance sheet, debt and liquidity

At March 31, cash and equivalents were $138.4 million; total debt was $1.474 billion, comprising $52.4 million short-term and $1.421 billion long-term debt. Stockholders’ deficit was $276.2 million, compared with equity of $613.2 million at year-end 2017.
Reported liquidity was $381.2 million: $138.4 million cash plus $242.8 million available under the $250 million revolving facility, after letters of credit. The revolver was undrawn.
On February 12, GrafTech refinanced prior facilities and redeemed its Senior Notes using a new $1.5 billion secured term loan. The term loan matures in 2025, has variable-rate pricing initially at Adjusted LIBO plus 3.50% or ABR plus 2.50%, and amortizes at 5% of original principal annually. The new revolving facility matures in 2023.
During Q1, GrafTech paid a $1.112 billion dividend to its pre-IPO stockholder, Brookfield, funded from the refinancing proceeds. This transaction materially reduced reported equity.
Subsequent to quarter-end, GrafTech declared a conditional $750 million unsecured Brookfield promissory note with no proceeds to the company. The filing states that conditions were expected to be met and the note would be outstanding; it bears Adjusted LIBO plus 4.50%, rising by 2.00 percentage points after its third anniversary, and matures eight years after issuance. The company said it would explore refinancing it.

Changes, outlook and material developments

Market recovery and restricted industry supply drove record graphite-electrode prices. Management cited stronger EAF steel demand, industry capacity reductions, and tight petroleum needle coke supply, partly reflecting battery demand.
About 60% of Q1 revenue came from three-to-five-year take-or-pay contracts. GrafTech reported contracted volumes of approximately 132,406 metric tons for 2018, 138,446 for 2019, 134,831 for 2020, 117,600 for 2021 and 112,883 for 2022. Remaining performance obligations under these longer-term contracts totaled $5.878 billion.
Approximately 96% of 2018 production capacity was contracted or committed. The average selling price for contracted and committed orders in the remaining 2018 quarters was expected to be about $9,650 per metric ton; management expected minimal spot sales in Q2 and Q3. The filing warns that future electrode prices may fall from current record levels.
Management expected higher raw-material costs in later 2018 quarters, particularly for externally sourced needle coke and coal-tar pitch. Seadrift supplied about 75% of GrafTech’s needle-coke requirements; the remaining 25% was purchased externally.
A debottlenecking program was expected to increase operating capacity by about 21%, or 35,000 metric tons, by year-end 2018. Management expected $37 million of project capital expenditures and total 2018 capital expenditures of approximately $65–70 million, including about $35 million of maintenance spending.
After quarter-end, the company completed its IPO on April 23 at $15 per share; the selling stockholder, not GrafTech, received the proceeds. Brookfield retained approximately 87% ownership after the offering and partial overallotment sale. A 3,022,259.23-for-one stock split became effective April 12 and was applied retroactively to share and per-share figures.
Brookfield also received a conditional $160 million cash dividend declared after quarter-end; the company expected the conditions to be met and payment around May 9. A separate post-IPO quarterly dividend of $0.0645 per share was declared for payment June 29, subject to its stated record date.
The post-IPO tax receivable agreement entitles Brookfield to 85% of certain realized savings from pre-IPO tax assets, plus interest. The filing describes possible payments of up to approximately $100 million under specified assumptions, while noting uncertainty and exclusions.

Risks, contingencies and unusual items

Graphite-electrode pricing is cyclical; contracted prices may be below spot prices, and management expects prices could decline from recent highs. Contract benefits depend on customer performance and GrafTech’s ability to fulfill volumes.
Needle-coke and other raw-material shortages or cost inflation, dependence on Seadrift, manufacturing disruption, and delays or underperformance in the capacity expansion could affect production, costs and customer commitments.
Debt increased substantially following the refinancing and Brookfield distributions. The term loans are floating-rate; a hypothetical 100-basis-point rate increase was estimated to raise Q1 interest expense by $2.1 million. Debt covenants and secured collateral may constrain operations and distributions.
In Brazil, employees’ wage-related litigation was ruled in their favor at the state-court level in 2017 and is under appeal. GrafTech said the potential loss could be material but could not assess it because claimants and damages were not specified. Management did not expect other legal matters to materially affect the company.
Tax accounting for certain 2017 Tax Act provisions remained provisional. Other disclosed risks include steel-market cyclicality, foreign-exchange exposure, environmental and safety obligations, and Brookfield’s control of the company.

Key facts for investors to verify

Whether reported pricing, volumes and contract execution persist, and how much of future production is committed versus available for spot sales.
Actual 2018 raw-material cost trends, capacity expansion timing and costs, and whether the planned production increase is achieved.
Post-quarter capitalization and cash obligations, including issuance and terms of the $750 million Brookfield note, payment of the $160 million dividend, and available liquidity after those items.
Debt-service capacity under variable rates, compliance with credit covenants, and the company’s ability to refinance Brookfield-related obligations on acceptable terms.
Developments in the Brazil litigation, tax-law measurements and potential tax receivable agreement payments.
The durability of record-high electrode prices and the impact of any market reversal on take-or-pay contract economics and profitability.