GrafTech International Ltd. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. GrafTech manufactures graphite electrodes and petroleum needle coke; results below are for continuing operations unless noted. The company completed its IPO in April 2018, but the selling stockholder—not GrafTech—received the IPO proceeds.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $454.9 million | $137.2 million | $1,363.1 million | $358.3 million |
| Gross profit | $274.6 million | $16.8 million | $871.8 million | $27.9 million |
| Operating profit (loss) | $259.9 million | $2.1 million | $823.9 million | ($12.3 million) |
| Net income (loss) | $199.5 million | ($3.9 million) | $624.6 million | ($47.6 million) |
| Operating cash flow | Not separately provided for the quarter | $612.2 million | $33.6 million |
Q3 gross and operating margins were approximately 60% and 57%, respectively, versus approximately 12% and 2% a year earlier. Nine-month gross margin was approximately 64%. The improvement primarily reflected substantially higher realized electrode prices amid stronger EAF steel demand and constrained industry supply. Higher needle coke and pitch costs partly offset the benefit.
- Sales and pricing: Q3 electrode sales volume was 45,000 metric tons versus 44,000; weighted-average realized price was $9,744 per metric ton versus $2,903. For nine months, volume was 133,000 versus 129,000 metric tons and realized price was $9,932 versus $2,547.
- Adjusted EBITDA: $276.8 million in Q3 versus $22.2 million; $879.1 million for nine months versus $38.7 million. This non-GAAP measure excludes specified items and should be considered alongside GAAP results.
- Cash flow and investment: Nine-month operating cash flow was $612.2 million, including a $143.7 million working-capital use, mainly from higher receivables and inventories. Capital expenditures were $47.6 million.
- Debt and liquidity: Total debt was $2.183 billion, comprising $2.077 billion long-term and $106.3 million short-term. Cash was $102.5 million, with $243.5 million available on the revolving facility; reported total liquidity was $346.0 million. Stockholders’ equity was negative $1.038 billion, largely following substantial distributions and a share repurchase.
- Margins and cash uses: Interest expense was $33.9 million in Q3 and $100.4 million for nine months. Nine-month financing cash flow was an outflow of $474.7 million; the company reported $1.316 billion of dividends paid and a $225 million share repurchase.
Material changes versus prior comparable periods
- Revenue increased 231% in Q3 and 280% for nine months; the increase was predominantly price-driven. The filing attributes higher prices to stronger EAF demand and limited electrode and needle coke supply.
- Cost of sales rose 50% in Q3 and 49% for nine months, much less than revenue, but management noted that higher-priced raw materials will affect costs in future quarters.
- Interest expense increased substantially following the 2018 refinancing and additional term borrowing. Nine-month expense also included costs associated with early redemption of the prior Senior Notes.
- The company recorded a $61.8 million related-party Tax Receivable Agreement expense in the first nine months after releasing part of a deferred-tax valuation allowance.
- The company adopted ASC 606 in 2018; it reported no material difference in the nine-month financial statements compared with the previous revenue guidance.
Outlook, commentary, risks and unusual items
- Management reported 100% utilization at operating capacity excluding the temporarily idled St. Marys facility, and 85% utilization on total capacity. It expected annual production capacity to increase 21% to 202,000 metric tons by year-end 2018 through debottlenecking.
- Management estimated 2018 capital expenditures of approximately $70 million: about $35 million for maintenance and $42 million for debottlenecking, with overlap/rounding in the stated estimates. It expected 2018 needle coke production of approximately 110,000 metric tons and 2019 production of approximately 125,000 metric tons.
- Three-to-five-year take-or-pay contracts represented approximately 79% of Q3 revenue and 72% of nine-month revenue. Management 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 contracts totaled approximately $5.173 billion; these are estimated future revenues, not guaranteed earnings.
- Management cited limited needle coke and coal tar pitch supply, expected higher external needle coke purchases, and a planned fourth-quarter maintenance outage at Seadrift. It also warned that electrode prices may decline from recent record highs and that steel-market cyclicality, raw-material costs, foreign exchange and floating-rate debt could affect results.
- The new term loan balance increased to $2.25 billion following the June incremental borrowing, which was used to repay a $750 million Brookfield promissory note. The loans mature in 2025 and have floating-rate exposure. A hypothetical 100-basis-point rate increase would have increased nine-month interest expense by $12.6 million.
- Legal proceedings include a Brazilian employee wage claim for which the company said potential loss could be material but could not be assessed because the claim amount and claimant count were unspecified. Management did not believe other matters would materially affect the company.
- Other notable items include a $23.8 million loss on debt extinguishment in the cash-flow reconciliation, a $61.8 million TRA liability/expense, and a possible $65–$90 million LTIP payout upon a qualifying change in control; awards were 60% vested at quarter-end. The filing gave no formal earnings guidance.
Important facts for investors to verify
- Whether contract pricing, committed volumes and customer protections support earnings if spot electrode prices decline; confirm contract termination and credit provisions.
- Whether debottlenecking reaches the expected capacity and cost benefits on schedule, and how higher external needle coke costs and the Seadrift outage affect margins.
- Debt service capacity under floating rates, revolving-facility covenant headroom, and the effect of dividends and other capital returns on liquidity.
- Cash conversion as working-capital needs rise, particularly receivables and inventories, and reconciliation of reported operating cash flow to future cash available after capital spending and debt service.
- Potential outcomes of the Brazilian claim, the Tax Receivable Agreement payments to Brookfield, and the change-in-control LTIP exposure.