GrafTech International Ltd. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. GrafTech manufactures graphite electrodes and petroleum needle coke, serving electric arc furnace steelmakers and other metals producers. Results are unaudited.
Financial and operating performance
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Net sales | $185.6 million | $363.6 million | $324.4 million | $729.9 million |
| Gross profit / margin | $28.3 million / 15.3% | $162.2 million / 44.6% | $54.5 million / 16.8% | $337.2 million / 46.2% |
| Operating income | $8.6 million | $143.4 million | $11.4 million | $296.3 million |
| Net income (loss) | $(7.9) million | $115.0 million | $(15.2) million | $239.2 million |
| Diluted EPS | $(0.03) | $0.44 | $(0.06) | $0.92 |
| Adjusted EBITDA (non-GAAP) | $26.0 million | $158.2 million | $41.1 million | $327.8 million |
Q2 sales volume fell 38% to 26,400 metric tons; first-half volume fell 49% to 43,300 metric tons. Q2 LTA realized prices declined 6% year over year to $9,000 per MT, and non-LTA prices declined 6% to $5,600 per MT. Q2 production volume was 25,200 MT, down 43%. Cash cost of goods sold per MT rose to $5,252 in Q2 and $5,402 for the first half, versus $4,095 and $3,963, respectively, in 2022.
First-half operating cash flow was $15.8 million, compared with $206.4 million a year earlier. Capital expenditures were $39.8 million, resulting in free cash flow of $(24.0) million; adjusted free cash flow was $3.4 million, including $27.5 million of interest-rate-swap settlements. Cash and cash equivalents were $132.2 million at June 30. Available revolver capacity was $204.5 million, for reported liquidity of $336.7 million, down from $461.6 million at year-end 2022.
Gross debt was approximately $950.3 million by principal value; the balance sheet reports $923.5 million after unamortized discount and issuance costs. Equity was $320.8 million. The company reported compliance with debt covenants. The 2023 cash flow statement reflects $438.6 million of net debt issuance proceeds and $433.7 million of term-loan repayments.
Changes and management explanation
Revenue declined 49% in Q2 and 56% in the first half. Management attributed the declines principally to reduced sales volume following the 2022 Monterrey suspension, which disrupted customer commitments for the first half of 2023, and to softer electrode demand. A shift in sales mix from LTA to non-LTA volume also weighed on sales. The Monterrey facility resumed operations in late 2022.
Lower sales reduced cost of goods sold, but higher-priced inventory reflecting 2022 raw-material, energy and freight cost increases, low production, and under-absorbed fixed costs compressed margins. Excess fixed manufacturing costs recognized in expense were $12.8 million in Q2 and $25.4 million in the first half. Interest expense increased, reflecting debt refinancing costs and swap-related items.
Outlook, financing, and notable items
- GrafTech lowered its 2023 sales-volume estimate to 95,000–105,000 MT from 100,000–115,000 MT, citing continued softness. Q3 volume is expected to be broadly in line with Q2.
- Management expects second-half cash cost of goods sold per MT to be below first-half levels, but full-year cash cost per MT to increase significantly year over year due to lower volumes, under-absorbed fixed costs, and higher raw-material costs.
- Existing LTAs are expected to generate $235–$265 million of 2023 revenue, including anticipated termination fees, and $100–$135 million in 2024. Timing and amounts may vary with customer performance, force majeure notices, arbitration, credit risk, and demand.
- Full-year 2023 capital expenditures are expected to be $55–$60 million. Management expects positive operating cash flow and adjusted free cash flow for 2023 and says liquidity is adequate for at least the next 12 months.
- In June, GrafTech issued $450 million of 9.875% senior secured notes due 2028 and used net proceeds to repay its 2018 term loan, which had been scheduled to mature in 2025. The refinancing extends maturities but adds higher-cost debt; the existing $500 million 2020 notes carry a 4.625% coupon.
- On August 2, 2023, after quarter-end, the board suspended the $0.01 quarterly dividend. The company says future dividends are not assured.
- Management sees longer-term demand potential from EAF steelmaking and petroleum needle coke use in synthetic graphite for lithium-ion batteries, while emphasizing near-term commercial softness.
Risks and contingencies
- Customers in an arbitration dispute over LTAs seek approximately $188.2 million, including interest. GrafTech says it has valid defenses and intends to defend its contractual rights; the filing does not quantify a probable loss.
- Mexican tax authorities assessed approximately $26.8 million for one VAT audit period and proposed approximately $51.0 million for another, including penalties, inflation and interest. GrafTech disputes the tax treatment and says a loss is not probable; amounts may continue to accrue.
- A Brazilian employee wage-related proceeding remains pending; the company says the potential loss cannot currently be assessed.
- Risks include dependence on cyclical steel and EAF markets, electrode pricing and global overcapacity, raw-material and energy costs, customer credit and LTA performance, foreign exchange, and substantial secured debt and restrictive covenants. The Monterrey facility also remains subject to environmental and administrative proceedings.
Management concluded disclosure controls were effective as of June 30, 2023; it reported no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether sales volumes, pricing, and LTA customer performance support the revised 2023 volume outlook.
- Whether cost reductions and production adjustments improve margins and cash generation as forecast.
- Liquidity and covenant headroom, including the impact of the 9.875% notes and lower revolver availability.
- Developments in the customer arbitration, Mexican VAT disputes, and Monterrey environmental proceedings.
- The effect of the dividend suspension on capital allocation and any future dividend decisions.