GRAFTECH INTERNATIONAL LTD quarterly report, Q1 FY2023

GrafTech International Ltd. — Q1 2023 Form 10-Q

Reporting period: Three months ended March 31, 2023. GrafTech manufactures graphite electrodes for electric arc furnace steelmaking and petroleum needle coke products. Its sole reportable segment is Industrial Materials.

Financial results and key metrics

Metric	Q1 2023	Q1 2022
Net sales	$138.8 million	$366.2 million
Gross profit / margin	$26.2 million / 18.8%	$175.0 million / 47.8%
Operating income / margin	$2.8 million / 2.0%	$152.9 million / 41.8%
Net income (loss) / diluted EPS	$(7.4) million / $(0.03)	$124.2 million / $0.47
Adjusted EBITDA (non-GAAP)	$15.1 million	$169.6 million
Operating cash flow	$24.8 million	$146.3 million
Capital expenditures	$25.3 million	$16.9 million
Free cash flow (non-GAAP)	$(0.5) million	$129.5 million

• Sales fell 62% year over year. Sales volume declined 61% to 16.9 thousand metric tons; production volume fell 66% to 15.8 thousand metric tons. Capacity utilization was 27%, versus 79%.
• Management attributed the volume decline mainly to the lingering effects of the Monterrey, Mexico suspension, which disrupted customer commitments for the first half of 2023, and to weaker electrode demand. Lower LTA volume also shifted sales mix toward non-LTA business.
• Q1 LTA revenue was $69.9 million, with weighted-average realized LTA pricing of $9,000 per MT, down 6% year over year. Non-LTA realized pricing was $6,000 per MT, consistent with 2022.
• Cash cost of goods sold per MT, a non-GAAP measure, increased to $5,636 from $3,834. Reduced production led to $12.6 million of excess fixed manufacturing costs, including $2.8 million of depreciation; higher-cost inventory also reflected increased raw material, energy and freight costs.
• Interest expense increased 39% to $12.8 million, including a $1.4 million mark-to-market loss on a de-designated interest rate swap, compared with a $3.9 million gain in Q1 2022.

Financial position and liquidity

• At March 31, 2023, cash and equivalents were $135.4 million; reported total debt was $922.6 million net of discount and issuance costs. Gross debt was approximately $934 million. Stockholders’ equity was $330.5 million.
• Available liquidity was $462.4 million: $135.4 million cash plus $327.0 million available under the revolving credit facility. No revolver borrowings were outstanding; $3.0 million of letters of credit reduced availability. GrafTech reported compliance with debt covenants.
• The term loan matures February 2025; the $500 million 4.625% senior secured notes mature December 2028. The $330 million revolving facility matures May 2027. The term loan’s effective interest rate was 7.84% at quarter-end.
• Operating cash flow was substantially below the prior year, while capital expenditures exceeded operating cash flow. Cash rose slightly to $135.4 million from $134.6 million at year-end. Q1 included $25.7 million of cash provided by working-capital changes.
• GrafTech paid $2.6 million in dividends and made no share repurchases or voluntary debt prepayments in Q1. The quarterly dividend was $0.01 per share.

Outlook, commentary and material risks

• Management expects Q2 2023 sales volume of 24–27 thousand MT, with non-LTA pricing slightly below Q1 levels. It forecasts full-year 2023 sales volume of 100–115 thousand MT and capital expenditures of $55–$60 million.
• Management expects 2023 LTA volume of 27–31 thousand MT and LTA revenue of $235–$265 million, including expected termination fees from certain customers. For 2024, it estimates LTA volume of 13–16 thousand MT and revenue of $100–$135 million. Contract performance, force majeure notices, arbitration, customer credit and demand may affect actual results.
• Management expects a significant year-over-year increase in cash cost of goods sold per MT in 2023, driven by fixed costs spread over lower volumes and the full-year impact of higher raw-material costs. It expects positive operating cash flow for 2023, adequate liquidity for at least 12 months, and does not anticipate drawing on the revolver.
• The Monterrey facility resumed operations in November 2022 after a temporary suspension. The suspension’s impact on volume is expected to persist through Q2. Related Mexican administrative and court proceedings remain relevant; an April 25, 2023 court ruling reaffirmed the facility’s operating license, subject to possible appeal, while a separate administrative environmental proceeding remains pending.
• Customer arbitration claimants most recently asserted approximately $171.7 million in damages, including interest, over disputed LTAs. GrafTech says it has valid defenses and intends to defend its position. The company also faces Mexican VAT assessments of about $25 million for a 2019 period and a proposed assessment of about $51 million for 2018; it disputes the tax authority’s position and does not consider a loss probable. Potential Brazilian employee litigation losses could be material, but the company says the amount cannot currently be assessed.
• Other material risks include dependence on cyclical steel and EAF markets, electrode pricing and demand, raw-material and energy costs, foreign exchange, interest rates, geopolitical and economic conditions, production disruption, customer non-performance, debt service and covenants. Management reported effective disclosure controls and no material Q1 change in internal control over financial reporting.

Most important facts for investors to verify

• Whether sales volumes and demand recover as forecast, particularly after the Monterrey-related customer commitment disruption.
• Actual pricing, shipment volumes and customer performance under LTAs, including whether forecast termination fees are realized.
• Whether cost per MT and margins improve as production increases, given Q1 underutilization and higher input costs.
• Cash generation, working-capital requirements, planned capital spending and available revolver capacity; reconcile cash flow with non-GAAP free cash flow and adjusted EBITDA.
• Outcomes and potential financial effects of the LTA arbitration, Mexican VAT assessments and Monterrey regulatory proceedings.
• Debt refinancing and interest-rate exposure ahead of the February 2025 term-loan maturity, as well as the company’s ability to maintain covenant compliance and dividends.