GrafTech International Ltd. — Q3 2020 Form 10-Q
Business context and reporting period. GrafTech manufactures graphite electrodes for electric-arc-furnace steelmaking and petroleum needle coke. It reports one segment, Industrial Materials, and is substantially vertically integrated into needle coke. This unaudited filing covers the quarter and nine months ended September 30, 2020; comparisons are to the corresponding 2019 periods. Brookfield owned approximately 65% of outstanding shares at quarter-end.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net sales | $287.0 million | $420.8 million | $886.4 million | $1,376.2 million |
| Gross profit / margin | $155.1 million / 54.1% | $242.3 million / 57.6% | $485.0 million / 54.7% | $805.1 million / 58.5% |
| Operating profit / margin | $135.4 million / 47.2% | $226.0 million / 53.7% | $432.9 million / 48.8% | $756.8 million / 55.0% |
| Net income | $94.2 million | $175.9 million | $309.3 million | $569.7 million |
| Diluted EPS | $0.35 | $0.61 | $1.15 | $1.96 |
| Adjusted EBITDA | $153.1 million | $245.5 million | $483.4 million | $813.7 million |
- Q3 sales fell 32%; nine-month sales fell 36%. Management attributed the declines chiefly to lower steel production and customer inventory destocking, lower spot prices, and lower LTA pricing from mix, contract modifications and other adjustments. Sales volume decreased 18% in Q3 and 25% for the nine months.
- Q3 and nine-month adjusted EBITDA decreased approximately 38% and 41%, respectively. This is a non-GAAP measure; the filing cautions it should not be viewed in isolation from GAAP results or cash requirements.
- Nine-month operating cash flow was $416.7 million, versus $584.8 million in 2019. Working capital provided $85.1 million, largely from lower receivables and inventory and deferred tax payments. Capital expenditures were $30.7 million; free cash flow is not reported as a defined figure in the filing.
- At September 30, cash was $158.8 million and available revolving-credit capacity was $246.9 million, for reported liquidity of $405.7 million. Long-term debt was $1,564.4 million and short-term debt $0.1 million. Stockholders’ deficit was $472.1 million.
- Debt decreased from $1,812.7 million at December 31, 2019. GrafTech repaid or repurchased $253 million of term-loan principal during the first nine months; it reported an additional $60 million repayment in October. The term loan matures in 2025; the revolving facility matures in 2023.
Material changes and management outlook
- Q3 sales volume was 33,000 metric tons versus 40,000; production volume was 32,000 versus 40,000. Total capacity utilization was 58%, compared with 73% a year earlier. Year-to-date sales volume was 98,000 metric tons versus 130,000.
- Management reported a measured recovery in steel markets after Q2, with global steel capacity utilization outside China above 60% in Q3 and U.S. utilization around 64%, approaching 70% by late October. Plants remained operational and on-time delivery was 98%.
- For 2020, management expected LTA sales volume above the midpoint of 100,000–115,000 metric tons and LTA revenue of $1.0–$1.08 billion. It expected full-year capital expenditures of approximately $35 million. Management anticipated weak overall electrode demand and pricing for the remainder of 2020 as customers worked through inventories.
- Estimated LTA shipments and revenue: 2021, 98,000–108,000 metric tons and $925 million–$1.025 billion; 2022, 95,000–105,000 metric tons and $910 million–$1.010 billion; 2023–2024, 35,000–45,000 metric tons and $350 million–$450 million. Revenue estimates include expected termination fees for certain customers and are subject to contract performance, customer demand, credit risk and timing.
- Management prioritized debt repayment and balance-sheet flexibility, expecting to use most fourth-quarter incremental free cash flow for debt reduction. The dividend had been reduced in April to $0.01 per share quarterly; the board declared another $0.01 dividend for payment December 31, 2020.
Risks, contingencies and unusual items
- COVID-19 remained a key uncertainty, with possible further effects on steel demand, customer performance, facility operations, supply chains, cash flows and financing access. Management said the ultimate impact could not be predicted.
- Some LTA customers struggled to take committed volumes. GrafTech reported contract disputes and several arbitrations, including customer efforts to modify agreements; it said it intended to enforce its contractual rights while negotiating modifications.
- A September 2020 Delaware stockholder lawsuit challenges a $250 million company repurchase of shares from Brookfield and a related Brookfield block trade, and contests an independent director’s appointment. The filing does not state a clear estimated loss.
- Brazilian employee litigation could result in material claims, but the company said it could not assess potential loss because the claims did not specify claimant numbers or damages. An appeal followed a favorable May 2020 appellate decision for the company. A Mexican water-use administrative proceeding concerning the Monterrey facility also remained pending.
- Other items include a $3.3 million first-quarter benefit from reducing the Tax Receivable Agreement liability due to revised profit expectations, and a $2.0 million opening retained-earnings adjustment on adoption of the expected-credit-loss standard. The filing estimates a potential $55–$70 million LTIP liability upon a qualifying change in control; awards were fully vested at quarter-end.
Key facts for investors to verify
- Whether demand, pricing, customer destocking and LTA shipment performance subsequently tracked the 2020 outlook.
- Whether customer contract modifications, disputes or arbitrations affect contracted revenue, termination fees or cash collections.
- Debt repayment pace, interest costs, revolving-facility availability and compliance with financing covenants as earnings and cash flow change.
- Developments and potential exposure in the Delaware stockholder case, Brazil employee claims and Mexico water-use proceeding.
- COVID-19 effects on operations and customers, and the assumptions underlying remaining LTA revenue estimates.