GrafTech International Ltd. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. GrafTech manufactures graphite electrodes used in electric arc furnace steelmaking and is substantially vertically integrated into petroleum needle coke. Results reflect the early impact of COVID-19, weaker steel production, and customer inventory destocking.
Financial performance
- Revenue: $318.6 million, down 33% from $475.0 million. Graphite electrode sales volume fell 24%, to 34,000 metric tons; production was 33,000 metric tons versus 48,000.
- Profitability: Gross profit was $179.7 million (56.4% margin), versus $279.5 million (58.8%). Operating profit was $164.1 million (51.5% margin), down 38%. Net income was $122.3 million, down 38%; diluted EPS was $0.45 versus $0.68.
- Non-GAAP results: EBITDA was $185.0 million versus $278.7 million; adjusted EBITDA was $179.2 million versus $283.8 million.
- Cash flow: Operating cash flow was $139.3 million versus $156.8 million. Capital expenditures were $13.9 million. Financing cash outflow was $53.0 million, including $30.1 million of share repurchases and $22.9 million of dividends.
- Liquidity and debt: Cash was $152.1 million; reported liquidity was $399.0 million, including $246.9 million available under the revolving facility. Total debt was $1.814 billion. The term loan’s effective interest rate was 4.50% at quarter-end.
- Balance sheet: Inventory was $322.6 million, up from $313.6 million at year-end. Stockholders’ deficit was $680.4 million.
Changes and notable items
- Revenue and profit declined primarily due to lower sales volumes, ongoing customer destocking, lower steel production, and the initial COVID-19 impact. Lower interest expense partially offset the decline in earnings.
- Other income included a $3.3 million benefit from remeasurement of the Tax Receivable Agreement liability, reflecting lower expected 2020 profits. A $3.3 million favorable non-cash foreign-currency impact also affected other income.
- Other comprehensive loss was $56.9 million, driven mainly by losses on commodity and interest-rate derivatives and foreign currency translation. Unrealized losses on commodity derivatives were $33.7 million pretax; the derivative liabilities also include interest-rate swaps.
- The company repurchased 3.33 million shares for $30.1 million during the quarter. On May 5, the board declared a reduced quarterly dividend of $0.01 per share.
Outlook, management commentary, and risks
- GrafTech reduced its estimate of 2020 long-term contract revenue to $950 million–$1.10 billion from $1.251 billion previously; it expected $675 million–$825 million in the remainder of 2020 after recording $276 million in Q1. Management attributed the revision to customer force majeure notices, COVID-related shutdowns, and customer difficulty taking contracted volumes. Some deferred revenue may be recovered in later years.
- More than 20 long-term contract customers submitted force majeure notices. Contracts generally allow deferral of volumes and extension of contract terms for the force majeure period. Management reported some shipment delays and non-performance, while noting no additional customer bankruptcies at the time of filing.
- Management expected demand weakness through the rest of 2020 and into 2021, continued electrode destocking through year-end and potentially into 2021, and further declines in spot prices. Q1 average price for non-long-term-agreement business was approximately $6,500 per metric ton.
- In response, the company reduced electrode-plant headcount and fixed costs by 15%, eliminated discretionary spending and substantially reduced contractors. It cut planned 2020 capital expenditures to $30 million–$35 million from a level approximately twice that amount. Management planned to direct most incremental 2020 free cash flow toward debt reduction.
- Management said all plants remained open and reported 96% on-time delivery in Q1. It planned a roughly four-week Seadrift needle coke plant maintenance outage later in Q2 and said inventory was sufficient to cover it.
- Key risks include the uncertain duration and impact of COVID-19, weaker EAF steel demand, customer credit and contract performance, lower spot pricing, raw-material and energy costs, foreign exchange, and the company’s substantial debt. A $50 million foreign tax payment was deferred from Q1 to Q4 2020.
- Legal matters include Brazilian employee wage litigation for which the company could not estimate a potential loss, and a Mexican water-usage-fee inquiry. The company stated that other proceedings were not expected to materially affect its financial position, results, or cash flows.
Important facts for investors to verify
- Whether force majeure deferrals, customer credit concerns, or contract disputes reduce or delay the stated long-term contract revenue and volume expectations.
- Whether demand, spot prices, and customer destocking evolve as management expected, and whether deferred contract volumes are recovered in later years.
- Cash generation, revolver availability, covenant compliance, and progress toward debt reduction amid the downturn.
- The eventual cash and earnings effects of commodity and interest-rate hedges, including the significant quarter-end unrealized losses.
- The potential exposure from Brazilian litigation and the outcome of the Mexican water-usage inquiry.
- Execution of the announced cost, capital-spending, and dividend reductions.