GrafTech International Ltd. — Q3 2019 Form 10-Q
Business context and reporting period. GrafTech manufactures graphite electrodes used in electric arc furnace steelmaking and petroleum needle coke, a key electrode input. This summary covers the quarter and nine months ended September 30, 2019; financial statements are unaudited. Amounts below are in U.S. dollars, generally rounded to millions.
Key financial results
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $420.8 | $454.9 | $1,376.2 | $1,363.1 |
| Gross profit / margin | $242.3 / 57.6% | $274.6 / 60.4% | $805.1 / 58.5% | $871.8 / 64.0% |
| Operating profit / margin | $226.0 / 53.7% | $259.9 / 57.1% | $756.8 / 55.0% | $823.9 / 60.5% |
| Net income | $175.9 | $199.5 | $569.7 | $624.6 |
| Diluted EPS | $0.61 | $0.67 | $1.96 | $2.08 |
| Adjusted EBITDA (non-GAAP) | $245.5 | $276.8 | $813.7 | $879.1 |
- Cash flow: Nine-month operating cash flow was $584.8 million, capital expenditures were $44.1 million, and operating cash flow less capex was approximately $540.7 million. Working capital used $80.3 million of cash.
- Liquidity and debt: At September 30, cash was $381.2 million, revolving facility availability was $246.9 million, and stated liquidity totaled $628.1 million. Total debt was $2,036.4 million ($70.9 million short-term and $1,965.5 million long-term), down from $2,156.6 million at year-end 2018. The company repaid $125 million of term debt in February. Net debt was approximately $1,655.2 million.
- Other balance-sheet items: Current assets were $1,000.8 million and current liabilities $276.2 million. Stockholders’ deficit was $606.9 million. Cash and cash equivalents increased from $49.9 million at December 31, 2018.
Material changes versus comparable periods
- Q3 sales fell 7%, primarily due to a 5% reduction in electrode sales volume and lower by-products and other revenue. The average realized price for GrafTech-manufactured electrodes rose to $9,960 per metric ton from $9,664.
- For the first nine months, sales rose 1% as electrode volume increased 3% and realized price increased to $9,977 per metric ton from $9,811. Higher needle-coke input costs and higher volumes drove cost of sales up 16%; gross profit declined 8%.
- Q3 net income declined 12%; nine-month net income declined 9%. Nine-month tax expense rose to $90.9 million from $36.3 million, chiefly because the 2018 period included a partial release of a valuation allowance. The effective tax rate was 13.8% versus 5.5%.
- Nine-month adjusted EBITDA declined to $813.7 million from $879.1 million. The 2018 comparison included $61.8 million of Tax Receivable Agreement expense, which is excluded from adjusted EBITDA.
- Q3 selling and administrative expense included a write-off of receivables tied to a customer entering bankruptcy proceedings. The allowance for doubtful accounts increased to $4.2 million from $1.1 million at year-end.
Outlook, management commentary and risks
- GrafTech reported approximately 146,000 metric tons of take-or-pay contract volumes for 2019, 142,000 for 2020, 125,000 for 2021 and 117,000 for 2022; about two-thirds of production capacity was contracted. Management said these volumes were slightly lower than previously reported due to the financial condition of certain customers. Remaining estimated revenue under longer-term contracts was $4.10 billion at September 30, excluding contracts with an original duration of one year or less.
- Contracts generally provide fixed prices and volumes, escalation mechanisms and termination payments typically equal to 50%–70% of remaining contracted revenue; some also have parent guarantees or collateral. Management noted that actual volumes can vary with shipment timing and customer financial condition.
- Management said spot electrode prices had eased from historic highs but remained above historical averages. It cited slower steel production and electrode consumption in parts of Europe and South America, and weaker global steel-demand forecasts. Higher needle-coke prices, including demand from electric-vehicle batteries, are expected to continue affecting earnings; vertical integration provides partial protection, but roughly one-third of needle-coke needs are expected to be purchased from third parties.
- The company targeted returning approximately 50%–60% of 2019 cash flow after capital expenditures to stockholders, with the remainder for debt repayment. It paid $74.0 million in dividends and repurchased $9.5 million of shares in the first nine months. The board declared a subsequent quarterly dividend of $0.085 per share, payable December 31, 2019.
- Operational improvement projects at Monterrey and St. Marys are expected to finish in the first half of 2021. They are intended to improve environmental performance and production flexibility; management estimated capital spending would remain near current levels, subject to board approval.
- Key risks and contingencies: The business is cyclical and dependent on EAF steel demand, electrode pricing, needle coke, energy and global economic conditions. Floating-rate debt exposes earnings to interest-rate changes; swaps entered into during Q3 cover $1.0 billion of notional debt and are expected to fix cash flows at an effective rate of 5.1%, potentially 4.85% depending on credit ratings. A Brazilian wage-claim case received an adverse Supreme Court ruling in September 2019; a related employee claim could be material, but the company could not estimate potential loss. Other proceedings were not considered likely to have a material adverse effect. A Monterrey environmental administrative proceeding was closed in September after corrective measures and immaterial fines.
- No formal full-year earnings guidance was provided in the supplied filing text. Management stated it believed available liquidity was adequate. The company cautioned that results may vary materially from expectations and that dividends are discretionary.
Important facts for investors to verify
- Customer credit quality, the bankrupt customer’s receivable exposure and the financial condition of customers underpinning take-or-pay contracts.
- How electrode pricing, contracted volumes and regional steel demand develop, and whether the remaining contract revenue converts to shipments and cash as expected.
- Third-party needle-coke costs, cost pass-through or escalation provisions, and the effect of higher input costs on margins.
- Debt service, floating-rate exposure, covenant headroom and the company’s ability to balance debt reduction, repurchases, capital spending and dividends.
- The scope, timing and potential financial impact of the Brazilian employee litigation, which the company said it could not quantify.
- Whether the expected 2021 facility projects stay on schedule and within the contemplated capital-spending level.