GrafTech International Ltd.

Ladies and gentlemen, thank you for standing by and welcome to the graph tech first quarter 2020 earnings conference call and webcast. At this time, all participants are in a listen only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this time, you will need to press star then one on your telephone. If you require any further assistance, please press star then zero. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Adam Diebel. Please go ahead, sir.

Thank you, Amy. Good morning and welcome to Graf Tech International's first quarter 2020 conference call. On the call with me today is Graf Tech's Chief Executive Officer, Dave Rintoul, and Chief Financial Officer, Quinn Coburn. Now turning to our first slide. As a reminder, some of the matters discussed on this call may be may include forward looking statements regarding among other things results, performance and strategies. These statements are based on current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these indicated those indicated by forward looking statements are shown here. We will also discuss certain non gap financial measures for which you will find reconciliations in these slides. The slides are posted on our website at www.graftech.com in the investor section. For your reference, a replay of the call will also be available on our website. Now, I am pleased to turn the call over to Dave.

Thank you, Adam. Good morning, everyone, and thank you for joining us today. I hope this call finds you, your families, and your colleagues well. On that theme, we'll begin, as we always do, with safety. which is more critical than ever in these times. Health and safety excellence is a core value of Graphtec. Our first quarter total recordable injury rate has improved significantly to 0.54, a more than 40% decrease from the prior year. I would like to thank the team for their efforts associated with this achievement. Over the last 18 months, we have made significant progress in improving our safety program. This is fundamental to our belief that a safe plant provides a foundation to achieve success on the balance of the business metrics. Now turning to slide four, I would like to give you an update on where we stand within the context of COVID-19 and the impact that it has upon our business But first, I'd like to acknowledge and thank the healthcare workers and first responders who have been the heroes working to help those directly affected by the virus. Early on in this crisis, we established a COVID-19 response team, which continues to meet three to five times per week and consists of a cross-functional group of senior management. Initial actions taken consisted of bans on travel and in-person meetings, as well as working from home wherever possible. We have developed a safe work playbook outlining exact protocols for safe operations in this new environment. For those team members and plants, this means actions such as taking temperatures where local privacy laws permit, mandating the use of gloves by all plant employees, additional cleaning using disinfectants, and using good social distance practices to name a few. We have implemented daily check sheets to maintain focus and ensure compliance with new practices and procedures. We have also developed return to work protocols so that when the time is right, we may have team members currently working from home safely return to the office. Now turning to slide five. I can't say enough about our team and the job they have done to keep our plants running safely and effectively throughout this crisis. As a result of their hard work, all of our facilities have managed to stay open and operating. We did this by proactively working with eight different sets of government controls and guidelines given our global footprint. As a result of our rapidly implemented protective measures to keep our employees and work environment safe, I am happy to report that over 99% of our employees have remained healthy. Not only have our plants remained operating, We have met all of our customer requirements and achieved an on-time delivery rate of 96% in the first quarter. The team did all of this while still achieving safety performance that I discussed earlier. Moving on to slide six. Despite the steel industry being deemed an essential business in many countries, a number of our customers have temporarily suspended or otherwise reduced operations. As a result, global steel production was down 1.4% in the first quarter and 4.1% if China is removed from those values. We currently serve customers in over 300 locations, and many have been adversely impacted in one way or another. The pace of customer inventory destocking was going as we expected until the pandemic outbreak. The impact of the pandemic has slowed the pace of destocking, which will now largely depend upon the timing of the economic recovery. Our substantial vertical integration into needle coke to provide us competitive advantage has provided us a competitive advantage. Although we are not currently negotiating any third party needle coke purchases, we do monitor international trade data that suggests some thinly traded needle coke transactions took place at just under $3,000 during the first quarter. We are planning our biannual turnaround at our Seadrift plant in June to conduct regular maintenance projects. This outage will last approximately four weeks, and we have sufficient needle coke to last us through that outage. Now turning to slide seven. As a result of COVID-19, we have received over 20 force majeure notices on our long-term agreements. While there have been no additional bankruptcies within our customer base, we have had customers who have had their operations disrupted and are struggling to take volumes and perform on the contracts. Adding to this pressure, the spot price for graphite electrodes has been declining in recent periods, and pricing pressure has been exasperated by the COVID-19 crisis. We have now reached a point where our spot price, which averaged approximately $6,500 per ton in the first quarter, is below what is in the long-term agreements. While most customers understand the situation and value the long-term contracts for the security of supply and price certainty, some have recently chosen not to perform on their contractual obligations. In light of these challenges, we are now estimating that our 2020 long-term agreement shipments will be in the range of 100 to 115,000 metric tons. This is down from our previous quarter estimate of 130,000 tons. However, we expect some of this decrease will in fact be deferrals, which will be recovered in future years. We will continue to work with our valued customers for viable solutions to these issues, but we will take every measure to ensure that both Graphtec and our customers honor these contracts. Now we'll turn it over to Quinn on slide eight for more details on our first quarter results.

Thanks, Dave. During the quarter, we produced 33,000 metric tons of graphite electrodes and our capacity utilization was 65%. We shipped 34,000 metric tons as electrode demand was impacted early in the quarter by customer destocking and later in the quarter due to steel operating rates. Shipments were also impacted by just over 1,000 metric tons from transportation delays as a direct result of COVID-19. Revenue decreased due to lower shipment volume and lower prices. Now turning to slide 9, net income was $122 million, generating $0.45 of earnings per share. Adjusted EBITDA was $179 million, driven primarily by the lower sales volume. Free cash flow totaled $125 million in the first quarter as we continued to generate strong cash flow. While the working capital impact on cash was neutral overall, we benefited from our ability to defer a first quarter tax payment of $50 million until the end of the year in a foreign jurisdiction due to COVID-19 relief. Partially offsetting this benefit was our first required payment under our tax receivable agreement of $28 million. During the quarter, we also repurchased $30 million of our shares on the open market and paid dividends of $23 million. Now turning to slide 10, we ended the quarter with a strong liquidity position. Our total liquidity is approximately $400 million, consisting of $152 million of cash, $147 million on our revolving credit facility. We also have plenty of runway with regards to our debt maturity profile. Our term loan is not due until February 2025. And we also made prepayments on our term loan in 2019. Totaling 350Million, leaving us with no required amortization payments until 2022. Now, moving to slide 11 in response to the current environment, we have taken decisive actions that began with eliminating discretionary spending. We have decreased our capital expenditure plan by 50%. To approximately 30 to 35Million, which represents a maintenance level of capital expenditures. We have right sized our workforce by removing. Substantially all contractors and temporary workers. and reducing our full-time workforce. In all, we are reducing our headcount at our electrode plants by 15% compared to 2019. We are also reducing our fixed costs by 15% at our electrode plants. We are managing our inventory levels to match demand and expect the total inventory to be down by year's end. Now looking ahead on page 12, We also are taking proactive steps this quarter to increase our financial flexibility in the face of unprecedented uncertainty and an expected period of economic disruption. We have reduced our quarterly dividends to one cent per share, and we are adjusting our capital allocation to focus on liquidity and balance sheet flexibility. In Q1, we returned over $50 million to shareholders in the form of open market share purchases and dividends. During the remainder of the year, we will use a majority of our incremental free cash flow to pay down debt. We expect the Board to revisit the dividend level when market conditions improve. I'll now turn it back to Dave on slide 13.

Thank you, Quinn. Although the current conditions are difficult, we must remember that EAF steel manufacturing has several advantages over traditional steelmaking. Global warming is a critical issue facing steel companies going forward, and the EAF industry is among the largest recycling industries in the world. EAF production yields 75% less carbon emission than traditional blast furnace production, and the long-term growth rate has been approximately 3%, and there have been significant EAF capacity additions announced recently. While the near term will be challenging, the long-term future is positive for the EIF industry as a whole. Turning to slide 14, graphite electrodes are a critical component of the EIF growth, and our graphite electrodes are highly engineered and require extensive process knowledge to produce. The services and solutions that Graphtec provides will help position both our customers and ourselves for a better future. Moving ahead to slide 15, Graphtec is one of the largest electrode manufacturers in the world, and we are the only producer that is substantially vertically integrated into petroleum needle coke. We have taken decisive actions to manage through the COVID-19 crisis and have a strong liquidity position. We have a proven track record of cash generation and managing through downturns in the industry. While we cannot be certain when the current difficult macroeconomic conditions will return to normal. We believe graph tech is positioned well to weather this crisis. That concludes our prepared remarks and we'll now open up the call for questions.

At this time, if you would like to ask a question, please press star and one on your telephone keypad. Your first question today comes from the line of David Gagliano with BMO Capital Markets. Please proceed with your question.

Okay, great. Thanks for taking my questions, and thanks for the update in what's clearly a challenging time here. And my questions are related to the current dynamics in the contract market. Obviously, we've seen the reduction in the 2020 contracted volumes, and then there's no indications now for 2021 and 2022 contracted volumes. I'm wondering if you can give us a bit more information regarding the remaining 100 to 115,000 tons that's sold under contract for 2020 or expected to be in terms of also, you know, how much of that is incrementally is at risk of another reset lower? And also, if you can comment on the expected pricing now tied to those contracts for 2020. That's my first question.

Okay, so I think there's a couple of things in there, Dave, and good morning, and thank you for your ongoing interest in Gravtech. Look, the current global macroeconomic state of affairs and the subsequent recovery will ultimately dictate the exact answer to your question. What we've done with this reduction is taken into account that we have these force majeure notifications and some others that are plant closures where people close plants and didn't necessarily declare force majeure, but we know that they're closed, and trying to look through that and project the impact that those things will have on volume, along with some customers that we know that, while they're certainly not bankrupt yet, we know there's a few that are in some financial distress. So to be fair, yes, we've taken an estimation of that. We think one that is responsible and to some extent conservative. But the recovery of those in the contract is very specific how those are handled. Fortunately, the wording is quite constructive and very specific as to how that happens and how the contract gets extended into the out years to account for the period of time when force majeure in that example was put into place. In terms of the pricing, the pricing is really a factor of the mix, right? So that every one of those contracts allows for a certain product mix. And in the first quarter, we saw some variation from that mix that created a lower number. As we go through the balance of the year, depending upon the operations of various customers, that mix will probably change again. It could go up, it could go down, depending upon that mixture of customers. But the contract is very specific about what the pricing is. So it's not a matter of anybody changing price. It's more a matter of the mix that came within those contracts.

Okay, that's helpful. The previous indications for 2020 contracts was an average price of $9,600 a ton, then in 2021 and 2022 is $9,700 a ton. With the change today for 2020, what is that expectation for the average price, at least for 2020?

Yeah, Dave, it's Quinn. So in Q1, our average price was $9,450. I would expect it to be somewhere around there for the remainder of the year, 9,450 to 9,600. It won't be that much under 9,600. So, the 9,450 for Q1 is probably a reasonable estimate.

Okay. Thanks, Quinn. That's helpful. And then just the last question for me on this subject. Can you speak to, you know, how the contracts are structured with regards to over the life of the contract? and I know each one is different, but just in generalities, can you speak to how you would recoup the net present value of that contract over the life of the contract? Would it be extending volumes into the out years, or is there some sort of upfront payment or something else?

Well, there are a couple of different ways for that to happen, but the primary one and the one that the contract really envisioned in terms of you know, force majeure type events is that the contract essentially gets extended by whatever time frame that we've been in the force majeure condition. So the volume and the value of it gets recouped in that manner. There's also provisions within the contract that allow for a shorter time period for that to occur but every condition and every customer situation is going to be just a little bit different. So it's hard to give you a broad-based, yeah, this is the way it'll happen every time. So there is a mechanism that allows that recovery to happen at the beginning of the next year. There's another mechanism that allows in force majeure circumstances to extend the length of the contract by the length of whatever time the force majeure was taking place. So there are at least two different ways to handle that depending upon specific conditions.

Okay, got it. Appreciate it. Thanks for the info.

Okay.

Our next question comes from the line of Arun Viswanathan with RBC Capital Markets. Your line is open.

Great, thanks. Good morning. Thanks for taking my question. I guess I wanted to ask about needle coke. You know, we've seen a dramatic shift in the oil markets. And how does that affect decant oil? How does that affect needle coke pricing? And then how does that affect your own strategy on needle coke sourcing? I'm just curious if sea drift is less attractive now in this environment. Maybe we just start there. Thanks.

Well, I'll start by saying that the benefit of having C-drift still has not changed in so much as our cost structure is well below what takes place in the marketplace. Even with some of the numbers that I shared on the call earlier, we're still in a much better place than that with our internal cost to produce In terms of what goes on in the oil market in recent weeks, yes, that has an impact on the price of decant oil and lowers the cost of that. I'll remind everybody that we are hedged as well. But the net takeaway is developments in oil and needlecoking pricing at this point does not change the benefit for us of having C-Drift. It's a valuable part of the family and provides us with not only a cost-effective product compared to the market, but it allows us to do some things on a quality front to provide better electrodes at the end of the day.

And then I guess regarding the help of your customers, I guess, have you seen any shifts in purchasing patterns? I'm just curious if there's been, you know, increased adoption of lower quality electrodes. I don't know if you have any visibility on that, but that was one of the concerns that we had, that maybe some customers would be switching to smaller diameter products. electrodes in a tougher environment. Have you observed any of that?

Thanks. So technically, you know, the technology part of electric arc furnaces at the current conducting arms that hold the electrode are designed for a specific diameter. So it's not very practical for somebody to say, oh, I've been using 700 millimeter electrodes. I think I'm going to change tomorrow and I'm going to use 400 millimeter electrodes. Life life technically doesn't work that way on the furnace. In terms of behavior patterns overall, look, the COVID-19 thing has turned the entire world on its head. And so any conclusions we would draw about what's taken place in the last, you know, several weeks are not valid in terms of a longer-term pattern. People are trying to do their best at their steel plants to keep their doors open. And some have been able to do that with more success than others. And others that, you know, case in point, you know, the terrible situation that evolved in Italy, folks had no choice but to deal with it and shut down. So there's a real, the scheme or rather the range of reactions to this crisis is quite broad. depending upon what country people are in in their specific circumstances. So it would be unwise and inappropriate for me to generalize those conditions.

And then I just wanted to, I guess, ask beyond COVID, you know, when you think about the business versus a couple of years ago, you know, neocook pricing has come down, electric pricing has come down. You know, there was a potential for the industry to move more towards LTAs. I guess, is it fair to assume that that is less possible now, just given the reduction in needle coke and, you know, your competitors kind of not willing to sign contracts at these low levels? How are you thinking about your business as it evolves beyond COVID?

Sure. I think the fact of the matter is at this point in time, most of our customers are just trying to deal with what's going to happen tomorrow relative to their COVID-19 response. Most of the contracts we have in play are there until the end of 2022. I think that's good news for us because it will allow customers some period of time of recovery post this crisis for the world to get back to whatever the new normal is going to be, but certainly much closer to the way life was in 2018 and through the first part of 2019 as opposed to 2020. And people, including ourselves, will be assessing that as we get into the the latter part of 21 and into 22, and whether the conditions remain appropriate. I think, as I've said before in the past, these are a type of hedging that people do on all kinds of commodities in the steel business, whether it's natural gas, electricity, or in our case, graphite electrodes. We will certainly be the one that's positioned to continue to be able to offer that service and that contract configuration to customers. I suspect it'll still be of interest to some and maybe not others. But we will be positioned to be able to continue to provide that service. And the macroeconomic recovery in the market will dictate, you know, the reception to that mode of contractual business when we get closer to 2022. Okay.

And then just one more last one. Could you comment on electric vehicle uptake, I guess, of needle coke? Has there been any reduction, I guess, in needle coke demand globally because of maybe some slowdown in the electrical vehicle market? Thanks.

Well, look, I don't think that we have the statistics over the last several weeks what's happened in response to COVID-19 on the battery market per se. I do know this much, is that as we were monitoring the situation through the first quarter, there was no question that there was some of the needle coke that was being used in the battery business that, you know, in the last crisis that we had, the last global crisis that was anything close to this, that wasn't the case. So that is a market that didn't exist in the past. Certainly with the decline in the automotive sector as part of the COVID situation, I would have to believe that, you know, if cars aren't being manufactured, there would be some near-term, short-term impact on that. but do believe that that's a COVID-specific reflection of that change. So one would expect that as the economy recovered, then that demand would resume and pick up.

Okay. Thanks a lot. Good luck with the future.

Thank you.

Here, our next question comes from the line of Alex Hacking with Citi. Your line is open.

Hey, good morning, Dave and Quinn. Hope you guys are doing okay. My first question would be around the contracted volume. Thanks for the updated guidance for the year. I guess, is there any way you can give us color on kind of the cadence of that through the year? My assumption would be that 2Q would be weaker than 3Q and 4Q, but any color around that would be helpful. Thank you.

Yes, certainly. I think you're directionally correct because, you know, as we are sitting here, we're in the month of May already. April saw a lot of the force majeure. We see a lot of it coming off now and would expect that we'll start to resume shipments to some of those plants through this month and next month. But there's no question that there's the initial hit of the crisis, the COVID-19 impact that will cause the second quarter to be impacted by that. And we're optimistic that the third and the fourth quarter will see some degree of recovery from that, although you know, again, the economic condition and the demand for steel is ultimately going to drive this. And we're not going to pretend that, you know, our crystal ball is probably any better than yours with respect to steel demand. But our numbers that we gave in reducing reflected our best estimate that there would be some lingering impact throughout the year because I don't expect that you know, come anytime soon in this month, like there's a suddenly somebody's going to flick a switch and steel demand will suddenly return exactly to where it was back in, you know, in January. I think you're all aware that, you know, if you just look at the United States as an example, you know, it's not too long ago at the beginning of the year that utilization rates were at 81%. And last week, they were 51%. So obviously, that has to have an impact on not only in the second quarter, but as we move through the third and fourth quarter to some extent.

Okay, thanks. That's helpful. And then a follow-up, I guess coming back a little bit to the needle code question, but a bit more broad, and I'm not sure if you can answer this, but how do you see the global ex-China cost right now? I mean, you mentioned in your prepared remarks, I think, that You've seen some, you know, electro transactions around 3,000 a ton. I mean, if that really is where prices are, would, you know, do you, I guess, do you think everyone's underwater or you think the cost curve is reset to make that kind of a break-even price? Thank you.

So, look, we need to be very clear and transparent like we were trying to be in my prepared remarks. we obtained that information just like anybody else could through looking at trade statistics. And we saw a couple of, and we did say it was a very thinly traded, we saw a couple of instances where transactions took place at numbers just below that 3,000 value. So because we're not buying needle coke and because of the inventory situation and our own ability in the market conditions that we've referenced here for We don't expect to be purchasing needle coke this year, and vendors know that. So it's not like we're getting firsthand information. We're using the trade statistics to inform us. So I want to be very clear about that so there's no misunderstanding. And where that brings the other few folks that do make needle coke, I cannot speak to their cost curves. It wouldn't be fair and it wouldn't be appropriate for me to do that. I just know where ours are. And we think we know we're in good shape relative to those kind of values. And we'll continue to focus on running the business cost effectively, not just at the electoral plants, but also at our CDREF facility.

And Alex, this is Quinn. Just to clarify one thing, your question, you referred to graphite electrodes, but are prepared remarks around transactions below $3,000 related to needle coke?

Oh, okay. Thank you. Thank you for clarifying that. I misunderstood. So thank you. That's helpful. And then I guess just one final one, if I may. How should we think about working capital for the rest of the year? Obviously, you talked about selling inventory and going to generate some cash there. Is there any way you can quantify that? Thanks.

Yeah, sure. So we do expect inventories to come down over the course of the year. It will be a bit of a slow process for it to come down, given that volumes are lower. But certainly our purchases are lower, and we will manage our production generally to match the sales volumes there. So while it won't come down drastically in the near term, it will come down over time. And then you saw in the first quarter, we had quite a nice benefit of cash flow from accounts receivable. That's natural. If sales were to be lower, there would be some additional benefit from that. If sales are the same, then that will probably be about the same. So the way I would summarize it is, some meaningful positive benefit due to lower inventories, regardless of levels of volumes over the remainder of the year.

And that's total, as you might imagine, just to be clear, that's total inventories from needle coke all the way through to electrodes. We may decide to hold inventories in different places, but the total as a whole would come down.

All right. Thanks, guys, and stay safe.

Your next question comes from the line of Kurt Woodworth of Credit Suisse. Your line is open.

Thanks. Good morning, Dave and Quinn. Good morning, Kurt. So if you're not going to be sourcing merchant Coke, then is it safe to say that your sort of effective capacity this year would just be, I think it's roughly 135 KT you sourced out of Seadrift?

Well, it'll be less than that this year because we're taking, this is every second year we take a turnaround. And this year is a turnaround year. So we'll have that operation out of service for a month. So it will be lower than that value.

Yeah, last year we indicated that our production at C-DRIFT was roughly 125,000 metric tons. It'll be lower than that this year, Kirk, because of the one-month turnaround.

Okay. So, I believe it's roughly a one-to-one sort of coke to electrode ratio. So, if it's below 125, but you're still going to do potentially 120 of LTA, that would assume zero spot. Is that right?

Yeah, yeah, yeah. Good question, Kurt. So we did, in anticipation of the outage, build up our needle coke inventory to some extent. So we have enough inventory to cover us through the outage. And then going forward, we don't anticipate any meaningful purchases of third-party needle coke through the remainder of the year.

Okay. And, I mean, given the fact that, I mean, the spot market is – been, as you said, and there's great reports of spot pricing well below $5,000, $6,000 right now. I mean, is the philosophy just to kind of baseload your facilities as best you can? I mean, can you talk about how to optimize your footprint? Right now, I notice the fixed cost reductions. I mean, the business is fairly fortunate that you don't have a lot of fixed cost ratio, but Just in terms of, you know, how you're running the business on a lower utilization rate, can you comment on that and if there would be any unit cost pressure just on the unit basis going forward?

Sure. Look, therein lies one of the big benefits of the LTAs, of course, but in the spot area, We'll conduct ourselves in a manner to be competitive in the markets that we consider, you know, our traditional home markets. I think we can weather the storm as well as anybody can. Now, it doesn't prohibit people from perhaps doing irrational things. And that doesn't mean that we're going to follow somebody down an irrational path. But for the most part, to answer your question, we expect to be competitive. We're going to maintain our presence in the market and service the customers that we've been doing business with for years and years. And it may mean at the end of the day, and I think this is your point, that When you look at margins, the spot businesses may not be as attractive as it was a year or so ago, but we're in this for the long haul, and we will be in a place and available for our customers. No question about that.

Great. Thank you.

And at this time, I will turn the call back to the presenters for any closing remarks.

Well, thank you. In conclusion, Graphtec is well positioned to be resilient to these challenging macroeconomic conditions, and we are committed to providing our customers with a reliable service through the difficult days that lay ahead. I'd like to take this opportunity to wish everyone on this call continued health and safety in the coming months. Again, thank you for your interest in graph tech, and we look forward to speaking with you next quarter.

And this concludes today's conference call. Thank you for your participation. You may now disconnect.