GrafTech International Ltd.

Good afternoon, everyone, and welcome to the Graf Tech International's second quarter 2020 earnings results conference call and webcast. Please note that all lines are in a listen-only mode. After the presentation, we will open up the call for questions. At that time, if you have a question, please press pound 1 on your telephone keypad. Again, that is pound followed by 1. Please note that this call is being recorded today, Thursday, August 6, 2020. at 4 o'clock Eastern Daylight Time. I would now like to turn the meeting over to your host for today's call, Graf Tech International's Chief Executive Officer, Dave Rintel. You may begin.

Yes, good afternoon, and welcome to Graf Tech International's second quarter 2020 conference call. On the call with me today is Quinn Coburn, Chief Financial Officer, and Wendy Watson, who is our new Vice President of Investor Relations at Wendy is a seasoned investor relations professional, and we are excited to welcome her to the Graf Tech team. I'll now hand the call over to Wendy.

Thank you, Dave. It's a pleasure to be here, and I am looking forward to working with Graf Tech's investment community. Before we begin today's call, I want to remind you that some of the matters discussed on this call 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 those indicated by forward-looking statements are shown here. We will also discuss certain non-GAAP financial measures for which you will find reconciliations in these slides. These slides are posted on our website at www.graftech.com in the Investors 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, Wendy, and good afternoon, everyone, and thank you for joining us today. I hope this call finds you, your families, and your colleagues healthy. We'll begin, as we always do, with safety, which has become even more important during the pandemic. Health and safety excellence is a core value of Kraft Tech. Our total recordable injury rate for the first half of 2020 improved significantly to 0.42, a 56% decrease from 2019. We are especially pleased with this as it was achieved in addition to the actions taken in response to COVID-19. This year, the team has been particularly focused on safety tasks involving actions such as the interface between people and mobile machines, pre-task planning, and hands-off practices, just to name a few. We are extremely pleased with our safety results for the quarter. and committed to a culture of continuous improvement. As part of this continuous improvement, we will expand our leading safety indicators to enhance awareness going forward, safety awareness going forward. I want to take a moment to thank the team for their continued diligence and hard work in this area. However, the only correct number here is zero. Health and safety is fundamental to our belief that a safe plan provides the foundation to achieve success on the balance of the business metrics. Turning to slide four, we are proactively managing through the COVID-19 pandemic. Our executive-led COVID-19 response team continues to meet three times per week to assess the situation at all of our locations. Travel by team members remains heavily restricted. We have temperature checks in place for personnel entering our facilities. Personal protective equipment is being utilized, including mandatory glove use for 100% of our workforce operating facilities. Okay, turning to slide five. The actions that we have taken around our COVID-19 protocols have enabled our plants to continue operating safely and effectively. Our organization has quickly adapted to the new normal working environment. Our European plants were the first to adapt and implement new practices as the pandemic hit Europe prior to North America. Our North American plants are currently dealing with the recent surge in COVID-19 infections. in both the United States and Mexico. I'm pleased to be able to say that 99% of our employees remain COVID-19 free to date. Our plants have remained operating through the COVID-19 pandemic and are running at levels to meet our customers' requirements. During these challenging times, we are increasing our efforts to provide the highest level of service to our customers and have achieved an on-time delivery rate of 98% in the second quarter. Our CDREF facility recently completed its regularly scheduled maintenance outage. This planned biannual outage lasted five weeks. Our team safely completed the turnaround on time and on budget with the facility back in operations at the end of July. Moving to slide six. It goes without saying that COVID-19 has significantly impacted the steel industry and steel demand. The World Steel Association recently reported that global steel production outside of China was down 25% in the second quarter from the same period in 2019. Utilization rates have also fallen. As an example, in the United States, the utilization rate declined from approximately 80% in Q1 to and currently stands at 59%. Steel prices have generally decreased and are more volatile since the pandemic began. Customer destocking efforts have been reduced as operating rates have impacted electrode consumption. We continue to expect graphite electrode demand to remain soft for the remainder of 2020. Turning to slide seven, As we said on our last call, we are experiencing the impacts associated with challenges currently facing the steel industry. We have received approximately 35 force majeure claims. Some of our customers are struggling to take the volumes they've committed to under our LTAs. Additionally, we've had a few customers fail to perform on their contracts. We are working hard with our customers to develop mutually beneficial solutions. While I expect to take appropriate measures to ensure the obligations under our contracts are fulfilled, we have been able to modify some of our contracts to provide relief in the near term while securing additional volumes by extending the contract. We continue to anticipate that our 2020 LTA sales will be in the range of 100,000 to 115,000 metric tons. Now I'll turn it over to Quinn on slide eight for more detail on our second quarter financial results.

Okay, thanks Dave. During the quarter we produced 33,000 metric tons of graphite electrodes, which is in line with the last quarter. Our capacity utilization was 65%. We shipped 31,000 metric tons as electrode demand was impacted by lower steel operating rates and the impact of COVID-19. Our LTAs accounted for 26,000 metric tons of these deliveries and brings our year-to-date LTA deliveries to 55,000 metric tons. We sold 5,000 metric tons of electrodes in the spot market in Q2. As we expected, spot prices declined in the second quarter. Our average real-life price for non-LTA sales was $5,500 per metric ton. Given the current market environment, we expect that spot prices will likely continue to decline in the third quarter. Now turning to slide 9. Net income was $93 million, generating $0.35 of earnings per share. Adjusted EBITDA was $151 million. Pre-cash flow totaled $138 million in the second quarter, as we continue to generate strong cash flow. Turning to slide 10. During the second quarter, we successfully executed on our financial commitments to address the COVID-19 pandemic. We eliminated discretionary spending and reduced our capital expenditures forecast for the year by roughly 15%, while continuing to execute on our key strategic initiatives. We right-sized our workforce at our electrode plants to match our current production levels and achieved our target of reducing fixed costs at our electrode plants by 15%. Turning to slide 11, we again ended the quarter with a strong liquidity position. Our total liquidity was approximately $435 million, consisting of $188 million of cash and $247 million on our revolving credit facility. We achieved this liquidity while reducing our debt levels by $103 million in the quarter. This provides us with significant financial flexibility as our term loan is not due until 2025 and our next amortization payment is not due until mid-2022. We will continue to use the majority of our free cash flow in 2020 to reduce our debt and maintain balance sheet liquidity. Now I'll hand it back to Dave on slide 12.

Thanks, Quinn. While the global economy, including the steel industry, is facing significant challenges in the wake of the current pandemic, we remain confident about the long-term strengths of the electric arc furnace and graphite electrode industries. The EIF industry has several advantages over traditional steelmaking. For example, EIF facilities are more flexible to operate, and during this recent downturn, were able to be idled and restarted quickly and cost-effectively. Additionally, environmental considerations will continue to become an increasingly critical issue facing industrial companies. And EIF production yields 75% less carbon emissions than traditional blast furnace type operations. These economic, operational, and environmental advantages put the EIF industry in a strong position to weather this downturn in the short run and to achieve continuous solid growth over the long term. Turning to slide 13, as the EIF industry continues to grow, the use of graphite electrodes will continue to grow as well. Graphite electrodes are our mission-critical component to the EIF industry. The electrodes that we manufacture are highly engineered and require extensive process knowledge to produce. The services and solutions that Graphtec provides will help both position our customers and us for a better future. Moving ahead to slide 14. Graphtec is one of the largest electrode manufacturers in the world. They've taken decisive actions to manage through the COVID-19 pandemic. Our global footprint provides us flexibility should any operating environments become challenged due to further outbreaks. We have a strong balance sheet and a proven track record of cash flow generation and managing through industry cycles. We cannot be certain when the current difficult macroeconomic conditions will return to normal. We believe GravTech is very well positioned to weather the challenges of the current environment. That concludes our prepared remarks, and we'll now open the call-out for questions.

Thank you, sir. At this time, we will take questions. If you would like to ask a question, please press pound, followed by the number one on your telephone keypad. Again, that is pound one. Please note, due to the number of questioners, we please ask that you limit your question to one before rejoining the queue. Please hold while we compile the roster. Our first question comes from David. Gagliano with BMO Capital Market. Your line is open.

Okay. Thank you for taking my questions. I'll try and just keep it to one question. I'm going to try and turn it into a two-part question if possible. In terms of the near term, I'm wondering, you know, spot prices are falling, and there were obviously spot sales in the second quarter. So my first question is – first part of my question is that what – you know, what spot price would you no longer sell into this spot market? And are you continuing to sell into the spot market in the third quarter? And then I also have a longer term second part of the question. As a fourth quarter results, you know, the numbers for long-term contracts for 21 and 2022 were 125 and 117,000 tons sold forward. Average price was 9,700 bucks a metric ton. What are those figures as of now? That's my question. Thank you.

Okay, so in terms of your question on spot, there's no question that we will be selling spot business in the third quarter, absolutely. We intend to maintain our presence in the marketplace as appropriate. We have many good customers that we intend to maintain that relationship with and will be competitive as a means by which to ensure that our relationship remains both solid and positive as we move into the future.

Yeah, Dave, and on the second question, those are the contracted numbers that you referenced for 2021 and 2022. We haven't actually given any guidance beyond those contracted numbers. We haven't tried to assess at this point the number of tons that we will actually realize in 2021 and 2022. Of course, we're doing that internally. We're just not prepared at this point to have a good estimate to give publicly. As we've talked before, some of the tons that we did not realize this year should come back in future years and some of the tons in future years will potentially be pushed out. So we're monitoring that, working that, as we indicated in our release here. We need to work with customers in a proactive and mutually beneficial way to ensure these volumes are fulfilled on the contract. But exactly how that will roll out over the next couple of years, we haven't publicly given any information on that yet.

I think the last part of that answer is the most important part. We're working very hard with a number of our LTA customers that have experienced difficulty as a result of this pandemic. And as any good business partner, we're trying to find ways in which both parties can find an acceptable path into the future, assisting our partner while at the same time ensuring that we're being good stewards of our shareholders' well-being.

Okay, that's helpful. Thank you. And then just the last question. One of those questions that I asked, is there a level – I'm sure there is – is there a level where the spot price is just too low to sell and to maintain the relationships? And if so, what is that level?

Well, look, at this point in the evolution of the spot market, our focus is on servicing the customers that – We are in good partnership with and have been in business with for many years because we've been around for a long time, and we expect to continue to do that. So I don't think it's prudent for me on this call to put out such a value. So I'll leave that, go with that.

Our next question is from Aaron Viswanathan. With RBC, please ask your question. Your line is open.

Sorry about that. I was having trouble with my mute line. Thanks for all the details. I guess first question, you know, when we're starting to think about this industry, you know, you reference a lot of difficulties. Your customers are going through some financial difficulties. I guess maybe you could just discuss the contracting environment there. looks like you are, you know, potentially renegotiating some contracts and securing more volumes for out years. How are those discussions going? You know, I guess, you know, are you able to kind of give us any kind of thoughts on, you know, where those contracts are kind of ending up? Are they materially lower than your prior contracts? Are they closer to spot? Yeah, how do we think about the future here?

So, I think the important to remember is that there's no one-size-fits-all solution. Every one of the customers that has come to us has their own unique set of circumstances that is driving the components that are important to them. So the complication, but we're working through it, is that this is not a cookie-cutter exercise. every one of them is unique. And I think that speaks to, you know, our efforts in being a good partner, that we, in fact, are receptive to ensuring that solutions that we come up with work for both parties. And like I said, it's not just cookie cutter. So therefore, there's no specific that – I'm able to give you because each one of them is a bit different. But I did say something in answering a previous question that I think is important. As we strive to solve and work through issues in the near term for our customers, we also take very seriously our fiduciary responsibility to our shareholders. So we try to work hard to come up with win-win solutions where the responsibilities of the shareholders are not forgotten while we're trying to navigate near-term solutions for our customers.

Okay. And then maybe two areas more. So first on the cost side, you know, presumably you've seen some relief in certain raw materials. And maybe you can just discuss that. And again, are there other cost actions that you're taking both temporarily and structurally? And if you could speak to those. How should we think about the costs that you guys are taking out that are structural? You know, would those be a benefit to earnings in 21?

Sure. As we noted in our comments, we were able to reduce our fixed manufacturing cost for our electrodes by 15%, which we were very pleased with. And those are production costs in the quarter. And so the benefit of those reduced costs would go to inventory in the current quarter and would roll through the P&L in future quarters. So that will accrue. And then you're right. On the raw materials side, third-party needle coke has softened over time. And with the lower volumes, we've used less third-party needle coke. And so we've had a bit of a benefit there in terms of the average cost of coke in our electrodes. And that should also continue to improve somewhat over time. So we've got those two factors working in our favor going forward.

And then just lastly on, I guess, you know, how you're thinking about the capital structure, you know, you did have an event in the quarter, so maybe you can just discuss that sale down by your majority shareholder to the owners of that event. and then also maybe what does that imply, I guess, going forward from a capital return standpoint or your preference of deleveraging? How are you thinking about using free cash flow?

Sure. So first, on the distribution from Brookfield, obviously that doesn't impact us directly, except that it does increase the public flow, which we think is a long-term positive. increasing and enhancing the liquidity in our stock. It did result in the public flow increasing from approximately 25% to 35%, and conversely, Brookfield's consortium control position reduced from 75% to 65%. So in general, the increase in liquidity, we think, is positive for shareholders over the long term. But other than that, we really are not directly involved in those decisions. And other than that impact, not directly impacted by that. To your second question on the overall capital structure, as we've talked to previously, the way we think about our overall capital structure and our debt levels is that We want to manage our overall debt level in line with the visibility that we have to our cash flows and specifically to the long-term agreements that we have. We've set a leverage ratio target that would be something not to exceed two to two and a half times. At the end of the quarter here, our net leverage ratio was 1.9, so we're slightly below that range and we're comfortable being below that range. We wouldn't want to exceed that range. And as we've indicated before, we plan to be prudent in our balance sheet management. We plan to ensure financial strength and flexibility. I think that's even more important during this uncertain period of time with the pandemic and the uncertainty around the length of it and the overall impact on the economy and the steel industry. So we absolutely plan to prioritize balance sheet flexibility and ensure financial strength and therefore we'll continue to use the majority of our cash flow to pay down debt over the rest of the year. As we note in our press release, we do on an ongoing basis discuss capital structure with our board of directors and we will continue to examine opportunities to repurchase stock. But as we've indicated, the priority will be balance sheet strength.

That is all the time we have for questions today. I will turn it back to the speakers for concluding remarks.

Okay. Thank you, operator. In conclusion, Gravtech is well positioned to be resilient through these current macroeconomic conditions, and we are committed to providing our customers with reliable service through any challenges 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.