GrafTech International Ltd.

Ladies and gentlemen, thank you for standing by and welcome to the Graf Tech third 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 the session, you will need to press star one on your telephone keypad. If you require any further assistance, please press star zero. Thank you. I would now like to hand the conference over to your speaker today. Wendy Watson, please go ahead.

Good morning, and welcome to Graf Tech International's third quarter 2020 conference call. On the call with me today is Dave Rintoul, Graf Tech's chief executive officer, and Quinn Coburn, our chief financial officer. Turning to our first slide. As a reminder, some of the matters discussed on this call may include forward-looking statements regarding, among other things, results, performance, trends, and strategies. These statements are based on current expectation 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, and these slides include the relevant non-GAAP reconciliations. You can find these slides in the investor relations section of our website at www.graftech.com. A replay of the call will also be available on our website. I'll now turn the call over to Dave.

Thank you, Wendy. Good morning, everyone, and thank you for joining our third quarter call. I hope you, your families, and your colleagues are healthy and well. We will begin, as we always do, with safety, which has become even more important during the pandemic. Excellence in health and safety is a core value of graph tech and a key priority. Our year-to-date total recordable injury rate at the end of Q3 was 0.57, a 40% decrease from 2019. Thank you to the graph tech team for your continued diligence and hard work in this area. However, The only correct number is zero with every employee going home safely every day. Health and safety is fundamental to our belief that a safe plant is a foundation for the success on the balance of our business metrics. Turning to slide four. We continue to proactively manage through the COVID-19 pandemic. Our executive-led COVID-19 response team continues to meet three times per week to monitor developments and make responsive changes to our safe work playbook to facilitate team member and customer safety. Our plants have been diligent throughout the COVID-19 pandemic and thorough in their controls and associated audits. Our team members continue to adhere to exacting protocols and cleaning, PPE, social distancing, and other measures designed for safe operation of our facilities. Regular team member communication and education is critical and ongoing. During these challenging times, we are also focused on providing the highest level of service to our customers and maintaining an on-time delivery rate of 98% in the third quarter. Turning to slide five, we are very pleased to have launched our inaugural sustainability report in September. We are committed to advancing our ESG efforts and continue to monitor progress on our environmental initiatives. As we focus globally on being good environmental stewards, we are mindful that electric arc furnace steel production yields 75% less carbon emission than traditional blast furnace production. The steel industry overall is a leader in recycling, and more steel is being recycled every year in North America than paper, aluminum, plastic, and glass combined. We are proud of our inaugural sustainability report and are fully committed to these efforts across our organization. We expect to issue our sustainability report on an annual basis. Moving to slide six, we are seeing measured improvement from the second quarter in the global steel industry with regions recovering at different rates. Third quarter global steel production outside of China improved to 187 million tons from 167 million tons in the second quarter. According to the World Steel Association, China is expected to achieve a new high for steel production estimated at just over 1 billion tons in 2020. Global steel manufacturing utilization rates outside of China also improved in the third quarter to just over 60% from approximately 57% in the second quarter. In the U.S., the utilization rate now stands at just over 70%. Steel prices have also been increasing in the third quarter, with USA hot-rolled coil values at approximately $700 per ton, North European hot-rolled coil at 513 euros per metric ton, or $593 to $600 U.S. dollars per metric ton, and Black Sea billet pricing at $412 per metric ton, all of these up over the second quarter. While demand is improving in the steel industry, we expect customer graphite electrode destocking efforts to continue for the remainder of 2020. We expect measured improvement in graphite electrode demand as the electric arc furnace steel industry recovers. Due to a favorable mix in the third quarter, Our average price for non-LTA sales of graphite electrodes in the third quarter improved slightly to $5,700 per metric ton. However, as anticipated, we believe the general spot price of graphite electrodes continue to trend lower during the quarter. Turning to slide seven. Our commercial team has been working hard in the current environment to serve our customers and to develop mutually beneficial solutions for customers who have struggled to take the volumes they have committed to under our LTAs. We have made substantial progress in negotiating LTA modifications with several of our customers, providing them near-term relief in exchange for additional contractual commitments going forward. We expect to continue finalizing more of these mutually beneficial negotiations in the coming months. For the full year 2020, we anticipate LTA sales volumes will be above the midpoint of our expected range of 100 to 115,000 metric tons. Given the good progress we are making in the LTA negotiations with our customers, we estimate that our graphite electrode LTA sales volumes in 2021 will be in the range of 98 to 108,000 metric tons. In 2022, we will be in the range of 95,000 to 105,000 metric tons. And for the years 2023 through 2024, we estimate LTA sales volumes of 35 to 45,000 metric tons. This effort represents the partnership that Gravtech has with our customer base. Now I'll turn it over to Quinn on slide eight to discuss our third quarter financial results.

Okay, thanks, Dave. Third quarter 2020 net sales were 287 million, a sequential improvement of just over 2% from the second quarter and down 32% from the third quarter of 2019. During the quarter, we produced 32,000 metric tons of graphite electrodes in line with the last two quarters. Our capacity utilization was 67%. We shipped 33,000 metric tons in the third quarter for a total of 98,000 metric tons year-to-date. Our LTAs accounted for 27,000 metric tons of third quarter deliveries, bringing our year-to-date LTA deliveries to 82,000 metric tons. Now turning to slide nine. Third quarter 2020 net income was $94 million, or $0.35 per diluted share. Year-to-date earnings per diluted share are $1.15. Third quarter adjusted EBITDA was $153 million, and third quarter free cash flow was $123 million. Year-to-date free cash flow is $386 million. As you'll see on slide 10, we have used the majority of our 2020 free cash flow to repay debt. As we noted earlier in the year, we will make a foreign jurisdiction tax payment of approximately 50 million in the fourth quarter. This payment was deferred from the first quarter due to COVID-19 related relief. Now to slide 10. During the third quarter, we continued to execute on our financial commitment to reduce debt and maintain our balance sheet flexibility. We reduced our debt by approximately 150 million in the third quarter and an additional $60 million in October, bringing our 2020 debt reduction through October to $313 million. We continue to be disciplined with our capital expenditures, consistent with managing the business through the conditions created by the pandemic, expecting full year spend of approximately $35 million, a near 50% reduction year on year. We are also closely managing our working capital, including aligning inventory levels with customer demand and controlling our costs. At the end of the third quarter, our total liquidity was approximately $406 million, consisting of $159 million of cash and $247 million available under our revolving credit facility. Our strong liquidity position and continued debt reduction provides us with significant financial flexibility. We expect to continue to use the majority of free cash flow to further reduce debt and maintain balance sheet liquidity. Now I'll hand it back to Dave on slide 11.

Thanks, Quinn. The inherent manufacturing flexibility of electric arc furnished steel producing facilities with the ability to idle and restart operations quickly and cost effectively is a significant advantage over traditional integrated steelmaking. This advantage was evident over the past several months as the steel industry addressed pandemic-related challenges, and this flexibility will help drive growth for the EAF industry, including the need for high-quality graphite electrodes over the long term. Graphtec is one of the largest electrode manufacturers in the world, operating three of the largest global facilities. Graphite electrodes are a 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 GrapTek provides help position both our customers and ourselves for a better future. We have a sustainable and long-term competitive advantage from our low-cost structure and vertical integration into our key raw material, petroleum needle coke. And our global footprint provides us flexibility should any operating environments become challenged due to a second wave of the pandemic. Our balance sheet and proven track record of cash flow generation gives us the strength to manage through industry cycles. With commitment to our people and our significant competitive advantages, we continue to strongly believe Draft Tech is well positioned today and over the long term. That concludes our prepared remarks. We will now open up the call for questions.

At this time, as a reminder, to ask a question, you will need to press star 1 on your telephone keypad. To withdraw your question, press the pound or hash key. Your first question comes from Kurt Woodsworth from Credit Suisse. Your line is open.

Yes, hi, good morning.

Good morning, Kurt.

You know, Dave, when we look at the new updated LTA, you know, guidance, it seems like if I add up all the tons and include the 2023 year, you're really not too far off from your baseline level that the company initially established, yet you have had you know, clearly some of those tons permanently go off. So I'm just wondering, is that a function of, you know, part of the LTA renegotiation process where you actually add additional tons on the contracts on the back end to help preserve, you know, kind of this NAV argument that you have been trying to pursue?

Thanks for your question, Kurt. Yeah, it's an effort to find a place with some of the customers that are having some challenging times to come up with a win-win arrangement where we provide some assistance in the near term. And in exchange for that, we get consideration in some of the out years. So we think we're accomplishing that. And I think over the last several weeks, we've closed a number of these programs. arrangements with people, and I can see a few more or more to come, but I think it does that. It preserves what the customers are looking for in terms of some of the near-term challenges today, and it helps us preserve the value for our shareholders.

And some of the outcomes you just talked about, would that be a creative to your LTA book, or is some of it just simply pushing, you know, maybe a 2021 LTA into 2023?

I think it's a creative quid.

Yeah. One other thing to keep in mind, Kurt, is previously, you know, we had a few contracts that were fixed share contracts that could vary in volume, and previously we had indicated that that was could be up or down 5,000 tons per year. And in our previous disclosures, in our previous disclosures, we had stated those in the midpoint. In this disclosure, we've been taking a little more conservative view and put those at the low end of what those could be. So that's 10,000 tons. So taking that into account, you can see that we're actually overall, once adjusted for that, a little bit higher than the previous numbers.

Okay, yeah, that's what I thought. And then with respect to the comments that the spot price trended down in the quarter, yet you were able to obtain higher non-LTA value, given the spot where you see it today, can you give any guidance on kind of what range of pricing you're seeing in the market? And given where needle coke has come down to, would you say that the spot sales would be profitable at this point?

Sure. You know, that's a difficult question, I'm sure, as you know, at this point in time, and that we've been careful about disclosing what we thought in the past, careful disclosing what we thought spot pricing was because Early in our experiences as a publicly traded company, we found that that worked against us relative to our competitors using that data. But I also recognize your challenges and your colleagues' challenges in viewing the company. So we'll do our best here to try and provide as much color around that subject as possible. Having said that, one of the things that has happened is absolutely spot pricing has lowered today from what it was in Q2 and Q3. There's been a downward trend, to be clear. However, at the same time, the disparity or the distribution and standard deviation, if you will, of pricing around the world has grown. there's somewhat of a disconnect from region to region to region about what those numbers were. So if I gave you an average price today of where we thought it would be, it would not be, candidly, it wouldn't be terribly useful for you because it would be a different price in the U.S. and a different price in the EU and a different price in the Middle East. and yet another one again in Japan and Korea, et cetera. The distribution of the change disparity from region to region has grown as the price has come down. Now, the best way that I think we can help you think about that is that – If you look at information, it is publicly available, and that is the export-import numbers on needle coke. You'd find that that number recently, you know, it has a range as well, but it's anywhere from a few trades, not many, but a few as low as 1,300, and more at about the 1,800 level. So I think in the past we've given a lot of information about how to take those kind of numbers and translate back into cost structures. And so graphite electrodes. So my or our counsel would be, given that for the reasons I stated previously, that we're not going to come right out and tell you what we think prices are on graphite electrodes. I think you can use that needle coke number And think about that in the context of the incremental cost that people are facing now on electrodes and knowing that that's probably pretty close to the bottom range of what would be practicable. I hope that's helpful.

Yeah, very. Thank you. I understand there's a lot of regional variation, so that's fair. And then just last question with respect to the U.S. market issue. there's eight to nine million tons of new electric arc capacity coming online in the next, you know, call it 12 months. Can you talk at all about how, do you think that is going to move the needle at all with respect to price? Have you been able to, you know, win any business with that new capacity? Thank you.

Yeah, sure. Obviously, you know, it's the fundamentals of supply and demand. And so it'll certainly help the demand situation But what I would say is that just as our market lags as steel production comes off, it also lags on the other side. So as we're seeing strength in the steel market, and testament to that is $700 ton hot roll coil pricing, And, you know, rebar has been pretty steady at about $600. So there's a lot of positive signs in the, certainly in the U.S. steel market and, you know, recent earnings releases by some of the mills in the country would add to that sentiment. So we're optimistic that it will help. And obviously more facilities coming online will be helpful. recognize that the increase to just over 70% of utilization is good. But we also have to be realistic and understand that before COVID came along, the American steel industry was running in the 80-ish percent utilization. So the new facilities will inevitably help. And while I think we're on the way to good progress and optimistic about it. We're still not yet obviously back to pre-COVID in the United States, and I think maybe certainly Europe's a little further behind that. But generally speaking, no matter whether you look at that or Black Sea billet prices or even Asian hot row prices, all of the steel-related key metrics are moving in the right direction. So We are optimistic about what that will bring to the demand side of the equation, which will ultimately trickle through into the graphite electrode industry.

Great. Well, thanks very much, Dave and Quinn. Okay.

Your next question comes from Arun Viswanathan from RBC Capital Markets. Your line is open.

Great. Thanks. Good morning. I guess first off, just wanted to get back to some of those near-term fundamentals you were discussing. So maybe you could just help us square the kind of differing dynamics here. On the one end, you do have, it seems like, some improvement in steel markets, yet needle coke and maybe electrodes You know, you referenced spot pricing and electrodes going the other way. So, you know, why is that the case? I guess maybe you can just tie in some comments on supply and inventory on both needle coke and electrodes. Thanks.

Sure. Well, first of all, recognize that, you know, our industry will always lag whatever is transacting in the steel industry. So we'll see the decline a little later and we'll see the increase a little later. So I don't think it should come as a surprise at all that while the steel industry in the third quarter began to see an uptick, that it hasn't quite made its way into our world yet. I wouldn't have expected it would have just yet. And as long as it continued, we'll eventually see it make it into our world. In addition to that, and you're quite right, we entered into the pandemic. If you think about my comments back in our earnings release at the beginning of the year. At that point, we were talking about destocking taking through to into the third quarter of this year. And that was before the pandemic took place. So as we think about that now, that destocking is starting to happen again because the steel industry is picking up. But we had almost a period of time where not much of anything was happening relative to destocking because of the pandemic. So as I said in my comments earlier, we expect that destocking to continue through the balance of this year. So you combine the fact that there's always a natural lag in our industry combined with some of the destocking that had to finish And that's why you see a situation where I'm still talking about a decline in graphite electrode pricing. So we'll need to get into the new year. assuming that the steel market continues to move in a positive direction and that recent developments in the COVID world don't disrupt that. We hope it doesn't. But we're not saying our crystal ball is any better than anybody else's on that, so we're not going to try and predict that. But assuming that the market continues on its trend, once we get into the year, I think we'll start to see some of that pull from the demand side help out. And I would, on your inventory question, I mean, I think I've answered it from a graphite electrode perspective. On a needle coke perspective, there will be needle coke in the world, just like there was graphite electrodes because the pandemic interrupted everything. So there'll be some period of time where there'll be some needle coke overhang And then on top of all of this, of course, is that fortunately China has recovered strongly, making, you know, looks like they're going to make over a billion tons of steel this year. We know that they've also advanced in their construction of plants in our industry, and so time will tell some of that balancing out that comes from the supply side. I don't think that's That's still a little bit opaque at this point in time, and the pandemic has complicated views on that. But I think generally speaking, the demand from steel will pull the demand for graphite electrodes up as we get into the new year, and we'll find ourselves in a bit better place.

Thanks for that. So just to be clear, I guess when you started the year, you were expecting maybe three quarters to work through the inventory. Maybe with COVID, maybe that lengthened a little bit and you're now starting to see some destocking. I guess the other question I had also was just when you think of what's transpired here and your own production levels, when you started out, I think you had 180,000 tons of capacity. You went through a de-bottlenecking project and got your capacity close to 200. So, you know, I guess your LTAs are spoken for for the next couple of years around the 100,000 ton range. How do you think about all the other capacity that is within Graf Tech's control? I mean, is it best to just leave it idle for now or is there... you know, permanent shutdowns that could be contemplated. And if you could offer any thoughts on the industry as well, from a supply-demand standpoint, if you see any, you know, closings coming as well.

Thanks. So I think it's a good question. The one thing I just want to correct a little bit in the first part of your statement, We talked about destocking taking until the third quarter, not three quarters long. So at that point in time, it would have been January through to the end of June. So not nine months in length, but six months in length because we said it would be pretty much complete once we got to the third quarter. So I don't want to imply that we think currently we still have another nine months to go. So Relative to capacity, I think that it's a good question and somewhat a little early yet to address in so much as we have to see with the expansion of plants in the United States and the belief and the knowledge that, look, the environmental factors in the world are such that the electric arc furnace industry inevitably will grow. integrated steel production will inevitably decline. So as that increase takes place, there's a place for the graphite electrode industry and long-term growth in it. So what one has to do as we, when the time comes and we truly exit the pandemic, one has to assess that forward growth curve. And as you think about you know, carbon emission situation in Europe and the fact that carbon credits and that trading system is alive and well, and it will influence people on their decisions about how they're going to make steel. And that same methodology and that same thought process is not unique to just them alone. You even hear the Chinese now talking about having some kind of thoughts around developing policy on this similar front. So all of these things tell us that the electric arc furnace steelmaking world will expand and grow. So once we exit the pandemic, I think that's the time when we can triangulate and determine, okay, what is the graphite electrode capacity And how does that shape up against the growth pattern of electric arc furnaces, and what decisions would be appropriate at that point in time? I think it's just a bit too early yet to jump to that conclusion.

Thanks. And then lastly, if I could, just on the cash side, when you, again, when you contemplate these dynamics, you know, How do you feel that the priorities of cash use will be from here? I know deleveraging is still important, but maybe you can just reiterate how you're thinking about using that cash, given these dynamics. Thanks.

Yeah. Thanks, Arun. It's Quinn. The first thing I would say is, as we've said before, this is a topic that we review on an ongoing basis with management and the board of directors. And as you noted, Arun, in our comments and in the earnings release, we indicated that in the near term, we expect to continue to use the majority of our cash flow to reduce debt. You know, we always want to be in a position of balance sheet strength and think that's very good for the shareholder. So that will be our plan. Now, obviously, we will continue to evaluate all the options. As you well know, we have $59 million available in our share repurchase program, and we'll continue to examine that. That would continue to be an option. But as noted, in the near term, the priority will be debt reduction.

Thanks.

Again, if you would like to ask a question, please press star 1 on your telephone keypad. Your next question comes from Alex Hacking from Citi. Your line is open.

Yeah, good morning, and thanks for the time. So I apologize. My phone cut out a little bit earlier. Did you say that needle coke, spot needle coke, I know you don't buy it, but you estimated it was around $1,800 a tonne?

Yeah, well, we said if you look in the export-import data that's publicly available, if you do the research, you'll find that there are a few trades that were as low as $13. Most of them were in the $1,800 range.

Okay, so that's – I mean, am I correct that that represents a fairly substantial decline from – where we were sort of three months ago when they were more in the 2,000 to 2,500 range?

Yeah, I mean, if you want to classify, yeah. I mean, I think the range that you provided a few months back is, I think it might be more like four or five months back, but you're in the right genre.

Okay, thanks. Just checking. I'm a little surprised just given how the steel market is stronger. But that's extremely helpful. Thank you.

But don't forget, Alex, everything in our world lags the steel guy. So what you're seeing now is think back to where the steel guys were like in March, April, May when things were really bad. Everybody was, you know, they were declaring force majeure. et cetera, et cetera. So all of our industry and the neocook guys, you know, and the neocook guys even lag further because they lag us a little bit.

Yeah, okay. Point taken. Thank you. And then I guess, you know, you talked a little bit before about, you know, Chinese supply. I mean, how do you assess competition for from China at the moment? I mean, I think in the past you've spoken about, you know, maybe two or three Chinese manufacturers of electrodes that could sort of produce, you know, Western quality, you know, UHP quality electrodes and potentially export those. Like, has your view there changed at all? I guess, you know, just a broad question, you know, how do you assess, you know, Chinese graphite electrode, you know, capabilities at the moment? Thanks.

Sure. Thanks, Alex. We've actually spent quite a bit of effort in the last number of months trying to assert that for ourselves, obviously for our own business purposes. And we still believe that there are a, you know, small, there's a handful of larger suppliers that are making their way into the UHP space and developing, I would say, tier two level type electrodes. Not quite up to the standards of ourselves and the Japanese, but respectable in that way. There's a lot of smaller operations that aren't there. And you have to understand the Chinese steel industry a little bit to understand why they don't have the same need. Because they're, for the most part, a lot of their electric arc furnaces, as you know, are brand new. Most of them are fed with hot metal, or many of them. I probably should qualify that and say many. with a launder system. And many are fed with scrap through a conveyor, preheat conveyor system. Those are, that application is much less demanding than I'll call it the traditional EIF that's bucket charged like most of the operations in this country would be. So many of those smaller operations may not have the need to be able to service their own domestic applications. So while we believe the Chinese are continuing to grow, and we want to be careful to be respectful of that and be transparent about that, and they're growing in advance of their electric arc furnace, trajectory, and we still believe that the objective that the Chinese government set of having 20% EAF furnace production by 2025 is still alive and well. That would mean, if you think about the billion ton number I talked about earlier, that there would be 200,000 tons of EAF steel production in China by 2025.

200 million.

200 million, sorry. Thanks, Glenn. 200 million. So when you think about that in the context of the United States, where we have, you know, 70, arguably 70, 80 million tons of EAF capacity, you know, China will have almost three times the EAF production capacity in five years that we currently have in this country. It's a mammoth change. So they will need a big graphite electrode industry to be able to service that, and they are, in fact, working on building that. Once again, as we exit the pandemic and we get some clearer vision on where the economy is going to be in supply and demand, we'll know more about You know, maybe what's been happening in China during the pandemic around some of these facilities. We do know that there's many of them, as I said, that are small or smaller and most likely geared towards domestic supply. That's what we know at this point. I would be careful in saying that, you know, it is an opaque situation. area of the world to try and dig, you know, exacting information out. That's what we believe and what we think we know at this point, and we will continue to work on that, trying to get it clearer and clearer for our own purposes as well.

Thanks. That's very helpful. Thanks again for the questions.

Okay. If there are no further questions at this time, I turn the call back over to Dave Rintoul.

Thank you very much. We appreciate everybody's focus and attention to our call today. Thank you for joining us. I'd like to take this opportunity to wish everyone on the call health and safety in the coming months. Once again, thank you for joining us, and we look forward to speaking with you in the next quarter. Take care and have a good day.

Ladies and gentlemen this concludes today's conference call. Thank you for participating. You may now disconnect.