Earnings Call Transcript - EAF Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the GrafTech’s Third Quarter 2020 Earnings Conference Call and Webcast. At this time all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Thank you. I would now like to hand the conference over to your speaker today, Wendy Watson. Please go ahead.

Wendy Watson, Speaker

Good morning, and welcome to GrafTech International's third quarter 2020 conference call. On the call with me today is Dave Rintoul, GrafTech'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 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. In these slides include the relevant non-GAAP reconciliations. You can find these slides in the Investors Relation 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.

Dave Rintoul, CEO

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'll 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 GrafTech 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 GrafTech team for your continued diligence and hard work in this area. However, the only correct number is 0 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 of the balance of our business metrics. Turning to Slide 4, we continue to proactively manage through the COVID-19 pandemic. Our executive lead 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 the 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 5, we're 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 emissions than traditional blast furnace production. The steel industry overall is a leader in recycling, and more steel has been 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 6, 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 US$593 to US$600 per metric ton, and Black Sea bullet 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 continues to trend lower during the quarter. Turning to Slide 7, 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 100,000 metric tons 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 98,000 metric tons to 108,000 metric tons. In 2022, we will be in the range of 95,000 metric tons to 105,000 metric tons. And for the years 2023 through 2024, we estimate LTA sales volumes of 35,000 metric tons to 45,000 metric tons. This effort represents the partnership that GrafTech has with our customer base. Now I'll turn it over to Quinn on Slide 8 to discuss our third quarter financial results.

Quinn Coburn, CFO

Thanks, Dave. Third quarter 2020 net sales were $280.7 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%, with 33,000 metric tons in the third quarter for a total of 98,000 metric tons year-to-date. Our LTA 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 9, third quarter 2020 net income was $94 million or $0.35 per diluted share, and 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 cash and 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 provide 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.

Dave Rintoul, CEO

Thanks, Quinn. The inherent manufacturing flexibility of electric arc furnace 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. GrafTech 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 EAF industry. The electrodes that we manufacture are highly engineered and require extensive process knowledge to produce. The services and solutions that GrafTech 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. Our global footprint provides us with flexibility should any operating environments become challenged due to a second wave of a pandemic. Our balance sheet and proven track record of cash flow generation give us the strength to manage through industry cycles. With our commitment to our people and our significant competitive advantages, we continue to strongly believe GrafTech is well positioned today and over the long term. That concludes our prepared remarks. We will now open up the call for questions.

Operator, Operator

Your first question comes from Curt Woodworth from Credit Suisse. Your line is open.

Curt Woodworth, Analyst

Yes. Hi. Good morning.

Dave Rintoul, CEO

Good morning, Curt.

Curt Woodworth, Analyst

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

Dave Rintoul, CEO

Thanks for your question, Curt. Yes, 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 years. So we think we're accomplishing that. And I think over the last several weeks, we've closed a number of these arrangements with people. And I can see there are more and more to come. But I think it does preserve what the customers are looking for in terms of some of the near-term challenges today and helps us preserve the value for our shareholders.

Curt Woodworth, Analyst

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

Dave Rintoul, CEO

I think it's accretive, Quinn.

Quinn Coburn, CFO

Yes. One other thing to keep in mind, Curt, is previously we had a few contracts that were fixed share contracts that could vary in volume. And previously we had indicated that that, could be up or down 5,000 tons per year. And in our previous disclosures, we had stated those in the midpoint, and 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.

Curt Woodworth, Analyst

Yes, I thought that as well. Regarding the recent decline in spot prices during the quarter, you were able to secure higher non-LTA value given the current spot market conditions. Can you provide any insights on the range of pricing you are observing in the market? Also, considering the drop in needle coke prices, would you say that spot sales are currently profitable?

Dave Rintoul, CEO

Sure. That's a difficult question, I'm sure as you know, at this point in time, and that we've been careful about disclosing of what we thought in the past, careful about disclosing what we thought spot pricing was because early in our experiences, as a publicly traded company, found 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. So having said that, one of the things that have happened is absolutely, spot pricing has lowered today from what it was in Q2, and Q3 has been a downward trend to be clear. However, at the same time, the disparity or the distribution and standard deviation, if you will, pricing around the world has grown. So there's somewhat of a disconnect from 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 wouldn't be terribly useful for you because it would be 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, etcetera. If 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 the information that is publicly available, and that is the export and import numbers on needle coke, you would find that that number, recently 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 is 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, if you have a graphite electrode, our counsel would be given that for the reasons I've 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 context of the incremental cost that people are facing now on electrodes and knowing that that's probably pretty close to the bottom range. I hope that's helpful.

Curt Woodworth, Analyst

Yes, very, thank you. Now, I understand there's a lot of regional variation. So that is fair. And then just last question with respect to the U.S. market, there's 8 million tons to 9 million tons of new electric arc capacity coming online in the next call it 12 months. Can you talk at all about, do you think that is going to move the needle coke with respect to price? Have you been able to win any business with that new capacity? Thank you?

Dave Rintoul, CEO

Yes, sure, obviously, it's the fundamentals of supply and demand, and so it will 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, testament to that is $700 ton hot-rolled coil pricing. And rebar has been pretty steady at about 600 bucks. So there are a lot of positive signs certainly in the U.S. steel market and 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% 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 80ish 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 is a little further behind that. But generally speaking, no matter whether you look at that, our Black Sea bullet prices or even Asian hot-rolled 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 drive growth in the graphite electrode industry.

Curt Woodworth, Analyst

Great. Thanks very much, Dave and Quinn.

Operator, Operator

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

Arun Viswanathan, Analyst

Great, thanks, good morning.

Dave Rintoul, CEO

Good morning.

Arun Viswanathan, Analyst

Good morning. Just wanted to get back to some of those near-term fundamentals you were discussing. So, maybe you could just help us square the different dynamics here. On the one end, you do have, it seems like some improvement in steel markets, yet needle coke and maybe electrodes, your reference spot pricing and electrodes going the other way. So, 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.

Dave Rintoul, CEO

Sure. First, it's important to understand that our industry tends to lag behind the steel industry. We typically experience a decline in demand after the steel sector, and likewise, we won't see an increase until later as well. So, it’s not surprising that while the steel industry began to show improvement in the third quarter, we haven't felt that effect yet in our operations. I would not have expected to see it immediately. This trend is expected to eventually influence us as it continues. Additionally, reflecting on my earlier comments from our earnings release at the beginning of the year, we indicated that destocking would likely extend through the third quarter, even before the pandemic occurred. Now we're seeing destocking resume as the steel market improves, though there was a period during the pandemic where destocking was virtually nonexistent. We anticipate that this destocking process will carry on for the remainder of the year. This combination of the inherent lag in our industry alongside the completion of destocking accounts for the ongoing decline in graphite electrode pricing. Looking ahead to the New Year, provided that the steel market maintains its positive trend and recent developments related to COVID do not disrupt this, we expect demand to help us recover. Regarding inventory, from a graphite electrode standpoint, the similar oversupply in needle coke is expected due to pandemic disruptions. There may be times where needle coke supply exceeds demand. On a positive note, China's recovery is promising, and they are projected to produce over a billion tons of steel this year and have advanced their plant constructions. However, the supply situation remains somewhat unclear, complicated by the pandemic. Generally, we believe that as demand from the steel industry increases, it will lift the demand for graphite electrodes, putting us in a more favorable position as we move into the New Year.

Arun Viswanathan, Analyst

Thank you for that. To clarify, at the beginning of the year, you anticipated needing about three quarters to address the inventory issues, possibly due to COVID, which may have extended that timeline a bit. You are now beginning to notice some destocking. Additionally, regarding your production levels, you initially had a capacity of 180,000 tons, and after a debottlenecking project, your capacity is now nearly 200,000 tons. Your long-term agreements cover around the 100,000 ton range for the next couple of years. How do you view the remaining capacity that GrafTech controls? Is it preferable to keep it idle for the time being, or are there considerations for permanent shutdowns? I would also appreciate your insights on the industry from a supply-demand perspective, particularly if you anticipate any closures. Thank you.

Dave Rintoul, CEO

That's a good question. I want to clarify the first part of your statement. We mentioned that destocking would take until the third quarter, not for three quarters. So it covers the period from January to the end of June, which is six months, not nine. We believe it will be mostly complete by the third quarter, so we don't anticipate needing another nine months. Regarding capacity, it's an early topic to address, as we need to monitor the expansion of plants in the United States. The environmental factors worldwide indicate that the electric arc furnace industry will grow, while integrated steel production will decline. This transition will create opportunities for the graphite electrode industry, leading to long-term growth. As we move past the pandemic, we need to evaluate that growth trajectory, especially considering carbon emissions and trading systems in Europe that will impact steel production decisions. Similar discussions are emerging in China, suggesting a broader trend. As the electric arc furnace steelmaking industry expands, we believe it will be crucial to identify graphite electrode capacity and its relationship to electric arc furnace growth patterns. Making decisions at that point will be essential, but it's still too early to reach any conclusions.

Arun Viswanathan, Analyst

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

Quinn Coburn, CFO

Yes. Thanks, Arun, it's Quinn. First thing I would say is, as we 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. 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 all know, we have $59 million available in our share repurchase program. And we'll continue to examine that, and that would continue to be an option. But as noted in the near-term, the priority will be debt reduction.

Arun Viswanathan, Analyst

Thanks.

Operator, Operator

Your next question comes from Alex Hacking from Citi. Your line is open.

Alex Hacking, Analyst

Yes, good morning, and thank you for your time. I apologize for the interruption earlier. Did you mention that the estimated price for spot needle coke is around $1,800 a ton?

Dave Rintoul, CEO

Yes, what 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 1,300, and most of them were in the $1,800 range.

Alex Hacking, Analyst

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?

Dave Rintoul, CEO

Yes, if you are looking for a class, I believe you are referring to the range I provided a few months ago, which was likely more like four or five months back, but you are in the right area.

Alex Hacking, Analyst

Thanks for the information. I'm a bit surprised given the strength of the steel market. That's very helpful. Thank you.

Dave Rintoul, CEO

But don't forget, everything in our world follows the steel industry. So what you're seeing now is reminiscent of where the steel industry was back in March, April, and May, when conditions were really tough. Everyone was declaring force majeure. So, all our industry and needle coke suppliers lag a bit behind, with the needle coke suppliers lagging even more.

Alex Hacking, Analyst

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

Dave Rintoul, CEO

Thank you, Alex. We have put considerable effort over the past several months into understanding this for our business purposes. We still believe there are a few larger suppliers entering the UHP market that are developing Tier 2 level electrodes. While they may not meet our standards or those of the Japanese manufacturers, they are respectable. Many smaller operations do not reach this level. It's important to understand the Chinese steel industry to see why they don't have the same needs, as many of their electric arc furnaces are new and are mostly fed with hot metal or, in some cases, scrap through a preheat conveyor. This application is less demanding than the traditional EAFs that are bucket charged, which is how most operations in our country run. Thus, many smaller operations may only satisfy their domestic needs. While we acknowledge the growth of the Chinese market and wish to be respectful and transparent about it, they are indeed progressing in their electric arc furnace development. We still believe the Chinese government's goal of achieving 20% EAF production by 2025 remains viable. To put that in perspective, based on the earlier discussed figure of 1 billion tons, this would indicate 200 million tons of EAF steel production in China by 2025.

Quinn Coburn, CFO

Thank you, Quinn. So, in the context of the United States, where we have around 70 to 80 million tons of EAF capacity, China is projected to have nearly three times that EAF production in five years. This represents a significant shift. As a result, they will require a substantial graphite electrode industry to support that growth, and they are indeed working on developing it. As we move past the pandemic and gain clarity on the economic outlook regarding supply and demand, we will have a better understanding of what has been occurring in China during the pandemic in relation to these facilities. We know that many of them, as I mentioned, are smaller and likely focused on domestic supply. I want to emphasize that obtaining precise information from that region can be quite challenging. This is our current understanding, and we will continue to seek clearer insights for our own needs.

Alex Hacking, Analyst

Thanks, this is very helpful. Thanks again for the question.

Operator, Operator

There are no further questions at this time. I turn the call back over to Dave Rintoul.

Dave Rintoul, CEO

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.

Operator, Operator

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