Earnings Call Transcript - EAF Q1 2021

Operator, Operator

Good day, and thank you for standing by. Welcome to the GrafTech First Quarter 2021 Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today. Wendy Watson, you may begin.

Wendy Watson, Speaker

Good morning, and welcome to GrafTech International’s first quarter 2021 conference call. On with me today is Dave Rintoul, GrafTech's Chief Executive Officer; Quinn Coburn, Chief Financial Officer; and Jeremy Halford, Senior Vice President, Operations and Development. Dave will begin with a review of our safety performance, current industry conditions and our demand and production levels. Jeremy will discuss operational matters and give an update on our ESG initiatives. Quinn will cover financial details and Dave will close with final remarks. 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 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 be available on our website. I'll now turn the call over to Dave.

David Rintoul, CEO

Thank you, Wendy. Good morning, everyone, and thank you for joining our first quarter earnings call. I hope you, your families and your colleagues are all well. We begin, as we always do, with safety. Our first quarter total recordable injury rate is 0.58, indicating our continuous focus on the safety of each and every team member. Health and safety excellence is a core value at GrafTech. Our ultimate goal is zero injuries with every employee going home safely every day. Our team continues to be diligent and thorough in our COVID-19 controls and protocols. As shown on the slide, we continue to see improvement in both pricing and capacity utilization rates in the global steel markets during the first quarter. Steel industry pricing continues to increase with most types of steel at or near all-time highs. U.S. hot-rolled coil values are currently at approximately $1,500 a ton, and hot-rolled coil prices in both the U.S. and Europe were up about 35% over the course of the first quarter. The global steel manufacturing utilization rate outside of China was 73% in the first quarter of 2021 compared to 72% in the fourth quarter of 2020. The U.S. steel industry utilization rate improved to 77% in the first quarter from 72% in the fourth quarter of 2020. In our last earnings call, I pointed out that we expected graphite electrode pricing to bottom out early in 2021, and the demand for graphite electrodes was beginning to rebound. Our commercial experience today validates the recovery of graphite electrode demand and pricing, and provides us with conviction on our outlook for the second half of 2021. Graphite electrode spot prices are increasing off those trough levels, and we will realize those increases in our second half 2021 results. As a reminder, our industry lags demand recovery in the steel industry due to our position in the steel producer supply chain. As the steel industry's capacity utilization improves, we first see increasing demand for graphite electrodes, which is then followed by higher pricing for our products. We remain confident that the improvement in our reported non-LTA pricing will be realized in the second half of 2021, and has us well positioned for continued improvement into 2022. We are pleased with the year-over-year improvement we saw in our first quarter sales volumes and production, both up 9% over the first quarter of 2020. We shipped 37,000 metric tons and produced 36,000 metric tons of graphite electrodes. Now, as we focus on responding to the improving market demand, I would like to welcome Jeremy to the call who will discuss various operating items and our ESG effort.

Jeremy Halford, SVP, Operations and Development

Thanks, Dave, and good morning, everyone. In the first quarter, we maintained our strong delivery performance record, shipping 37,000 metric tons to our customers with excellent on-time performance of 95%. This level of execution helps to further strengthen our customer relationships and differentiates GrafTech from our competitors. We are continuing to prioritize operational initiatives that are focused on improving efficiencies in our manufacturing facilities and we are staffing appropriately to meet increasing demand for our graphite electrodes. Our ESG efforts align seamlessly with our focus on safety, environment, and quality, as Dave described. Our ESG steering committee, comprised of several members of our Executive Team, oversees our sustainability strategy. During the first quarter, we undertook several initiatives related to our ESG strategy. We launched the process for our second annual sustainability report, which we plan to publish later this year, and are currently undergoing a rigorous materiality assessment, which will help us to continue to refine and further improve our ESG efforts. Additionally, we continue to strive to be good corporate citizens, supporting our communities and organizations wherever possible. We worked with a local community organization in Monterrey, Mexico to distribute grocery packages and cloth face masks to local families. Additionally, our Pamplona, Spain facility was ISO 14001 certified in the first quarter, and we continue to upgrade our manufacturing facilities to improve our environmental footprint. We look forward to continuing our ESG dialogue and sharing our progress with you. Now, let me turn it over to Quinn who will discuss our first quarter financial results.

Quinn Coburn, CFO

Thanks, Jeremy. We were very pleased with our first quarter results. We earned $0.37 of EPS, $155 million of adjusted EBITDA, and generated $108 million of free cash flow in the first quarter. We continue to achieve strong free cash flow conversion with 70% of first quarter’s adjusted EBITDA converted to free cash flow. We continued to strengthen our capital structure in the first quarter. We reduced our debt by an additional $150 million and entered into an amendment to our credit facility to reprice our term loan interest rate. In connection with this debt reduction and credit facility repricing, Moody's upgraded our corporate credit rating to A3 and Standard & Poor's raised the issue-level rating on our debt to BB. As a result of these transactions and upgrades, we successfully reduced our interest rate by 100 basis points annually. These actions support our continued commitment to ensure balance sheet strength and flexibility. At the end of the first quarter, our total liquidity was approximately $342 million, consisting of $96 million of cash and $246 million available under our revolving credit facility. With strong earnings and cash flow we delivered in the first quarter, reinforces our expectation that 2021 will be another year of significant cash flow generation. Consistent with our actions in the first quarter, we plan to use the majority of that cash flow to further reduce debt. Our focus on the balance sheet and maintaining a strong capital structure provides us with significant financial, operational, and strategic flexibility, which is particularly important as we positioned the company to capitalize on improvements in the market. We are maintaining our full-year 2021 capital expenditure outlook of $55 million to $65 million. We will use these funds to support our high-quality, low-cost global operating assets and to target high-return operational improvements. Please note that these estimates do not include any possible change in control charges that could be triggered if and when the ownership of our largest shareholder Brookfield actually falls below 30%. Brookfield currently owns approximately 37% of our shares. Now I'll hand it back to Dave.

David Rintoul, CEO

Thanks, Quinn. I will wrap up with some comments on our favorable positioning in the market. GrafTech is one of the largest producers of ultra-high power graphite electrodes in the world, operating three of the largest global facilities. GrafTech electrodes are a mission-critical component to the EAF steel industry, and there is no substitute for our product. Our customers are the lowest-cost producers of steel and are some of the largest recyclers in the world, producing steel with 25% of the carbon emissions of traditional integrated steel producers. We expect the EAF steel industry growth to continue to outpace the global GDP over the long term, positioning our products for solid long-term growth. We are pleased to see that the recovery and strength of the steel industry is beginning to have a positive impact upon our business. As we highlighted earlier, we expect to begin to benefit from those favorable trends in the second half of this year. With the commitment of our people and our significant competitive advantages, we continue to strongly believe GrafTech is well positioned today and over the long term. This concludes our prepared remarks, so we'll now open the call up for questions.

Operator, Operator

We have our first question from the line of Curt Woodworth.

Curtis Woodworth, Analyst

Yes. Hey. Good morning, everyone.

David Rintoul, CEO

Hey, Curt.

Quinn Coburn, CFO

Good morning, Curt.

Curtis Woodworth, Analyst

Dave, I wonder if you could – I know you're always reluctant to talk about sort of spot price dynamics between needle coke and UHP. But it seems like our channel checks relative to the $4,200 you booked this quarter for non-LTA is now moving significantly above that closer to $6,000 or even higher. And we understand the needle coke market is tightening a little bit as well with some of the EV pull. So just any color you can kind of give on how you see supply and demand? If you can give any kind of reference points on pricing that would be appreciated.

David Rintoul, CEO

Sure, we can do that. So I think just to kind of set the stage a little bit. On the last earnings call, you'll recall, Curt, that I referenced that we thought that pricing would bottom out somewhere in the first quarter and that we were seeing the beginnings of a demand pickup. And that projection turned out to be correct. And having said that, please remember that the lags that I spoke to, steel starts to see more demand. They started making more tons. Once they started making more tons, they begin to chew into their electrode inventory. I remember, we went into the COVID pandemic with a high electrode inventory that we spoke about almost a year and a half ago. I also commented in our earnings call that we expected by the end of Q1 that because of the improved demand that electrode inventory would begin to normalize, it has done that. And we exited Q1 with the graphite electrode inventory in our customer base normalized. So that meant at that point in time that people were now imbalanced and needing to purchase electrodes consistent with their production cycles. As that occurs, our demand improved, and we acknowledge that. And as in any market product, shortly after demand begins to pick up, you start to see prices falling at some point. All of this has happened quite as we expected. And remember that when you buy an electrode in early Q2, it's not going to get delivered until early Q3. It's a three-month process thereabouts to make an electrode. So the fact that we bottomed out in Q1 or during Q1 on pricing is reflected about what you're going to see. And our performance in the second quarter, as we acknowledged, the second half being better with pricing. The realized pricing that hits the P&L is beginning to see the increase in the third and then subsequently fourth quarter. On needle coke, yes, we see that because there's an improvement in the overall electrode and steel world that there will be positive influences there. We expect to see things more on the top-end of that range. And we have procured the needle coke we need for this year and we'll soon be thinking about 2022 as we expect that the market for our products will continue to improve and think we're going to have a good second half as well as into 2022. Hopefully that assists you and provides some insight, Curt.

Curtis Woodworth, Analyst

Yes. That's helpful. And then I guess with respect to the non-LTA book, when we look across a lot of it, your competitors seem to be running at relatively high utilization rates. So it does seem like the market is definitely getting tight. Can you provide any sort of guidance on how we should think about spot volume progression or the cadence of that volume trend over the back half of the year? Thank you.

David Rintoul, CEO

Sure. Out in the market, obviously GrafTech has the advantage of a sizeable part of its order book secured through the LTA process. Therefore, we're not selling as many spot tons as most of our competitors. But I think your view is reasonable. Although I will tell you that we know that some of our competitors are still working hard to fill their specific plants, and it would be inappropriate for me to name those plants. They're competing hard to fill some of those plants at numbers that are not in the range you suggested in the first part of your call. Yes, so that's probably where I should stop so I don’t get myself in trouble with our general counsel.

Curtis Woodworth, Analyst

Okay. All right. Thank you.

David Rintoul, CEO

They're working hard. They are starting to fill their plants, but based on their actions, they're not quite there yet. I think we're in a much better place that’s allowing us to behave in a way that's a little more beneficial to our shareholders.

Operator, Operator

Your next question comes from the line of Arun Viswanathan.

Arun Viswanathan, Analyst

Great. Thanks for taking my question. Good morning.

David Rintoul, CEO

Good morning, Arun.

Arun Viswanathan, Analyst

Yes. I guess, just going back to the last set of questions. So first off, it looks like your average price was around $8,200 and that was made up of the $4,200 on spot. And I think – I don’t know, I think you said $9,500 on contracts. So maybe you can just reiterate what you said on the LTAs as an average price. And then – so you do see that trending up. I guess, what's the cadence we should expect there? I mean, there's been a lot of cost pressure in the market that we're seeing. Does that have any impact on pricing? Or is it mainly supply, demand-driven? And do you have any escalators within your contracts to deal with some of that inflation? That's my first question, I guess.

David Rintoul, CEO

So let me begin by asking Quinn to validate the pricing and numbers that were in the release.

Quinn Coburn, CFO

Sure. Thanks, Dave. Just to reiterate, the LTA price we realized in the first quarter was $9,500, the non-LTA price we realized in the first quarter was $4,200, and 26,000 tons were sold under LTA and 11,000 tons were sold under non-LTA. And then if you do the averages of that, then that's approximately 7,900 per metric ton as a weighted average price of those two. As far as cost, as you mentioned, there are some pressures on cost. We see a decrease in costs in our Q1 results relative to our Q4 results. It's about a $400 decrease relative to Q4 and about a $300 decrease relative to the full-year. The pressures that we're seeing on costs would be freight costs, but that's the kind of pressure we see globally. Generally speaking, Arun, what I would say going forward is that I would expect the Q2 costs to be similar to Q1. In the back half of the year, we might have a little more pressure with the rising third-party needle coke. We'll try to manage that and proactively manage that. So generally speaking, I would see Q2 being similar, probably the back half being similar with maybe a little bit of pressure upwards from a third-party needle coke.

Arun Viswanathan, Analyst

Great. Thanks for that. And then maybe you can also just reiterate your priorities on cash used from here. Obviously, you've done some deleveraging. Is there any interest or potential for reinstating a larger dividend? Or would you opt for buybacks as you go through the year? Thanks.

Quinn Coburn, CFO

As we noted on our last conference call and also in our remarks today, we will continue to focus and prioritize the majority of our cash flow this year towards debt reduction, as I've mentioned before. Absolutely, we monitor our capital allocation strategy very closely. We discuss it with management every quarter and we discuss it with the Board of Directors every quarter. We'll continue to monitor that for the future in terms of shifting that a little bit more towards returning capital to shareholders. But for this year, we've indicated that the majority of our cash flow will be to reduce debt.

Arun Viswanathan, Analyst

Thanks.

Operator, Operator

Your next question comes from the line of David Gagliano.

David Gagliano, Analyst

Thanks for taking my question. I just wanted to ask a little bit about the change of control provision you mentioned with Brookfield. I think you said below 30% and there are payments made by GrafTech to Brookfield. Is that correct?

David Rintoul, CEO

No. You've got the first part of it correct. The change in control language kicks in when Brookfield moves below 30%, and there is a LTIP plan that covers several employees that were in place at the time that Brookfield purchased GrafTech as a retention mechanism. Those payments get made directly to those employees, not to Brookfield.

David Gagliano, Analyst

I'm sorry, those payments get made directly to – and I’m still confused. They get paid to the GrafTech management?

David Rintoul, CEO

Yes. They get paid to members of GrafTech management that were in place at the time of the buyback in 2015.

David Gagliano, Analyst

Okay. That's what I thought. And then – so then related to that question with – are there any other triggers or anything else that we should think about? Or do those payments just automatically happen, right, when it goes below that 30% threshold?

David Rintoul, CEO

More or less, there's a slight 30-day delay. But for all intents and purposes, it's immediate. We’ve given them preferences – David, to be in the spirit of full transparency, we also commented and it was in Quinn's comments during the prepared remarks. There's also some stock and options that get accelerated to the tune of just over $15 million, but that's not a cash payment; that's a non-cash item.

David Gagliano, Analyst

Okay. Understood. And then just the last part of – are there any retention requirements or those people that receive those payments free to take the money and leave on day one theoretically?

David Rintoul, CEO

There are no retention requirements. The intent of those payments was to see them through to this point. But I would share with you that GrafTech has a solid succession planning program and there are no worries about whatever people elect to do.

David Gagliano, Analyst

Okay. Appreciate the clarity. Thanks.

Operator, Operator

Your next question comes from the line of Alex Hacking.

Alexander Hacking, Analyst

Yes. Good morning. I just wanted to follow up on the volume side. I mean, firstly, Dave, I just wanted to clarify that you said that you believe customer inventory was now fully normalized. Did I hear that correctly?

David Rintoul, CEO

Yes.

Alexander Hacking, Analyst

Okay. Thanks. And then in terms of – not talk about this year, but more sort of structurally. I mean, what do you think is a normalized sales volume for GrafTech? And just for context, back in 2018 or beginning of 2019, you were selling about 45,000 tons a quarter. But subsequent to that, it turned out that customers had overstocked, right? Which suggests that number may be too high to think about as sort of a normalized shipment number. So any comments that you would have around that would be helpful. Thanks.

David Rintoul, CEO

Sure, Alex. Thanks for your question and interest in our firm. You're in a way asking me to try to predict the future and to some extent provide guidance, which I won't provide direct guidance on. But what I would point out to you is that during this same period, there's been growth of the electric arc furnace industry globally. If you think specifically about the United States, SDI is going to bring their furnace online in a number of months. I believe that North Star Bluescope will as well. There's been growth and over the next 12 to 18 months, there's about 14 million tons of additional capacity coming online just in the United States. Our previous numbers certainly do not frighten me. I think there's no reason that we can't get back to those kinds of values going forward now. The exact timing of that depends upon, obviously, steel recovery still being strong. But I'm not frightened by any prospects to get back to those values that we were at.

Alexander Hacking, Analyst

Okay. Thanks.

David Rintoul, CEO

Look, I think we're going to – I think things are in our favor; heck, the steel guys are selling a $1,500 a ton with margins that they never dreamed of. So why shouldn't some of that trickle down to the graphite electrode boys?

Alexander Hacking, Analyst

I hope so. And then thanks for the color. And then just one other question, I don't know how much you can comment on this. But are you seeing any – with the market coming back, are you seeing any pressure from electrodes coming out of China or in any of your markets? Because there was a period of time where exports out of China were starting to emerge when prices were a lot higher than they were today. Are you seeing any of that? And any color that would also be appreciated.

David Rintoul, CEO

Sure. I mean the Chinese were in the market before, and admittedly a lot of that presence was in ladle electrodes. They have made some progress in the UHP space. The quality still is not, for the most part, as good as ours. They are a factor that we need to be cognizant of and we remain optimistic because we still believe that with the commitment of the Chinese government to the environment, they're going to grow their electric arc furnace industry and easily get to 200 million tons by 2025. The evidence is there. They're on that trajectory. That trajectory is going to require graphite electrodes. So I think there will be some moderating effect by the domestic improvements within China. But we have to be cognizant of China as being a competitor and we will continue to do so.

Alexander Hacking, Analyst

Great. Thanks a lot.

Operator, Operator

This concludes our question-and-answer session. I will now hand the call back over to Mr. Rintoul for closing comments.

David Rintoul, CEO

Well, thank you very much, everyone. I'd like to take this opportunity to wish everyone on this call health and safety in the coming months. Thank you for your interest in GrafTech, and we look forward to speaking with you next quarter. Thank you, and have a great day.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.