Q3 2019 Earnings Call

Thank you for standing by and welcome to the Q3 29 team Graftech International earnings Conference call.

This time all participants are in a listen only mode. After the speakers presentation. There will be a question and answer session to ask a question. During the session. You want me to press Star one on your telephone please be advised that today's conference call is being recorded.

You require any further assistance. Please press star zero I would now like to handle the conference over to your speaker today, Meredith Bandy Vice President of Investor Relations. Please go ahead.

Thank you can see good morning, and welcome to Graftechs third quarter 2019.

On the call wouldn't be today is chief Executive Officer, David <unk>, Chief Financial Officer coupon.

Your first line as a reminder, some of the matters.

Forward looking statements regarding results performance and strategies among other things. These statements are based on current expectations are subject to risks and uncertainties factors that could cause actual results to differ materially from those indicated by forward looking statements.

Yeah.

We will also discuss certain non-GAAP financial measures for which you'll find reconciliations of any size. The slides are posted on our website www dot graftech dot com.

<unk> action for your reference a replay of this call will also be available on our website now I'm pleased to turn the call over to Dave.

Thank you Meritas good morning, everyone.

Thank you for joining us today.

Graftech is well positioned to benefit from the long term growth of electric arc furnace here you have steelmaking.

Low cost vertically integrated production and a long term contracting strategy.

Hi Tech continues to generate meaningful free cash flow.

We are committed to deploying that cash for shareholder returns and balance sheet improvement.

Turning to slide four let's begin as we normally do with safety health and safety Excellence is a core value a graph check and considered a fundamental requirement of our organization success.

Our year to date total recordable injury rate has improved to 1.03.

A more than 30% improvement from the prior year.

Like to thank all of our team for this achievement.

At the same time, each and every one of US must remain vigilant. So that we can reach our ultimate goal of zero harm that means everyone goes home safely every day.

A safe plant is in effect of flat and we strive to be both at all of our locations.

On slide five.

I've checked delivered solid quarterly results despite challenging conditions in a number of the markets in which we operate.

Overbuying late last year and early this year, coupled with reduced steel production in some regions has resulted in excess electrode inventory the customers are working through.

Steel is a cyclical business and we're seeing that play out in the market today.

We expect graphite electrode inventory de stocking to continue through the first half a 2020.

Inventories and should decline and conditions improve as we move into the second half of 2020.

Short term steel manufacturing difficulties will work themselves out.

Longer term here you have steelmaking continues to take market share as evidenced by the new electric arc furnace rebuilds and builds excuse me.

We're seeing in the United States.

As a reminder, the majority of Graftech sales volume remains on long term contracts, which help reduce the volatility of our earnings and preserve margins.

We are able to offer these stable long term contracts, thanks to our substantial vertical integration into petroleum needle coke.

Our wholly owned Seadrift facility provides a secure supply high quality petroleum needle coke at costs that are meaningfully below current market pricing.

Now turning to slide six.

In our earnings release, we announced a series of operational improvement projects at our Monterrey and St Mary's facilities.

These projects are intended to optimize our manufacturing footprint, while improving environmental performance and increasing production flexibility.

We expect these projects to be completed in the first half of 2021 at which time will we will be able to shift additional gravitation machining from Monterrey to St. Mary's.

We estimate the 2020 capital spending would be near current levels, which includes these projects as well as maintenance capital projects subject to the approval of our war.

Moving on to slide seven as I mentioned earlier Graftech as the majority of our long term production capacity, we sold under long term take or pay contracts.

These contracts provide profitability and visibility of earnings.

In addition to the recent softness in the global steel industry. We have also seen a couple of our LT customers declare bankruptcy.

While we can volumes as shown on this slide have been reduced by approximately 3000 tons per year in 2020 through 2022 to reflect such changes in the financial health of certain customers.

Graftech continues to pursue a blended commercial strategy.

The majority of our sales are under long term contracts. We also have meaningful volumes under short term agreements in spot sales.

Our ability to offer multiple contract for mass for our customers is a key element to our commercial strategy short and long term contracts to offer different advantages for different customers. We expect quote to continue to be an important part of our commercial strategy going forward.

Now I'll turn over to quit on slide eight for more details on our financial results.

Thanks, Dave as Dave highlighted third quarter financial results remain relatively solid.

By some softening of economic conditions.

Third quarter 2019, net sales of 421 million were down 7% from 2018 on lower sales volumes.

During the quarter, we produced and sold 40000 metric tons of graphite electrodes.

As usual third quarter production volumes reflect planned annual maintenance outages.

This year, we were able to leverage that downtime to manage production to be more in line with.

With recent sales volumes, while maintaining cost performance.

We now expect full year production capacity utilization to average approximately 85% as we match production to customer demand and supply chain conditions, specifically that you inventory overhang that they spoke to earlier.

We expect demand to rebound later next year as customers work through inventories.

Q3 weighted average pricing was a bit higher than the prior period.

As expected Q3 spot pricing was down relative to Q2.

Approximately 79% of our third quarter revenues.

Or to customers with long term term agreements.

Turning to slide nine for financial results.

Third quarter 2019, net income totaled 176 million or 61 cents per diluted share.

Q3, 2019, adjusted EBITDA was 245 million down from prior year period, due to lower sales volumes and higher raw materials.

Specifically related to third party petroleum needle coke costs.

Lower Q4 third party petroleum needle Coke pricing is expected to translates to lower cost of sales in the second half of next year.

Third quarter 2019 free cash flow of 211 million increase from Q2.

Favorable working capital changes, partially offset lower operational results.

As you May recall last quarter shipments were weighted towards the latter part of the quarter, which resulted in higher accounts receivable as of June thirtyth.

In Q3 that working capital change was largely reverse.

Turning to slide 10.

In the past 12 months Graftech has generated nearly three quarters of billion dollars for free cash flow of which more than 40% has been returned to shareholders today through dividends and share repurchases.

We have also repaid over 150 million of debt during that time.

Graftech has a strong track record of free cash flow generation.

Shareholder returns and debt repayment remain the key priorities for uses of cash.

Looking ahead on page 11.

Dave discussed our strategy on future investments is to focus on high returns quick payback projects to reduce operating costs increased productivity and developed products that our customers value.

In addition, we will continue to invest in health safety and environmental performance.

We continue to target shareholder returns of approximately 50% to 60% of 2019 free cash flow with the balance earmark primarily for debt repayment.

Shareholder returns are expected to include dividends and share buybacks as appropriate.

Including the 100 million share repurchase program, we announced last quarter.

To date, we have utilized about $10 million under that program.

The timing of future share repurchases will depend on share price traded volumes and other market conditions.

We'll also manage our debt levels to align with the visibility that we have to our free cash flow.

We repaid 125 million of debt earlier, this year and anticipate making further debt repayments by year end.

I'll now turn it back to Dave on Slide 12.

Thanks Quinn.

The steel market will no doubt habits shares of ups and downs.

With the long term outlook for E. F. Steelmaking growth remains strong electric arc furnaces continued to take market share from integrated producers globally electric arc furnaces make up almost 29%, including China of steel production and that share is expect to continue.

Grow overtime.

Electric arc furnaces are advantaged relative to integrated mills due to their flexible cost structure lower capital intensity and better environmental performance.

In addition, graftechs vertical integration into petroleum needle Coke offers is sustainable long term competitive advantage.

Increased demand for needle Coke from electric vehicle batteries has contributed to elevated needle coke pricing.

Low cost vertically integrated production in a long term contracting strategy, we expect to continue to generate meaningful cat free cash flow as Quinn discussed we're committed to deploying that cash for shareholder returns and balance sheet improvement.

This concludes our prepared remarks, we'll now open the call up for questions.

At this time I would like to remind everyone in order to ask a question. Please press Star then the number one on your telephone keypad again that is star then the number one on your telephone keypad. If you wish to withdraw your question you May press the pound key.

Our first question comes from the line of David Gagliano with BMO capital markets. Your line is open.

Hi, Thanks for taking my questions.

Some of the or I guess standard question Terry.

And to be asking on these calls.

Related to the current market conditions.

First of all just specific comment where you see spot pricing now.

And then also somewhat related there was a 3000 ton drop and you alluded to it on the in the prepared remarks for 2020 to 2022 contracts I think was 3000 here.

What specifically prompted that decline was it wasn't that actual bankruptcy or a renegotiation then.

Are there other contracts that are.

In a similar situation.

Good morning, Dave Thanks for your questions I'll start with the the first one on spot pricing.

I think as everybody is aware, we don't normally provide certainly forward guidance on spot pricing.

And as I referenced the steel market are certainly cyclical and as such it seems long seen our industry and that then translates into.

Certainly an impact.

Declining way.

Currently on the spot market given that we're in the midst of negotiations on Q1, and 2020 business overall bogged down inclined to give specific numbers today and inflows those.

Well its negotiations however, as I said suffice it to say that we do service a cyclical market and as such we're seeing some of those effects to be sure.

On the 3000 Toms we made that adjustment because we have had a couple of bankruptcies I, it's not a representative or intended to imply anything I'll call renegotiation or difficulties and other contracts that that is specific.

Weekly areas, where theyre them I financial situation that led us to believe that.

Liquidity because of the customer question may be problematic and we thought it was appropriate to.

Make the reduction in the slides so that.

Anyone could be could be aware that more and what we're seeing.

Okay. That's helpful. Thank you so.

Not to put words in your mouth, but.

Terms of expectation for additional changes to that contract book at this point.

We should not expect those changes I'm, putting words in amount I guess.

Oh, well look Dave or your Crystal ball might on this subject might actually be better than mine in terms of are there any other steelmakers and laws that are going to go bankrupt.

I am certainly for both their stake in our sake, I'm, hoping thats not the case.

No I was actually more asking about the other top of the comes up quite a bit in terms of Ah I.

I guess more directly are you having customers approach here to renegotiate those.

Existing contracts that are in place.

And so so our approach to customers. It inquiring about work, we're flexible in our approach to that as long as the the outcome I'll I'll their needs are such that.

Graftech and our shareholders our whole at the at the end of the day with the way. The initial contract stood so there haven't been any significant changes here to four to speak too.

But I would prove to be we would be remiss, if we were not.

Oh, good business people partnering with our customers to be opened two.

Things that might be a value to them that I'm still allow us to be in a situation where the value of the L.P.A. is in fact kept intact. So that's our position on that subject.

Okay. Thanks very much.

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

Hi, Thanks, Thanks for the question so Jeff just a follow up almost lost comments <unk>.

I would.

Am I correct in assuming that the what you're saying there is that.

You are willing to potentially cut prices.

On existing L.P.A. is as long as customers are willing to extend those out so in that sense the customers getting up potentially a lower near term price are you guys are locking in more volume into the future.

What would that be an example of a kind of flexibility that you were talking about.

On no Alex not quite.

Okay, I was very deliberate in saying that the outcome of those discussions would have to be that the value of the existing ltacs kept intact. So that would mean if you. If you look at the net present value of the value of the LTV at this point in time.

Ever changes, we want to make would have to preserve obviously for the interest of our shareholders.

That NPV. So it's it's not quite as simple as your example might suggest.

Okay could you give an example of what you're talking about be more specific I guess.

Or you know you don't want well.

I don't think this call that I want to put out into those in the marketplace or suggestions on such modification to it.

I think it's an individual one on one we've had discussions with certain customers at the end of the base some of them decided to think through and others have said not we'll just leave the LTAC and place. There are there are a number of combinations of permutations that can allow us to assist the customer in a near.

Our term request to preserve the net present value of the Lpa. So I don't think its conducive or good business for us to try and a line on this call the combinations and permutations that could exist in that it is really a customer by customer preference and pursue.

No I, what matters to one customer might not matter to another in terms of how they might view that so I don't expect a that they'll be.

Great number of those things transpire, but as good business people, we are always a willing to work with our customers to find an optimal solution that works for both parties.

Okay I appreciate the color. That's that's helpful. I guess, just a couple of others. If it's okay. You mentioned that you expect the destocked to continue through one H. next year.

And then you know normal business to pick up in the second half I guess why.

What makes you think that this is going to be another six to seven month process is there a certain amount of tonnage that you're looking at that you think this too much out there.

So I think it's a twofold component one we're looking at the recovery of the broader steel group.

And I'm thinking that that will happen.

In the new year and.

Has that transpires the inventory that we.

I think is on the ground by our major accounts anyway as that steel business returns to healthier levels.

In the first part of 2020, they'll begin to burn down that inventory and we're estimating that as we get into the second half that the graphite electrode business will return to a more normal state. If you will so that's a combination of I'm trying to estimate.

The return of the steel industry as well as our estimate on inventories and doing a little map on all of that and believing that.

The second half would they should have burned through a girl most of this inventory in the first half of the year.

Okay. Thanks, and then just one more if it's okay just on the buyback.

How are you look I guess any color on how you're planning to deploy that I guess I'd assume that you would have been a bit more aggressive this quarter. I think you only spent 9 million out of the hunter. It that was authorized for any comments there. Thanks.

Yes, sure Alex it's Glenn.

We continue believe the share repurchases are very attractive use of our cash flow, obviously, we repurchased very opportunistically.

During the quarter, we believe creating value for our shareholders.

And we do have the 90 million remaining and we do plan to continue repurchases in future quarters. So that's.

Probably about the level of detail that I can I can provide.

Okay. Thank you.

<unk>.

Thank you.

Your next question comes from the line of Erin Viswanathan. Your line is open.

Great. Thanks. Good morning, I guess first question is just a little bit more details on this inventory situation can you share maybe oh level of days of supply your customer level or producer level or tons, and you know I guess or maybe even the industry kind of utilize.

Station rate that you see right now and the market.

Good morning, Aaron I think what I would.

Answer to that is that.

We attempt to the best of our ability to keep a handle on inventory in and are different customers in different regions in the world and it's a very.

Mixed bag I'm terms of the degree of inventory across the board with a pretty large standard deviation. So for that reason I'm not I don't think I've got to be inclined to say that we're going to provides an exact number where we think inventories that other than to say that.

We know that people have a enough inventory on the ground that we think working through their current.

And our expected run rates as we go into 2020 that we expect the first half of next year too.

See that begin to burn down and the spot demand reflecting a.

Back to these players are in the process of burning down inventory as opposed to.

Building inventory.

And then I'm just.

When it is.

Yeah, Thanks, and just on the needle Coke side could you could you provide some color.

That's an increase cost there.

How neocart prices are trending and what your expectations are into next year. Thanks.

Sure.

No we're careful not to comment on other companies numbers I see in this case, whether its a.

P 66, or others, its probably not for us to.

You know disclosed what they're doing or say, what they're doing however, we will direct you to and I'm sure you've read the same public reports that we have that needle coke pricing has in fact dropped and that's not something that.

Hasn't in the last couple of weeks become more or less public knowledge and you can you can read about it in the them reports that I've seen in public places seem to have a number about right.

And just lastly on the capital return side are you still a projecting a around 50% to 60% of.

Free cash flow to be deployed into capital returned to shareholders. Thanks.

Yes, absolutely that remains our target.

The balance used to repay that as we mentioned we did fine too.

Two repaid by the end of the year repay additional debt by the end of the year with regards to the capital return, we don't have any specific timeline or deadline, but absolutely.

50% to 60% remains our target.

Thanks.

This concludes the Q and they session for today's call I will now turn the call back to David rental for closing remarks.

[noise] [noise]. Thank you very much in conclusion Graftech is a leading provider of highly engineered graphite electrode services solutions and products to the I asked steel market.

Our vertical integration is significant and sustainable competitive advantage and our long term contracts continue to provide profitability and visibility we have a proven track record of cash flow generation and returning cash to shareholders again. Thank you for your interest in Graftech and we look for just speaking with you.

Next quarter.

This concludes today's conference call. Thank you for your participation you may now disconnect.