GrafTech International Ltd (EAF) 2014 Q2 法說會逐字稿

Good morning my name is Kimberly and I will be your conference operator today. At this time I would like to welcome everyone to the GrafTech second quarter earnings conference call.

(Operator Instructions)

I would now like to turn the conference over to Ms. Kelly Taylor. Ms. Taylor, please go ahead.

Thank you, Kimberley. Good morning and welcome to GrafTech International second quarter conference call on the call today is GrafTech's Chief Executive Officer Joel Hawthorne, and our Chief Financial Officer, Eric Asmussen.

We issued our preliminary earnings release this morning. If you did not receive a copy please contact Marie Noar at 216-676-2160 and she will be happy to fax or email a copy to you. As a reminder some of the matters discussed during this call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Please note the results are preliminary and are subject to change.

Final results will be included in our quarterly report on Form 10-Q to be filed with the SEC. Please also note the cautionary language about our forward-looking statements contained in our press release that same language applies to this call. Also to the extent that we discuss any non-GAAP financial measures you will find reconciliations in our press release that is posted on our website at www.GrafTech.com. In the investor relations section.

In particular on this call we will be discussing for the periods reported the non-GAAP financial items of EBITDA and adjusted operating income for your reference a replay of the call will be available on our website. At this time I would like to turn the call over to Joel.

Thanks Kelly. Good morning everyone. Thank you for joining the GrafTech call today.

First let me set the tone for today's call. Like you, I am and our Board is disappoint with results this quarter in the impairment of assets in our engineered solutions segment. I am working closely with our Board to review all aspects of the GrafTech business structure and resource requirements going forward. I have a very engaged Board and I will leverage the Board's expertise for insight in each business area to restore GrafTech to profitability. As detailed in our press release this morning, GrafTech recorded a plenary non-cash impairment charge of $126 million in engineered solutions segment. The impairment is a write-down of a long assets in our Advanced Graphite Materials business.

With the recent deterioration of the current and future market outlook for profitability related to production of graphite related products that are primarily servicing the solar industry, also with the migration of the solar supply chain to a very competitive China market, this caused us reevaluate business. That reevaluation resulted in the impairment that was announced today. We are extremely disappointed with this development but with the impairment it was required. Factors that led to this included continued unfavorable market pricing and supply dynamics for isomolded products, recent capacity expansions by established producers and new entrants in China that have added to an oversupplied market, and lastly the migration of the solar value chain including polysilicon, silicon, silicon wafer production to China.

The combination of those above factors led us to the conclusion that pricing would not return to previously expected levels in the solar supply chain and have an impact on the broader isomolded market. The impairment is based on the value of the AGM business as a whole compared to the current carrying value of the AGM Total Asset Group. Additionally, as part of this review of Engineered Solutions AGM business unit we identified we could improve efficiencies and operate more effectively by leveraging supply chain relationships to serve certain markets more effectively.

As a result, we will discontinue isomolded graphite production. Total sales of isomolded products accounted for approximately $3 million of AGM sales in 2013 and year-to-date sales were approximately $1.5 million. We expect this decision to result in a total charge of approximate $24 million of which $7 million is expected to be cash. There was an $11 million charge included in Q2 results. This decision will impact product line production at facilities in Clarksburg, West Virginia; Colombia, Tennessee; and Emporium, Pennsylvania.

And will impact a total approximately 75 teammates here at GrafTech when we began increasing our investment in isomolded in 2009 the market conditions were significantly different than what we face now and what we anticipate in the future. We had anticipated the iso-market fundamentals remain solid and attractive returns on the investment.

However, given recent develop months including the rapid price erosion and a glut of supply chain overcapacity and the solar supply chain moving to China we've concluded that is more economical for us to discontinue our investment and work with existing suppliers to be more effective to service our in customers. Our total investment in isomolded was approximately $70 million the majority of these assets will be redeployed for future use in other product lines. We're confident that the initiatives we're now announcing today will help us further reposition the company to drive profitable and sustainable growth. We're sharpening our commercial focus in ES by targeting the higher growth higher-margin product lines and leveraging supply chain and collaborative relationships to optimize our go to market strategy.

We expect to generate approximately $18 million in ongoing annual savings associated with the Engineered Solutions product line rationalization. CAT savings are expected to be approximately $8 million. The impact of this initiative and the $75 million in annual savings on the IM side which is generated -- which is largely completed will generate cumulative savings over $90 million on an annual basis when fully recognized. Also in conjunction with the changes we're making to the ES business were also reevaluating all aspects of our business for additional cost savings opportunities.

We expect to complete this assessment over the next quarter. Anticipated actions under consideration include a combination of layoffs attrition, early retirement, reduced contractor cost, and other cost savings initiated designed to generate cost savings by simplifying work processes and drive greater accountability in the organization. While it is always difficult to make decisions that impact our teammates these actions are designed to make GrafTech a more competitive global company that is better positioned to drive growth and innovation and respond more quickly to customer demands.

Now let me turn to Q2 results. Total company sales were $284 million down 6% versus Q2 2013. Earnings were a loss of $160 million largely as a result of special charges associated with the impairment and ES rationalization initiatives. Excluding these one-time charges earnings were a loss of $6 million or $0.05 per share. EBITDA came in at $28 million lower than expected largely due to higher costs and the launch of new products in our AET business for consumer electronics and the underperformance of our AGM business both in our engineered solutions segment.

Operating cash flow for the quarter was $34 million which included $9 million of rationalization and related cash costs. Our team has made solid progress in reducing working capital requirements and improving operating cash flow. Operating cash flow in the first half of 2014 was $56 million and improvement of $44 million year over year. We expect continued to reduce net debt levels as we move throughout the year and further decrease working capital requirement. Free cash flow remains a priority and was positive $9 million for the quarter in the first half of the year as we focus to continue to deleverage our balance sheet and drive credit metrics next year to under three times debt to EBITDA.

In our industrial materials segment sales declined 11% to $270 million in the second quarter compared to the prior-year quarter. Mainly due to lower realized graphite electrode pricing as previously anticipated. Weaker needle coke sales volume and price also contributed to the revenue decline. Adjusted operating income for the segment was approximately breakeven largely due to lower graphite selling prices as I mentioned compared to the prior-year and the higher cost associated with the regularly scheduled five-year maintenance at Seadrift in the second quarter. During 2014 second quarter the five-year plan maintenance at Seadrift was completed on time and under budget.

However, after commencing operations Seadrift experienced an unplanned outage in July. This lasted approximately 3 weeks. This will result in minimal disruption to our customer orders due to current inventory position but will negatively impact our cost in the third quarter of 2014 of approximately $3 million. We have essentially completed building our 2014 graphite electrode order book. We continue to expect to run our graphite electrode and needle coke facilities at close to full capacity in the second half.

As discussed previously the global graphite electrode market remains challenging and has resulted in a weaker pricing outlook for 2014 compared to 2013. We estimated 2014 electrode prices will be down approximately 10% year-over-year. At the high end of our previous guidance range of 8% to 10%. But we see that pricing has stabilized in the second half of the year. Our previously announced rationalization initiatives industrial materials is essentially complete and will significantly improve GrafTech's competitive by reducing the cost and increasing the operating efficiencies that will position us well to capitalize on the gradual recovery we're seeing in global steel demand.

These industrial materials initiatives are expected the generate $75 million in annual savings and we expect to recognize approximately half these or $35 million in savings in the second half of the year. Additionally as part of this initiative our focus remains to significantly reduce industrial materials working capital primarily inventory. Our target of $90 million in 2014 an additional $60 million in 2015. We're on track.

Turning to Engineered Solutions segment. Sales in the second quarter increased 11% to $78 million compared to the prior year period. New product sales in the fast-growing markets included advanced consumer electronics, high temperature furnace systems drove the increase in revenue. Adjusted operating income for segment was $6 million lower than expected as higher costs associate with the new product launch in our advanced consumer electronics product line weighed on probability. Also weighing in was the underperformance of our HCM business.

While I'm pleased with the 20% Engineered Solutions revenue growth in the first half of the year, we have now looking forward we expect to see weaker consumer electronics product launches and temporary delays in our high temperature furnace customer orders. This will drive lower sales in the third quarter resulting in the lowering of our 2014 revenue growth expectations and related operating margins. For the full year the company expects segment revenue increase only 5% to 10% and operating income margins in range of 8% to 10%. Looking at our balance sheet our financial position remains strong.

As I mentioned earlier our focus is driving free cash flow we reduced our net debt by over $60 million in the past 12 months. Our debt-to-capital ratio at the end of Q2 was 32%. Our debt to EBITDA was 4.3 times and we are driving to improve this to blow 4 times by the end of the year and target 3 times in 2015. In addition, we have approximately $300 million available on our revolving credit facility which with the refinancing in Q2 does not mature until April of 2019. Let me now turn to outlook and guidance.

According to the World Sales Association 2014 global steel production increased 2% excluding China to the end of June in 2014. For the same period. The European Union and the Middle East countries continue to recover with year-over-year still production growth rate of 4% and 9% respectively. Here in North America, steel production and operate rates continued to show improvement as well. GrafTech's global steel customers remain cautiously optimistic as trends indicate stable to improving conditions for the remainder of this year our industrial materials business continues to see volume recovery.

We expect to operate our graphite electrode and needle coke facilities at full capacity in the second half of the year as I mentioned earlier. Our engineered solutions segment will continue to execute on plan. However the timing of product launches and customer orders that were expected will unfavorably impact us and margins in the third quarter. GrafTech's target 2014 EBITDA is now expected to be in the range of $135 million to $150 million. A reduction in the company's higher estimate that reflects the following three key changes.

Approximately $13 million is due to changes in Engineered Solutions revenue and profit expectations for 2014, approximately $7 million is due to electrode graph pricing declining to the higher end of our previous forecasted range, and lastly approximate $3 million of costs associated with the unplanned outage at Seadrift during July here recently. The company's targets third-quarter EBITDA in the range of $30 million to $40 million.

The implied increase in the fourth quarter EBITDA to $45 million to $55 million is expected to be largely driven by the recovery of Engineered Solutions sales, normalized operations at Seadrift, and the benefits of the company wide rationalization initiatives. In conclusion, Q2 was a challenging quarter no doubt. We are extremely disappointed with the results and are taking aggressive action to counter the difficult market environment and to better allocate capital to deliver value to shareholders.

We continue to believe that GrafTech is positioned as one of the best carbon and graphite materials science companies in the world and we're committed to improving performance in the short term as well as the long-term my focus right now with the engagement and insight of our Board will be to deliver $75 million of the iron rationalization cost savings and $150 million in working capital reductions. Implement the new ES rationalization objectives as outlined today to achieve the $18 million in annual savings, study and reevaluate all aspects of the business for additional cost savings opportunities to drive these cost savings for simplification and greater accountability within the organization.

Lastly, to continue to meaningfully deleverage our balance sheet in the near term. That concludes my prepared remarks. Kimberley, I would now like to open the call up to any questions.

(Operator Instructions)

Luke Folta, Jefferies.

Hey, Luke.

Good morning, Joel. First question, just to tighten up the model a bit: Are you able to give us some sense of where shipments or utilization was in the second quarter? I'm mainly trying to get a sense of how much we should expect volumes to improve into the second half from the second-quarter number.

Graphite electrodes or needle coke?

Both, if you could.

Again, when you look at graphite electrodes in 2Q, we were running just below 90% utilization. As I said in the second half, we should be running that closer to full operation and levels in the second half of the year based on that [195] that we've announced before of capacity utilization.

For needle coke, obviously we had the outage in 2Q, which obviously took capacity out. We were out for the majority of the quarter. The utilization was quite low, as you're in the five-year maintenance outage.

You'll see that turn; when you go into the third quarter, it will ramp back up to full capacity, net of this three-week outage we had in July. It will ramp back up to full capacity for the rest of the year. It also will be running, again, between that 95%-plus utilization to 100%.

And at full capacity, you're selling 70% of that to your electrode operations internally?

That's about right. We're about 70%, 75% internal consumption, and third-party sales are the difference, depending on where you are -- it depends on what quarter.

Okay. And also, I just wanted to see -- we understand that you announced a price increase just a couple of weeks ago, and it seems like SGL has also announced a price increase it sounds somewhere in the neighborhood of about 10% or so. I just wanted to confirm that that is the case, and understand: Is that more or less just to cover spot orders through the end of the year or is that something we should think about into 2015?

Luke, you nailed it. That was increases for spot orders here in the second half of the year. As I mentioned, our order book was, [in essence], full -- we're running full. We went to the market for a second-half pricing for any spot market orders.

Obviously, we will look at, when we get into, as we normally do, September time period -- reassessing the market, market conditions, and look ahead to 2015 to decide where we want to set the beginning, from our standpoint, the order book bidding for 2015.

Okay. And given your order book being mostly complete, should we not think about a major impact from this price increase in second-half 2014?

Correct. Very little impact, since we are complete with our order book.

Right. Okay.

On the potential for additional restructuring beyond what you've already announced, are the actions that you are expecting to take or considering taking -- is that something that we should think about potentially impacting capacity anywhere, or is this just more a function of reducing costs in the current footprint that you have in ES and IM?

Just the function of reducing costs. One of our objectives as we look at the current market and future market is getting our cost structure to compete in this environment. When you think about what we'll be looking at in looking at our cost structure, both IM, ES, the corporate needs to support that, and driving us to profitability at these current levels. Then obviously if we do that, that is our objective, then when their markets return, which they will, that will obviously help us further.

Okay. (technical difficulty)

Hello? Luke, are you there?

That is not coming from my line. I'm not sure what that is, Joel. It's not on my end. That's all I had; I will turn it over.

Michael Gambardella, JPMorgan.

Good morning, Joel, how are you?

Good, Mike. How are you doing?

On the electrode pricing, it seems like -- I've been covering the Company since it was called Yukon many years ago, and it seems like this whole pricing structure that the industry has is a farce, and I can't remember the last time at this point of the year where you and SGL didn't come out with some big price increase. And it's basically meaningless because it doesn't impact the rest of the year because you're usually booked already. Why do this? I don't understand it.

Is it just: You're throwing a price increase out there -- announcement just to start negotiations? But it seems like every year it's -- we're putting out this price increase; it's not going to affect the rest of the year, so why bother?

Mike, let me give you -- and again, as I mentioned earlier, we are sold out for the back half of the year, so what we're trying to do is look at what our cost is, what the market demand -- supply/demand is, what can be the level of pricing going forward, analyzing that, and again, making a determination of what we think the appropriate price level is to get an effective return, obviously for graphite electrodes. Obviously, supply/demand has an impact on that, and again, we're watching supply/demand across the globe, besides ours, and there has been rationalization taking place.

Again, the reason we do it obviously second half [there are] -- which is not material, as I just mentioned to Luke -- there are spot orders we see that we capture the high value of spot orders on, but they are minimal. Again, our objective is trying to gauge what the market will be going forward. With that said, as I said earlier, our mission now is to look at what is the cost structure of the Company, and even at these levels, can we get the cost at the appropriate levels at the current pricing levels?

The market, ultimately, Mike, as you know, and you've said in the past: The market ultimately takes care of itself. And pricing becomes what the market will determine throughout the bid season. Our objective now is obviously, by the announcement, is what we think based on current market conditions, but more importantly, us looking at how do we get our costs obviously to support what the market-level pricing could look like, either short term or in the future.

But with your pricing guidance -- you lowered your profit guidance down by $7 million for electrode pricing. We're halfway through the year. So, it's about a $14-million annualized hit. I thought a lot of your Business was locked-in, fixed-price annual business by this point. Are you seeing some of those customers that had locked in business at a fixed price earlier in the year demanding a price reduction now for the rest of the year?

No. Anybody that was on the books when we talked before -- and you're right, we're about 90% of the order book was completed. It was the last 10% or so that we are looking at. And again, what was on the books, we have not seen any price slide, any deterioration from what we booked for an annual basis.

What we did see, as we were rounding out our second-half book, pricing did slide, again, as we said, across the whole year, that 1%. When I look quarter to quarter sequentially, 1Q -- obviously 1Q is the best because you get the carryover from last year pricing, but when I look at 2Q, then sequentially 3Q and 4Q based on our current book, it has, as I said, stabilized out.

And there's a final question just on the competitive nature -- electrode market -- you mentioned the increasing in capacity in China, which has been going on for a while. I thought it was basically that China have added capacity over the last several years, and they went from being a net importer to a slight net exporter. Are you seeing incremental tons coming out of China, even beyond that slight net exporter position?

Yes, let me make sure we're not -- I talked earlier -- so we're clear, Mike -- on capacity in China; capacity I mentioned was isomolded. We're talking about isomolded, not graphite electrodes.

Just to clarify my earlier discussion was regarding isomolded capacity in China. We have not seen any significant change in, again, what we talked about prior calls on China capacity, and their home market and exports. We see it relatively the same what we have seen this whole year.

On the electrode pricing weakness, is that a function of incremental supply from non-Chinese producers, or is it a demand function or a combination of the two?

I think the demand obviously looks pretty good. When you look at EAF production, and you see that incrementally it is increasing. Demand out there for EAF and for graphite electrodes has been increasing. As I said, our volumes have been increasing.

I think the pressure on price is still coming as the supply side is working out the rationalizations of ourselves, other players in the industry, to come to what that new balance may look like. Clearly, what we saw was more supply side. Demand is still out there for EAF good -- will continue to be good. Our view is it will continue to improve obviously the second half going into 2015, and then the supply/demand of graphite electrodes is balancing out as the market adjusts to all of the rationalization initiatives.

And just final question on this EAF production grow out -- are you seeing the consumption of electrodes per ton of EAF? Has that stopped going up in terms of the larger [quantities] require less electrodes per ton? Have you seen that trend stabilize, or is that still continuing?

The trend for specific consumption, as we reported in the 10-K -- on average across the globe, it has stabilized. Obviously, as you mentioned, the newer, more modern furnaces that get put in are at a lower end of that scale, as they are more efficient. But the average -- and again, what we see in our database of furnaces around the world is kind of stabilized. But as new furnaces are added, new capabilities, EAF, they do come on at a lower consumption.

Okay. Thanks, Joel.

Thanks, Mike. I appreciate it.

Sal Tharani, Goldman Sachs.

I have a specific question on your comment about the Seadrift unplanned outage. You were able to still handle the customer requests through your inventory? I just want to understand -- was there something you were building, or is it a normal case that you always have inventory, and what is that level usually? Are you going to have to -- replacing that inventory, if that is a normal inventory?

At Seadrift, coming out of the outage, obviously we were at a lower end of what we would normally like to carry for our inventory. But we had enough through July, again, to hit customer orders, third-party orders no problem. Our plan is: We will make that up, obviously, throughout the rest of the year, so when we get to the end of the year, we're back to what we deem to be the appropriate inventory of how we operate Seadrift based on our intercompany shipments and third-party sales.

The overall inventory -- the question when you look at inventory, again, as I mentioned, the $150-million reduction of inventory -- the appropriate levels of inventory of Seadrift or graphite electrodes is all factored into getting to that level. And we are seeing us bring down the raw material side of the equation, needle coke inventories, but we will continue to see our graphite electrode inventories also decline as we head to the end of the year to get to the right place of our inventory levels.

Through July, we had a good inventory. Again, coming out of the outage, lower than what we normally like to see and carry. Throughout the rest of the year, we will get back to that level. As we exit the year, we will be in a good position with Seadrift and our needle coke inventory levels.

So you will be running needle coke full out, or some of that actually will go to just replace level of inventory. Can you tell us how much inventory or how many days of inventory you usually carry for the Seadrift?

We don't disclose that, but you're absolutely right in your comments that some will be going to replace the production to get back to our normal level. One way to look at it is: Our capacity -- public capacity of Seadrift -- if you look at -- we try to carry basically one month, plus or minus, of that on hand, in various stages. That will give you an idea.

Got you. And also, has Seadrift announced also the price increase, which it does usually around this time of the year?

We have not for needle coke. Again, assessing the market, and again, just like we do for electrodes in 2015, we usually look to around late August, early September time period to gauge the market for 2015, and what we see we could do on price, both for needle coke and electrodes.

Over the coming weeks, you may put something on the website for an announcement for the price increase or whatever the price for 2015 -- or is it the second-half price you will announce?

We won't announce for needle coke any second-half pricing. Once we conclude our view of the market, again, yes, we will go to our customers and let them know what we think -- here is the view of pricing based on what we see going into 2015.

What do you see in needle coke pricing? You mentioned electrode pricing is stabilizing in second half, after declining 10% for the first. What are you seeing in needle coke?

In needle coke, I'd comment: There is pressure out there in needle coke, but it is stabilizing also. Just like in electrodes, we've seen pressure throughout the first half and as we stabilize contracts. Again, our third-party sales in needle coke are, again, pretty much on an annual basis and negotiated earlier.

Obviously, we see the market of needle coke from a graphite electrode perspective because we gauge it there. Again, we see it stabilized. Going forward, again, it's going to be the needle coke guys' view of what their cost pressures they see, what returns they want, and what value they think they can push into the market going into 2015. I think we will all assess that and see that obviously when we get into the fall.

Great. Thank you.

Thanks, Sal.

There are no further questions at this time.

Kimberley, thanks. Let me conclude our call again today, thanking everybody for their time and for the questions and their interest in GrafTech. Obviously, I look forward to updating everybody on our progress at the end of the third quarter. Thanks again, and have a great day.

This will conclude today's conference. You may now disconnect.