GrafTech International Ltd (EAF) 2015 Q2 法說會逐字稿

Good morning. My name is Kayla and I will be your conference operator. At this time I would like to welcome everyone to the GrafTech second-quarter earnings conference call. (Operator Instructions).

Thank you. I would now like to turn the call over to our host, Kelly Taylor. Please go ahead.

Thank you, Kayla. Good morning and welcome to GrafTech International's second-quarter 2015 conference call. On the call with me today is GrafTech's Chief Executive Officer, Joel Hawthorne; and our Interim Chief Financial Officer, Quinn Coburn. We issued our earnings release today. If you didn't receive a copy, please contact Marie Noar at 216-676-2160, and she'll 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 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'd like to turn the call over to Joel.

Okay. Thank you, Kelly. Good morning, everyone, and thanks for taking the time and joining GrafTech's call today. I will review the Company's second quarter results, provide an update and color on current business conditions and give you an overview of our second half 2015 outlook.

As you probably saw in our press release this morning, the expiration date for the tender offer by Brookfield has been extended until August 13 to allow for the final regulatory approval. Additionally in anticipation of the closing of the convertible preferred investment and tender offer we have amended our principal credit facility to accommodate and expect a change in control.

Turning to our results. For Q2 total Company sales were $165 million, a decrease of 42% year-over-year and a decrease of 20%, compared to the first quarter this year. EBITDA excluding special charges came in at $13 million, compared to $28 million in the second quarter of last year. This compares to EBITDA in the first quarter in 2015 of $17 million.

In spite of successful execution on the previously-announced cost savings initiatives, EBITDA declined due to significant lower shipment volumes and pricing pressure in both of our operating segments. Operating cash flow for the quarter was $2 million compared to $34 million in the second quarter of 2014.

Turning to our Industrial Materials segment, sales were $125 million in the second quarter, a decrease of 40% year-over-year and 24% reduction versus the first quarter of 2015. Adjusted operating income for the segment was $4 million, as compared to $10 million in the second quarter of 2014 and $11 million in our first quarter of this year. The decline in that operating income was largely driven by lower graphite electrode volumes in response to the weaker customer utilization rates we're seeing and lower realized graphite electrode pricing.

Graphite electrode volumes declined 30% year over year to 33,000 metric tons in the second quarter of 2015. That compares to the 43,000 metric tons shipped in Q1 of 2015.

If you look at our graphite electrode volumes in the first half of 2015 and compare those to the first half of 2014, the year-over-year decline is 19% to 76,000 metric tons. This decline is driven by two key factors: demand reduction, which is reflecting weaker underlying demand, China export impact, and lower EAF utilization rates; also impacted by customer inventory reductions as our customers manage their working capital. We estimate the demand reduction has represented two-thirds of the volume decline while customer inventory reduction represents the remaining third.

Our graphite electrode facilities ran at 82% operating rate in the second quarter of 2015. We expect graphite electrode operating rates to be approximately 60% for the remainder of the year in response to softer demand and our continued efforts to reduce inventory levels.

Our needle coke facility ran approximately 90% of capacity in the second quarter. We plan to reduce needle coke operating rates in the back half the year to approximately 70%, again, in an effort to reduce overall inventories.

As mentioned, graphite electrode sales have been impacted by pricing decline. In the second quarter of 2015 average graphite electrode prices, excluding currency, were down 7% year-over-year consistent with our prior expectations.

Turning to our Engineered Solutions segment, sales in the second quarter declined to $40 million, compared to $78 million in the prior-year period and $42 million in the first quarter of 2015. More than half of the year-over-year decline was driven by lower sales of our advanced electronics technology products which were weaker due to competitive pressure in the consumer electronics supply chain which impacted both price and volumes.

Additionally, sales of our advanced graphite material products were lower due to weaker demand for those products serving the oil and gas drilling industry and the prior year sales of $4 million to the former customer that declared bankruptcy later in 2014. We reported breakeven adjusted operating income in the second quarter as compared to adjusted operating income of $9 million in the second quarter last year and adjusted operating loss of $1 million in the first quarter of 2015.

Total SG&A and R&D expenses continue to come down as we aggressively attack costs in this difficult operating environment. Overhead expense in the quarter, excluding special charges of $4 million related to the proxy contest and the transaction-related expenses, declined $9 million or 29% to $23 million in the second quarter of 2015. We are on track to achieve our targeted corporate cost savings initiatives.

Turning to our balance sheet, as we announced last quarter, we have agreed to issue $150 million of convertible preferred stock to Brookfield Asset Management. We plan to use the proceeds of this equity issuance, along with our delayed draw term loan and a small amount of our revolving credit facility to repay our $200 million senior subordinated notes.

In addition, as we detailed in our press release this morning, we amended the revolving credit facility to allow for a change of control in connection with the pending investment and tender offer by affiliates of Brookfield. In addition, effective upon a change of control which will be triggered under the credit facility upon a 25% ownership by Brookfield the financial covenants will be eased, resulting in increased availability under the revolving credit facility.

The size of the revolving facility will also be reduced from $400 million to $375 million. This still allows us -- for the Company to have flexibility as we go through these times.

On a related note, we continue to drive towards our goal of reducing working capital. We saw a small inventory build in the second quarter as sales did not materialize as we anticipated. We have taken aggressive action to reduce operating rates across the production platform to match current demand and to reduce inventory levels. We continue to expect a total inventory reduction of approximately $50 million in 2015.

Let me turn to the outlook for the remaining year of 2015. As highlighted in our press release, global GDP is expected to grow at 3.3% in 2015. Advanced economies' growth prospects are anticipated to improve throughout the year while a slowdown in growth is expected in emerging economies.

However, steel customer sentiment remains negative globally. Global steel utilization rates continue to be low, given excess industry capacity due to weak end-market demand and high export levels from China. In its July 22, 2015 report, the World Steel Association or WSA reported that global steel production declined approximately 2% in the six months ending 2015, as compared to the same period in the prior year. Excluding China, that same number declined 3% in the first six months. WSA reported that average growth steel capacity utilization rate was 72.2% in June, 350 basis points lower than June of last year.

Steel production in ten of the top 15 steel producing countries which represent a large share of EAF production declined approximately 6% year-to-date. We believe EAF production rates have been disproportionately impacted during this period. In the United States, where almost 60% of steel making capacity is EAF, steel production declined approximately 9% year-over-year in the six months ending June 30, 2015.

Other examples of major EAF-producing countries, based on recent public data, include South Korea where EAF steel dropped 18%, Brazil where EAF steel declined 16%, Turkey where EAF steel declined 12%, Japan where EAF steel dropped 6%, and Germany EAF steel declined 5%.

Market conditions remain challenging in both Industrial Materials segment and the Engineered Solutions segment. Pricing in the Industrial Materials segment will be lower year-over-year while volumes in this segment remain under pressure due to weak electric arc furnace steel production in response to continued end-market weakness and temporary displacement by high Chinese steel export levels.

In the Engineered Solutions segment, weaker advanced consumer electronics and oil and gas market demand for our products is negatively impacting volume shift and pricing.

Based on these conditions, the Company does not expect a significant improvement in results in the second half of 2015. While graphite electrode volumes are expected to slightly improve in the back half of the year and we will begin to see some of the benefit of lower oil prices, these benefits will be largely offset by lower graphite electrode prices and higher fixed cost absorption due to lower production rates in our Industrial Materials segment.

While we are facing some market headwinds in the Engineered Solutions segment, we continue to optimize our product portfolio and introduce new innovative products that differentiate GrafTech in the marketplace, especially in areas of business that have become increasingly competitive. We continue to drive out cost to improve profitability and return operating income margins back to target levels.

At the same time, we continue to innovate as we have more than 20 focused projects in active developments to promote long-term growth. The challenge is managing through the next six months. We continue to balance the economic tradeoff between price and volume to maximize EBITDA and right size our balance sheet inventory levels.

As mentioned in response to this current environment, we continue to execute on cost savings initiatives and align production rates with market demand. The Company's previously-announced cost savings programs remain on track. We are on track to deliver $50 million in cash savings to benefit 2015 EBITDA results.

Recall that these savings or part of our previously-announced cost savings programs totaling over $120 million, $100 million of which directly improves EBITDA. However, these savings will not fully offset the decline in pricing and volumes across both business segments.

Graphite electrode production rates have been reduced to align production to lower customer demand and to reduce inventory. Graphite electrode production rates average approximately 84% in the first half of 2015 and are expected to decline to approximately 60% in the second half of 2015. We will continue to realign the production platform and optimize the production portfolio of our advanced graphite materials business like we have done in the past.

Capital expenditures have been reduced by approximately $30 million year-over-year. Current capital expenditures now are estimated to be in the range of $50 million to $55 million in 2015. Global headcount has been reduced by approximately $800 million, more than 25%, since the beginning of 2014 as we manage through this difficult period.

As I said, 2015 will be a difficult year as we continue to face market headwinds. Despite the current market dislocation and overcapacity within the steel supply chain, we believe that electric arc furnace steel market and markets that our Engineered Solutions segment serves remain attractive on the longer-term basis.

With the benefits of the pending investment by Brookfield, we remain focused on leveraging the core competence that GrafTech has built and execute on a strategy that will allow GrafTech to manage through the current difficult industry challenges.

That will conclude my prepared remarks and, Kayla, I would now like to open up the call for any questions.

(Operator Instructions). Your first question comes from the line of Edward Marshall of Sidoti.

Good morning, guys.

Hey. Good morning, Ed.

So my question is on the volume. You're taking down utilization rates and presumably the industry as well; you've just seen destocking in the channels. My question is you talked about managing over the next six months. Are we setting up for a pretty good inventory situation as we move into 2016 as far as the markets are concerned and the inventory that's in the channel, do you have any clarity or any insight into that?

Yes, Ed. Obviously our customer base is squeezing their working capital which is graphite electrode inventory as they manage through this. I think there's some way still to go here and that's why we're reducing our operating rates in the back half of the year even at some of our customers.

I think possibly dependent on again how our customers operate and how we operate in the back half, we'll get back to I will say normal levels of inventory heading into 2016. But again that will depend on how the customers operate and again based on the order commitments they take through the back half of the year.

Of course. And then as we look at the cost savings that you plan to recognize this year, the $50 million or so, is that supposedly even across the quarters? Is it weighted first half to second half? Can you talk about maybe what's already been reflected in the P&L today that we can't see because of the pricing and volume declines?

Yes, I would say, Ed, the $50 million is pretty even that we're seeing throughout the quarters. About $25 million here in the first half we've seen. We'll probably see another $25 million.

And as I said, the volume reductions that we're seeing in the market and then our decision obviously to lower our production rates causing some cost inefficiencies are offsetting that, along with obviously the price declines.

Sure.

But we are seeing the benefits of the rationalization efforts that we've taken last year.

Great. Thanks, guys.

Yes. No problem, Ed.

Your next question comes from the line of Phil Gibbs of KeyBanc Capital Markets.

I think Ed asked the crux of my question. It was just essentially related to the aggressive reduction in your operates for the electrode business in the second half of the year and it sounds like it's based on inventory adjustments at the customer levels at this point.

Our inventory levels we want to bring down and obviously at the customer base, yes.

Okay. And is any of that a function of newer competition in the market or is it basically just a function of the operates at the customers?

Yes, we have analyzed very closely our customer base around the world and it is really a function of that operating rate of our customer base that's driving it. We see from our perspective that's the main driver.

Across your business, when you look at the electrode side and the refractories business and the industrial graphite business, is there anything that stands out to you in terms of a bright spot right now and where you may be seeing a little bit of light here in this marketplace?

Well, definitely from the actions we've taken in the cost side, very pleased where our cost is relative -- so that when the markets do improve, we will have a very good cost structure. So obviously the actions we've been talking about and our plants, the way our plants have been operating and juggling through this has been real good. So we feel very good about again the plants, the cost structure they're providing longer term.

I think, right, looking for the bright spot, Phil, is again on a global basis clearly EAF production is under a lot of pressure globally but there are pockets that are decent. We are seeing signs in non-residential construction that give us some indications for future benefit.

The challenge is when is that going to happen? And right now that really had not played out. Like I think a lot of the spots, recovery of non-residential is to a greater extent than we thought on a global basis.

And again the other thing that we think that will help the EAF industry is we've seen a lot of our customer base with the trade duties against some of the imports. And as those take effect in various regions both in the EU and in North America that obviously will benefit our customer base.

Terrific. Thanks so much.

No problem, Phil.

(Operator Instructions) Your next question comes from the line of Luke Folta of Jefferies.

Hey, Joel. And so if I look at your operating cash flow it was bit light of expectations clearly on earnings, but I think if I recall your guidance last quarter included I think it was $10 million to $15 million of cash restructuring charges in there. Were those realized or is that still to come in the second half?

And I guess anything else you could say in terms of the second half operating cash flow outlook. You know you mentioned the $50 million inventory piece, but any other moving parts there would be helpful.

Yes, look and the restructuring charges are there in 2Q as we talked about. And you're right the difference in the second quarter from what we guided is the inventory. That inventory number you said is -- we just didn't get out, because of how fast the market changed on us throughout 2Q as we keep trying to adjust production with where the sales were going. And that's why again we've adjusted pretty dramatically in the second half to make sure we get that cash flow out in the second half of the year.

Okay. But no further restructuring cash items in the second half?

Yes, Quinn, any second half?

Yes, our total year should be about $20 million to $25 million of restructuring in the first half. Just as you said, Luke, it was about $10 million to $15 million. It was in that range; that's correct.

Okay. All right. And then on the CapEx, so you've made some reductions, $50 million to $55 million now. Would you consider that the absolute bare bones level at this point now?

Yes. We're getting there, Luke, from a maintenance standpoint. Again we could probably squeeze just a little bit more out of that, if we felt we needed to. But you're right we're getting down to a low end bare bones of maintenance capital. So like we'll gauge it; the most we could probably squeeze out I'd say is $5 million more and then that's -- we're at rock bottom.

Okay, okay. All right. And I guess maybe splitting hairs a bit here, but when you say no improvement in the second half are you talking about from the second quarter run-rate or the first half run-rate?

Looking at the first half overall run-rate. Yes.

Okay.

Okay. And then just a question I had during the go-shop period, when you're looking at the tender offer from Brookfield. I guess is there anything you could say about what played out during that time frame? And was there a significant interest you thought that was actually real interest that maybe you guys didn't agree on a price but there were still like some genuine lookers there, people looking at it? Or was it you think people were just kicking the tires because they had the opportunity to do so? Just trying to get a sense of what the appetite would be for consolidation if the price was right.

Yes, I guess, Luke, what I can say about obviously the go-shop process. We reached out obviously to three different groups -- the industry itself; people who may have been forward or backward; or other type of investors -- and went through that process. And as we disclosed there was some interest that came through the process.

I can't speak to what their interest was or what -- why they were looking, but there was interest and went through that process. But as we've obviously announced it ended without any real tangible offers.

Okay.

Yes.

All right and then I know this is a really tough thing to get your arms around, but just as we think about next year, about the benefit you may be getting from lower oil price starting to flow through, any sense of what that drag -- or I guess if you took a look at this year's consumed decant price relative to today's spot like what magnitude that would have represented in terms of a drag on margins? Just to help us think about next year's starting run-rate.

Yes, again, when you look at the benefit of oil we talked in the past that roughly we buy call it net --

Right.

-- a million tons, or a million barrels of oil, right?

Right.

So you take that times the change in price, and that could give you a benefit to that. So it could be in a range of $30 million to $35 million of which unfortunately a lot of that's been passed on into the customer base in electrode pricing.

We are seeing some of that benefit as I mentioned. We will see some this year. But again some of them passed on and some we will not see because of the slower rate of our production throughout the year.

That's going to factor into 2016 as well. You'll have excess inventory into the first half of 2016?

Potentially, again that's depending on where the market is and our customer base, order patterns are. Potentially.

Yes. Okay. All right. Great, guys. Thanks. One last question. I'm not sure if you have color on this yet but the tender offer period has been pushed out a couple times to allow for the regulatory proceedings to go through. But do you have any color or insight as to how the offer is gaining traction among folks so far? Like if you had to take -- if you had to guess whether or not you hit the threshold like, if you hit the top threshold in terms of the full acquisition, you think we're there?

Yes, I would say Brookfield announced this morning in their announcement, they did disclose the number of shares Luke and it was -- yes I know. 102 million shares have been tendered out of what we currently have outstanding that we report, about 137 million. So that's about 74% of our shareholder base that is tendered.

Now again they can't withdraw, there's various things they can do. And again Brookfield is the one that reports that and they did report when they announced the extension again about 74% of our shareholder base has tendered. So I think it gives you a pretty good color, doesn't it?

Yes, it does. It does.

Yes.

All right, great. That's all I have. Thanks, guys.

Okay. Thanks, Luke.

Your next question comes from the line of Justin Bergner of Gabelli Co.

Good morning, Joel.

Hey. Good morning, Justin.

Most of my questions have been answered. Just a quick one on the, I guess, revolver being amended. The 25% Brookfield ownership that qualifies as a change in control, that's 25% of the shares being tendered in the tender offer, or does it include any consideration for the convertible instrument?

Either way. Either way.

Oh, so it's on a fully diluted basis?

Correct.

The change in control amendment. Okay.

Yes.

The second question I had was just as you look to the second half versus the first half given that you expect to be operating at a much lower utilization rate in terms of electrode production, what's the offset from an EBITDA point of view, to keep EBITDA in the second half at first half levels?

Well again, yes, some of the benefit I mentioned on oil coming through late year will be some of the offset. Some of the offset would be some of the great -- the plants have done a great job controlling costs at a plant level and managing the variable and efficiency of those variable costs.

And then the third bucket would be obviously SG&A, as we continue with our SG&A initiatives that were announced last year. There will be some from there. So those three buckets will offset the production penalties to maintain the level.

Okay, understood. And just as a reminder, the senior subordinating notes come due the end of November?

Correct.

Yes.

Okay, so the timeline for the regulatory approval process should be complete at least as regards the $150 million convertible preferred by then?

Correct.

Yes, yes, yes.

As I mentioned our expectation -- again you never know, but August 10 is the date I've been told that we'll get approval. And as we said on the $200 million notes once we do get that approval the $150 million convertible preferred proceeds, the term loan draw, and probably again a little revolver is what we'll use to repay back the $200 million. So --

Okay, thanks.

Okay. No problem, Justin.

Your next question comes from the line of Charles Bradford of Bradford Research.

Good morning.

Hey, Chuck.

A couple questions. First of all as I'm sure you're aware there have been three electric furnace melt shops announced for the US -- two starting next year, one the year after. So the first part of the question is when do new melt shops typically purchase their first electrodes? Is it right before startup or is there any time period earlier?

Typically, Chuck, I'll say they'll expect delivery a month to two months in advance of the startup. And then any negotiations typically can be anywhere from three to six months in advance of that, dependent on who the customer is and where they are in the world.

Outside the US, what have you seen as far as new electric furnace melt shops being announced?

Yes, I'd say obviously new have slowed down a little bit. You still do see obviously the normal upgrades to current EAS which obviously for our standpoint use the higher performing electrodes. We do see a little bit, our tracker, we do see still few projects around the world, but clearly it's slowed down from what we've seen two three years ago and of course we are aware of the ones here in the US.

And again, Chuck, I think again longer term we're still very comfortable that EAF has a strong position in the global steel production. Right now, we're just going through these temporary dislocations of market conditions, of which one of them being imbalance between scrap price and iron ore.

Well, it looks like scrap's going to be down another $20 next month, so that should address some of it. But thank you very much.

Yes. Thanks Chuck.

Your next question comes from the line of Phil Gibbs of KeyBanc Capital Markets.

Hey, Joel. When you talk to some of your customers globally, obviously there's been an influx of Chinese steel across the world right now in both semi-finished and finished products. Any sense in your discussions with them whether or not you expect those customers and countries outside the US to pursue trade remediation relative to China or maybe some other countries to protect their steel industries?

Yes, I -- again obviously our dialogue with the customers we do discuss that issue. I'd say you're seeing some of the customers already start to take those actions in some regions. I think again this is not my opinion. You'll continue to see that based on what you're seeing of those exports and the impact it is having in some of the geographic regions. And again we're seeing from our customer base, them having to shut down to try to manage on a global basis.

We've seen in the second quarter here a lot of our customer base start idling or shutting down their capacity as they try to balance through this. So again Phil, my opinion is you will continue to see some actions as the exports out of China continue to flood the global market.

So is it your opinion then that the Chinese are dumping steel around the world?

Well, I'll equate it to what we've done in graphite electrodes. In graphite electrodes, which has happened a few years back and close to this last downturn, there was duties put in place here in the US, in Mexico, Brazil. We've been working in the EU. So again I would say it's a similar situation that we saw on the electrode side years back when we put those duties in. So --

Okay.

Okay.

Thanks so much.

That's no problem, Phil.

Your next question comes from the line of Brian Chan of Bank of America.

Hi, guys.

Hey, Brian.

How are you?

Good.

Just had a few questions. Apologies if this was discussed already, but are there any updates you can provide on discussions with the rating agencies?

Nothing that I can provide. We always stay in touch with the rating agencies, keep them informed. We have ongoing discussions and those will continue obviously like we always do.

Okay. And are those discussions being held in -- [essentially] in concert with Brookfield and trying to manage the outcome that I guess that you guys are both looking for?

Well, again we talk to the rating agencies about everything going on, which a big event is the Brookfield investment and the tender offer process. So obviously we keep, like we do all constituents, the rating agencies informed of the impact and what that means to the Company.

And is Brookfield part of those discussions? Like are they in -- are they discussing? Are they there with you guys and making those and having those conversations? Or is it more you just update them afterwards?

Again I would say obviously Brookfield has an interest in the Company. We still -- unfortunately, the transactions have not all closed as have been announced, but we do communicate with them and they do communicate with us to keep abreast of where things are.

Okay. Appreciate it. Thanks, guys.

No problem.

And your final question comes from the line of Frank Duplak of Prudential.

Good morning, guys. I had a couple quick questions. I thought maybe earlier in the year you talked about maybe having some excess property that could be potential asset sales, maybe up as much as $10 million. Any update progress or is that not likely to happen now?

Well, you are correct. We do have the property that we have in Brazil and South Africa from our facilities that we currently are staging. So we are staging it, making sure it's ready for sale. It took us through the first half to get the facilities ready.

So again we will again start marketing those in the second half. So again depends on the appetite of the market in those locations if we're able to get a sale in second half. We will actively continue to try to promote those and if can sell here by the end of the year; but we'll see.

Yes. And then can you talk about what your current revolver availability is and then what would it be pro forma for this amendment?

Well, I'll just say, obviously because we reported at the end of the quarter we had $258 million available under the revolver. And I'll just say working with the bank group who's been very supportive, the objective was to make sure we had a lot of the availability of the new facility available; and so again we reduced it to $375 million. And I would say -- again depending on the market and the conditions -- a lot of that would be available to the Company.

And then my last question, I mean you talked about having to exercise a change in control at the banks. Do you think that would be necessary with the notes that are outstanding, or you think you won't have to exercise any sort of a change in control option there?

Well again it depends on how things proceed with the tender offer and the convertible preferred closing; and obviously then rating agencies and how they view the business. But we'll just have to wait and see how plays out over the next months.

Okay. Thank you very much.

Okay. No problem.

And there are no further questions in queue.

Okay. Thanks, Kayla, and again thanks for joining our call today. In behalf of the men and women of GrafTech thanks for your interest and participation. Have a great day.

Thank you, ladies and gentlemen. That does conclude today's conference call. You may now disconnect.