QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the quarterly period ended March 31, 2023
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from______ to ______
Commission file number: 1-13888
GRAFTECH INTERNATIONAL LTD.
(Exact name of registrant as specified in its charter)
Delaware
27-2496053
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
982 Keynote Circle
44131
Brooklyn Heights,
OH
(Zip code)
(Address of principal executive offices)
Registrant’s telephone number, including area code: (216) 676-2000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common stock, $0.01 par value per share
EAF
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesý No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yesý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
☒
Accelerated Filer
☐
Emerging Growth Company
☐
Non-Accelerated Filer
☐
Smaller Reporting Company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of April 21, 2023, 256,706,709 shares of common stock outstanding.
Presentation of Financial, Market and Industry Data
We present our financial information on a consolidated basis. Unless otherwise noted, when we refer to dollars, we mean U.S. dollars.
Certain market and industry data included in this Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2023 (the "Report") has been obtained from third-party sources that we believe to be reliable. Market estimates are calculated by using independent industry publications, government publications and third-party forecasts in conjunction with our assumptions about our markets. We cannot guarantee the accuracy or completeness of this market and market share data and have not independently verified it. None of the sources consented to the disclosure or use of data in this Report. While we are not aware of any misstatements regarding any market, industry or similar data presented herein, such data involves risks and uncertainties and is subject to change based on various factors, including those discussed under the headings “Cautionary Note Regarding Forward-Looking Statements” in this Report and “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022 ("Annual Report on Form 10-K") filed on February 14, 2023.
This Report may contain forward-looking statements within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements reflect our current views with respect to, among other things, financial projections, plans and objectives of management for future operations, and future economic performance. Examples of forward-looking statements include, among others, statements we make regarding future estimated revenues and volume derived from our take-or-pay agreements with initial terms of three-to-five years ("LTA"), future pricing of short-term agreements and spot sales ("Non-LTA"), anticipated levels of capital expenditures, and guidance relating to earnings per share and adjusted EBITDA. You can identify these forward-looking statements by the use of forward-looking words such as “will,” “may,” “plan,” “estimate,” “project,” “believe,” “anticipate,” “expect,” “foresee,” “intend,” “should,” “would,” “could,” “target,” “goal,” “continue to,” “positioned to,” “are confident,” or the negative versions of those words or other comparable words. Any forward-looking statements contained in this Report are based upon our historical performance and on our current plans, estimates and expectations considering information currently available to us. The inclusion of this forward-looking information should not be regarded as a representation by us that the future plans, estimates, or expectations contemplated by us will be achieved. Our expectations and targets are not predictions of actual performance and historically our performance has deviated, often significantly, from our expectations and targets. These forward-looking statements are subject to various risks and uncertainties and assumptions relating to our operations, financial results, financial condition, business, prospects, growth
strategy and liquidity. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to:
•our dependence on the global steel industry generally and the electric arc furnace steel industry in particular;
•the cyclical nature of our business and the selling prices of our products, which may decline in the future, may lead to periods of reduced profitability and net losses in the future;
•the sensitivity of our business and operating results to economic conditions, including any recession, and the possibility others may not be able to fulfill their obligations to us in a timely fashion or at all;
•the possibility that we may be unable to implement our business strategies in an effective manner;
•the possibility that global graphite electrode overcapacity may adversely affect graphite electrode prices;
•the competitiveness of the graphite electrode industry;
•our dependence on the supply of raw materials, including decant oil and petroleum needle coke and disruptions in supply chains for these materials;
•our reliance on one facility in Monterrey, Mexico for the manufacturing of connecting pins;
•the availability and cost of electric power and natural gas, particularly in Europe;
•our manufacturing operations are subject to hazards;
•the legal, compliance, economic, social and political risks associated with our substantial operations in multiple countries;
•the possibility that fluctuation of foreign currency exchange rates could materially harm our financial results;
•the possibility that our results of operations could deteriorate if our manufacturing operations were substantially disrupted for an extended period, including as a result of equipment failure, climate change, regulatory issues, natural disasters, public health crises, such as the COVID-19 pandemic, political crises or other catastrophic events;
•the risks and uncertainties associated with litigation, arbitration, and like disputes, including disputes related to contractual commitments;
•our dependence on third parties for certain construction, maintenance, engineering, transportation, warehousing and logistics services;
•the possibility that we are subject to information technology systems failures, cybersecurity attacks, network disruptions and breaches of data security;
•the possibility that we are unable to recruit or retain key management and plant operating personnel or successfully negotiate with the representatives of our employees, including labor unions;
•the sensitivity of goodwill on our balance sheet to changes in the market;
•our dependence on protecting our intellectual property and the possibility that third parties may claim that our products or processes infringe their intellectual property rights;
•the impact of inflation and our ability to mitigate the effect on our costs;
•the impact of macroeconomic and geopolitical events, including developments arising from the COVID-19 pandemic and the conflict between Russia and Ukraine, on our business, results of operations, financial condition and cash flows, and the disruptions and inefficiencies in our supply chain that may occur as a result of such events;
•the possibility that our indebtedness could limit our financial and operating activities or that our cash flows may not be sufficient to service our indebtedness;
•recent increases in benchmark interest rates and the fact that borrowings under certain of our existing financing agreements subject us to interest rate risk;
•the possibility that disruptions in the capital and credit markets could adversely affect our results of operations, cash flows and financial condition, or those of our customers and suppliers;
•the possibility that restrictive covenants in our financing agreements could restrict or limit our operations;
•changes in, or more stringent enforcement of, health, safety and environmental regulations applicable to our manufacturing operations and facilities;
•the possibility that the market price of our common stock could be negatively affected by sales of substantial amounts of our common stock in the public markets, including by Brookfield Corporation and its affiliates (together, “Brookfield”);
•the fact that our stockholders have the right to engage or invest in the same or similar businesses as us; and
•the possibility that we may not pay cash dividends on our common stock in the future.
These factors should not be construed as exhaustive and should be read in conjunction with the Risk Factors and other cautionary statements that are included in our Annual Report on Form 10-K and other filings with the Securities and Exchange Commission ("SEC"). The forward-looking statements made in this Report relate only to events as of the date on which the statements are made. Except as required by law, we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.
If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may vary materially from what we may have expressed or implied by these forward-looking statements. We caution that you should not place undue reliance on any of our forward-looking statements. You should specifically consider the factors identified in this Report that could cause actual results to differ before making an investment decision to purchase our common stock. Furthermore, new risks and uncertainties arise from time to time, and it is impossible for us to predict those events or how they may affect us.
Accounts and notes receivable, net of allowance for doubtful accounts of
$8,203 as of March 31, 2023 and $8,019 as of December 31, 2022
83,913
145,574
Inventories
468,609
447,741
Prepaid expenses and other current assets
72,683
87,272
Total current assets
760,645
815,228
Property, plant and equipment
890,253
869,168
Less: accumulated depreciation
363,154
350,022
Net property, plant and equipment
527,099
519,146
Deferred income taxes
17,973
11,960
Goodwill
171,117
171,117
Other assets
78,419
86,727
Total assets
$
1,555,253
$
1,604,178
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
$
86,645
$
103,156
Long-term debt, current maturities
128
124
Accrued income and other taxes
12,142
40,592
Other accrued liabilities
94,113
89,349
Related party payable - Tax Receivable Agreement
5,137
4,631
Total current liabilities
198,165
237,852
Long-term debt
922,500
921,803
Other long-term obligations
51,613
50,822
Deferred income taxes
46,698
45,065
Related party payable - Tax Receivable Agreement long-term
5,784
10,921
Commitments and contingencies - Note 7
Stockholders’ equity:
Preferred stock, par value $0.01, 300,000,000 shares authorized, none issued
—
—
Common stock, par value $0.01, 3,000,000,000 shares authorized, 256,678,298 and 256,597,342 shares issued and outstanding as of March 31, 2023 and December 31, 2022, respectively
2,567
2,566
Additional paid-in capital
745,891
745,164
Accumulated other comprehensive loss
(6,024)
(8,070)
Accumulated deficit
(411,941)
(401,945)
Total stockholders’ equity
330,493
337,715
Total liabilities and stockholders’ equity
$
1,555,253
$
1,604,178
See accompanying Notes to the Condensed Consolidated Financial Statements
Adjustments to reconcile net (loss) income to cash provided by operations:
Depreciation and amortization
10,777
14,434
Deferred income tax (benefit) provision
(3,750)
1,395
Non-cash stock-based compensation expense
796
465
Non-cash interest expense
2,184
(2,146)
Other adjustments
105
403
Net change in working capital*
25,657
12,590
Change in related party Tax Receivable Agreement
(4,631)
(3,828)
Change in long-term assets and liabilities
1,029
(1,180)
Net cash provided by operating activities
24,798
146,316
Cash flow from investing activities:
Capital expenditures
(25,271)
(16,855)
Proceeds from the sale of fixed assets
92
73
Net cash used in investing activities
(25,179)
(16,782)
Cash flow from financing activities:
Interest rate swap settlements
3,630
(887)
Debt issuance and modification costs
(128)
—
Principal payments on long-term debt
—
(70,000)
Repurchase of common stock
—
(30,000)
Payments for taxes related to net share settlement of equity awards
(129)
(230)
Proceeds from exercise of stock options
—
225
Dividends paid to non-related party
(1,926)
(1,985)
Dividends paid to related party
(640)
(640)
Net cash provided by (used in) financing activities
807
(103,517)
Net change in cash and cash equivalents
426
26,017
Effect of exchange rate changes on cash and cash equivalents
373
1,522
Cash and cash equivalents at beginning of period
134,641
57,514
Cash and cash equivalents at end of period
$
135,440
$
85,053
* Net change in working capital due to changes in the following components:
Accounts and notes receivable, net
$
62,350
$
(1,221)
Inventories
(16,897)
(24,215)
Prepaid expenses and other current assets
12,588
(5,298)
Income taxes payable
(25,594)
(19,419)
Accounts payable and accruals
(12,495)
56,958
Interest payable
5,705
5,785
Net change in working capital
$
25,657
$
12,590
Net cash paid during the periods for:
Interest
$
5,038
$
22,591
Income taxes
$
28,012
$
37,733
Non-cash investing activities:
Capital expenditures in accounts payable
$
(8,963)
$
(6,852)
See accompanying Notes to the Condensed Consolidated Financial Statements
7
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Dollars in thousands, except per share data)
(Unaudited)
Issued Shares of Common Stock
Common Stock
Additional Paid-in Capital
Accumulated Other Comprehensive (Loss) Income
Accumulated Deficit
Total Stockholders’ Equity
Balance as of December 31, 2022
256,597,342
$
2,566
$
745,164
$
(8,070)
$
(401,945)
$
337,715
Net loss
—
—
—
—
(7,369)
(7,369)
Other comprehensive (loss) income:
Commodity, interest rate and foreign currency derivatives income, net of tax of $67
—
—
—
(241)
—
(241)
Commodity, interest rate and foreign currency derivatives reclassification adjustments, net of tax of $886
—
—
—
(2,336)
—
(2,336)
Foreign currency translation adjustments, net of tax of $0
—
—
—
4,623
—
4,623
Total other comprehensive income
—
—
—
2,046
—
2,046
Stock-based compensation
104,533
1
795
—
—
796
Payments for taxes related to net share settlement of equity awards
(23,577)
—
(68)
—
(61)
(129)
Dividends paid to related party ($0.01 per share)
—
—
—
—
(640)
(640)
Dividends paid to non-related party ($0.01 per share)
—
—
—
—
(1,926)
(1,926)
Balance as of March 31, 2023
256,678,298
$
2,567
$
745,891
$
(6,024)
$
(411,941)
$
330,493
Balance as of December 31, 2021
263,255,708
$
2,633
$
761,412
$
(7,444)
$
(733,199)
$
23,402
Net income
—
—
—
—
124,183
124,183
Other comprehensive income (loss):
Commodity, interest rate and foreign currency derivatives income, net of tax of $(4,181)
—
—
—
14,800
—
14,800
Commodity, interest rate and foreign currency derivatives reclassification adjustments, net of tax of $519
—
—
—
(1,837)
—
(1,837)
Foreign currency translation adjustments, net of tax $1
—
—
—
7,022
—
7,022
Total other comprehensive income
—
—
—
19,985
—
19,985
Repurchase of common stock
(3,035,830)
(31)
(8,530)
—
(21,439)
(30,000)
Stock-based compensation
—
—
465
—
—
465
Options exercised
25,000
—
225
—
—
225
Payments for taxes related to net share settlement of equity awards
(22,293)
—
(63)
—
(167)
(230)
Dividends paid to related party ($0.01 per share)
—
—
—
—
(640)
(640)
Dividends paid to non-related party ($0.01 per share)
—
—
—
—
(1,985)
(1,985)
Balance as of March 31, 2022
260,222,585
$
2,602
$
753,509
$
12,541
$
(633,247)
$
135,405
See accompanying Notes to the Condensed Consolidated Financial Statements
8
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1)Organization and Summary of Significant Accounting Policies
A. Organization
GrafTech International Ltd. (the “Company” or “GrafTech”) is a leading manufacturer of high-quality graphite electrode products essential to the production of electric arc furnace (“EAF”) steel and other ferrous and non-ferrous metals. References herein to “GTI,” “we,” “our,” or “us” refer collectively to the Company and its subsidiaries. On August 15, 2015, GTI became an indirect wholly owned subsidiary of Brookfield. In April 2018, the Company completed its initial public offering (“IPO”) of 38,097,525 shares of its common stock held by Brookfield at a price of $15.00 per share. The Company did not receive any proceeds related to the IPO. The Company’s common stock is listed on the New York Stock Exchange under the symbol “EAF.” Brookfield has since distributed a portion of its GrafTech common stock to the owners in the Brookfield consortium and sold shares of GrafTech common stock in public and private transactions, resulting in a reduction of Brookfield's ownership of outstanding shares of GrafTech common stock to 24.9% as of March 31, 2023 and December 31, 2022.
The Company’s only reportable segment, Industrial Materials, is comprised of its two major product categories: graphite electrodes and petroleum needle coke products. Petroleum needle coke is our key raw material used in the production of graphite electrodes. The Company's vision is to provide highly engineered graphite electrode products, services and solutions to electric arc furnace operators.
B. Basis of Presentation
The interim condensed consolidated financial statements are unaudited; however, in the opinion of management, they have been prepared in accordance with Rule 10-01 of Regulation S-X and in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The December 31, 2022 Consolidated Balance Sheet data included herein was derived from the audited consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2022, filed on February 14, 2023, but does not include all disclosures required by GAAP in audited financial statements. These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements, including the accompanying notes, contained in the Company's Annual Report on Form 10-K.
The unaudited condensed consolidated financial statements reflect all adjustments (all of which are of a normal, recurring nature) which management considers necessary for a fair presentation of our financial statements for the interim periods presented. The results for the interim periods are not necessarily indicative of results which may be expected for any other interim period or for the full year.
C. New Accounting Standards
Recently Adopted Accounting Standards
In September 2022, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2022-04, Liabilities - Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations, which requires disclosures intended to enhance the transparency of supplier finance programs. The amendments in this ASU require buyers in a supplier finance program to disclose sufficient information about the program to allow a user of financial statements to understand the program’s nature, activity during the period, changes from period to period, and potential magnitude. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the disclosure of rollforward information, which is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. The amendments should be applied retrospectively to each period in which a balance sheet is presented, except for disclosure of rollforward information, which should be applied prospectively. The Company adopted this guidance on January 1, 2023 and the adoption did not have a material impact on its financial position, results of operations, cash flows or disclosures.
9
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(2)Revenue from Contracts with Customers
Disaggregation of Revenue
The following table provides information about disaggregated revenue by type of product and contract:
Three Months Ended March 31,
2023
2022
(Dollars in thousands)
Graphite Electrodes - LTAs
$
69,866
$
242,481
Graphite Electrodes - Non-LTAs
56,960
108,050
By-products and other
11,976
15,714
Total Revenues
$
138,802
$
366,245
Contract Balances
Substantially all of the Company’s receivables relate to contracts with customers. Accounts receivables are recorded when the right to consideration becomes unconditional. Payment terms on invoices range from 30 to 120 days depending on the customary business practices of the jurisdictions in which we do business.
Certain short-term and longer-term sales contracts require up-front payments prior to the Company’s fulfillment of any performance obligation. These contract liabilities are recorded as current or long-term deferred revenue, depending on the lag between the pre-payment and the expected delivery of the related products. Additionally, deferred revenue or contract assets originate from contracts where the allocation of the transaction price to the performance obligations based on their relative stand-alone selling prices results in the timing of revenue recognition being different from the timing of the invoicing. In this case, deferred revenue is amortized into revenue based on the transaction price allocated to the remaining performance obligations and contract assets are realized through the contract invoicing.
Contract assets are included in “Prepaid expenses and other current assets,” on the Condensed Consolidated Balance Sheets. We did not have any contract asset balances as of March 31, 2023 or December 31, 2022.
Current deferred revenue is included in “Other accrued liabilities” on the Condensed Consolidated Balance Sheets. The following table provides our contract liability balances as of March 31, 2023 and December 31, 2022:
March 31, 2023
December 31, 2022
(Dollars in thousands)
Current deferred revenue
$
33,358
$
27,878
The amount of revenue recognized in 2023 that was included in the December 31, 2022 current deferred revenue balance was $0.4 million. The increase in the current deferred revenue balance since December 31, 2022 is due to payments received from customers in the current year. The current deferred revenue balance includes cashed bank guarantees related to outstanding arbitration proceedings the outcome of which will determine the timing of revenue recognition.
Transaction Price Allocated to the Remaining Performance Obligations
The following table presents estimated revenues expected to be recognized in the corresponding period below related to performance obligations that are unsatisfied (or partially unsatisfied) at the end of reporting period. The revenue associated with our LTAs is expected to be approximately as follows for the full years of 2023 and 2024:
2023
2024
(Dollars in millions)
Estimated LTA revenue
$235-$265
$100-$135(1)
(1) Includes expected termination fees from a few customers that have failed to meet certain obligations under their LTAs.
10
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We recorded $69.9 million of LTA revenue in the three months ended March 31, 2023, and we expect to record approximately $165.0 million to $195.0 million of LTA revenue for the remainder of 2023.
The majority of the LTAs are defined as pre-determined fixed annual volume contracts while a small portion are defined with a specified volume range. For the years 2023 and 2024, the contractual revenue amounts above are based upon the minimum volume for those contracts with specified ranges. The actual revenue realized from these contracted volumes may vary in timing and total due to contract non-performance, force majeure notices, arbitrations, credit risk associated with certain customers facing financial challenges and customer demand related to contracted volume ranges. The estimates of LTA revenue as set forth above in the immediately preceding table includes our current expectations of termination fees from our customers who have failed to meet certain obligations under their LTAs.
(3)Goodwill and Other Intangible Assets
The goodwill balance was $171.1 million as of March 31, 2023 and December 31, 2022.
The following table summarizes intangible assets with determinable useful lives by major category, which are included in "Other assets" on our Condensed Consolidated Balance Sheets:
Intangible Assets
March 31, 2023
December 31, 2022
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
Gross Carrying Amount
Accumulated Amortization
Net Carrying Amount
(Dollars in thousands)
Trade names
$
22,500
$
(16,342)
$
6,158
$
22,500
$
(15,869)
$
6,631
Technology and know-how
55,300
(43,263)
12,037
55,300
(42,371)
12,929
Customer-related intangibles
64,500
(33,587)
30,913
64,500
(32,513)
31,987
Total finite-lived intangible assets
$
142,300
$
(93,192)
$
49,108
$
142,300
$
(90,753)
$
51,547
Amortization expense for intangible assets was $2.4 million and $2.6 million in the three months ended March 31, 2023 and 2022, respectively. Estimated amortization expense will be approximately $6.8 million for the remainder of 2023, $8.0 million in 2024, $7.3 million in 2025, $6.7 million in 2026, $6.1 million in 2027 and $5.5 million in 2028. Amortization expense is included in "Cost of goods sold" on the Condensed Consolidated Statement of Operations.
(4)Debt and Liquidity
The following table presents our long-term debt:
March 31, 2023
December 31, 2022
(Dollars in thousands)
2018 Term Loan Facility
$
433,708
$
433,708
2020 Senior Secured Notes
500,000
500,000
Other debt
273
268
Unamortized debt discount and issuance costs
(11,353)
(12,049)
Total debt
922,628
921,927
Less: Long-term debt, current portion
(128)
(124)
Long-term debt
$
922,500
$
921,803
The fair value of our debt was approximately $857.9 million and $843.2 million as of March 31, 2023 and December 31, 2022, respectively. The fair values were determined using Level 2 quoted market prices for the same or similar debt instruments.
2018 Term Loan and 2018 Revolving Credit Facility
In February 2018, the Company entered into a credit agreement (as amended, the “2018 Credit Agreement”), which provides for (i) a $2,250 million senior secured term facility (the “2018 Term Loan Facility”) after giving effect to the June
11
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
2018 amendment (the “First Amendment”) that increased the aggregate principal amount of the 2018 Term Loan Facility from $1,500 million to $2,250 million and (ii) a $330 million senior secured revolving credit facility after giving effect to the May 2022 amendment that increased the revolving commitments under the 2018 Credit Agreement by $80 million from $250 million (the “2018 Revolving Credit Facility” and, together with the 2018 Term Loan Facility, the “Senior Secured Credit Facilities”). GrafTech Finance Inc. (“GrafTech Finance”) is the sole borrower under the 2018 Term Loan Facility while GrafTech Finance, GrafTech Switzerland SA (“Swissco”) and GrafTech Luxembourg II S.à r.l. (“Luxembourg Holdco” and, together with GrafTech Finance and Swissco, the “Co-Borrowers”) are co-borrowers under the 2018 Revolving Credit Facility. The 2018 Term Loan Facility and the 2018 Revolving Credit Facility mature on February 12, 2025 and May 31, 2027, respectively. As of March 31, 2023 and December 31, 2022, there was no debt outstanding on the 2018 Revolving Credit Facility and there was $3.0 million of letters of credit drawn against the 2018 Revolving Credit Facility as of each date.
The 2018 Term Loan Facility bears interest, at our option, at a rate equal to either (i) the Adjusted LIBO Rate (as defined in the 2018 Credit Agreement), plus an applicable margin equal to 3.00% per annum following an amendment in February 2021 (the “Second Amendment”) that decreased the Applicable Rate (as defined in the 2018 Credit Agreement) by 0.50% for each pricing level or (ii) the ABR Rate (as defined in the 2018 Credit Agreement), plus an applicable margin equal to 2.00% per annum following the Second Amendment, in each case with one step down of 25 basis points based on achievement of certain public ratings of the 2018 Term Loan Facility. The Second Amendment also decreased the interest rate floor from 1.00% to 0.50% for the 2018 Term Loan Facility.
The 2018 Revolving Credit Facility bears interest, at our option, at a rate equal to either (i) the Adjusted Term SOFR Rate and Adjusted EURIBOR Rate (each, as defined in the 2018 Credit Agreement), plus an applicable margin initially equal to 3.00% per annum or (ii) the ABR Rate, plus an applicable margin initially equal to 2.00% per annum, in each case with two 25 basis point step downs based on achievement of certain senior secured first lien net leverage ratios. In addition, we are required to pay a quarterly commitment fee on the unused commitments under the 2018 Revolving Credit Facility in an amount equal to 0.25% per annum.
The Senior Secured Credit Facilities are guaranteed by each of our domestic subsidiaries, subject to certain customary exceptions, and by GrafTech Luxembourg I S.à r.l., a Luxembourg société à responsabilité limitée and an indirect wholly owned subsidiary of GrafTech, Luxembourg HoldCo, and Swissco (collectively, the “Guarantors”) with respect to all obligations under the 2018 Credit Agreement of each of our foreign subsidiaries that is a Controlled Foreign Corporation (within the meaning of Section 956 of the Internal Revenue Code of 1986, as amended from time to time (the “Code”)).
All obligations under the 2018 Credit Agreement are secured, subject to certain exceptions, by: (i) a pledge of all of the equity securities of each domestic Guarantor and of each other direct, wholly owned domestic subsidiary of GrafTech and any Guarantor, (ii) a pledge on no more than 65% of the equity interests of each subsidiary that is a Controlled Foreign Corporation (within the meaning of Section 956 of the Code), and (iii) security interests in, and mortgages on, personal property and material real property of each domestic Guarantor, subject to permitted liens and certain exceptions specified in the 2018 Credit Agreement. The obligations of each foreign subsidiary of GrafTech that is a Controlled Foreign Corporation under the 2018 Revolving Credit Facility are secured by (i) a pledge of all of the equity securities of each Guarantor that is a Controlled Foreign Corporation and of each direct, wholly owned subsidiary of any Guarantor that is a Controlled Foreign Corporation, and (ii) security interests in certain receivables and personal property of each Guarantor that is a Controlled Foreign Corporation, subject to permitted liens and certain exceptions specified in the 2018 Credit Agreement.
The 2018 Term Loan Facility amortizes at a rate of $112.5 million a year payable in equal quarterly installments, with the remainder due at maturity. The Co-Borrowers are permitted to make voluntary prepayments at any time without premium or penalty. GrafTech Finance is required to make prepayments under the 2018 Term Loan Facility (without payment of a premium) with (i) net cash proceeds from non-ordinary course asset sales (subject to customary reinvestment rights and other customary exceptions and exclusions), and (ii) commencing with the Company’s fiscal year ended December 31, 2019, 75% of Excess Cash Flow (as defined in the 2018 Credit Agreement), subject to step-downs to 50% and 0% of Excess Cash Flow based on achievement of a senior secured first lien net leverage ratio greater than 1.25 to 1.00 but less than or equal to 1.75 to 1.00 and less than or equal to 1.25 to 1.00, respectively. Scheduled quarterly amortization payments of the 2018 Term Loan Facility during any calendar year reduce, on a dollar-for-dollar basis, the amount of the required Excess Cash Flow prepayment for such calendar year, and the aggregate amount of Excess Cash Flow prepayments for any calendar year reduce subsequent quarterly amortization payments of the 2018 Term Loan Facility as directed by GrafTech Finance. As of March 31, 2023, we have satisfied all required amortization installments through the maturity date.
The 2018 Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants applicable to GrafTech and restricted subsidiaries, including, among other things, restrictions on indebtedness, liens, investments, fundamental changes, dispositions, and dividends and other distributions. The 2018 Credit Agreement contains a financial covenant that requires GrafTech to maintain a senior secured first lien net leverage ratio not
12
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
greater than 4.00 to 1.00 when the aggregate principal amount of borrowings under the 2018 Revolving Credit Facility and outstanding letters of credit issued under the 2018 Revolving Credit Facility (except for undrawn letters of credit in an aggregate amount equal to or less than $35.0 million), taken together, exceed 35% of the total amount of commitments under the 2018 Revolving Credit Facility. The 2018 Credit Agreement also contains customary events of default. We were in compliance with all of our debt covenants as of March 31, 2023 and December 31, 2022.
2020 Senior Secured Notes
In December 2020, GrafTech Finance issued $500 million aggregate principal amount of 4.625% senior secured notes due 2028 (the “2020 Senior Secured Notes”) in a private offering. The 2020 Senior Secured Notes and related guarantees are secured on a pari passu basis by the collateral securing the Senior Secured Credit Facilities. All of the proceeds from the 2020 Senior Secured Notes were used to partially repay borrowings under our 2018 Term Loan Facility.
The 2020 Senior Secured Notes pay interest in arrears on June 15 and December 15 of each year, with the principal due in full on December 15, 2028. Prior to December 15, 2023, up to 40% of the 2020 Senior Secured Notes may be redeemed with the net cash proceeds of certain equity offerings at a price equal to 104.625% of the principal amount thereof, together with accrued and unpaid interest, if any. The 2020 Senior Secured Notes may be redeemed, in whole or in part, at any time prior to December 15, 2023 at a price equal to 100% of the principal amount of the notes redeemed plus a premium together with accrued and unpaid interest, if any, to, but not including, the redemption date. Thereafter, the 2020 Senior Secured Notes may be redeemed, in whole or in part, at various prices depending on the date redeemed.
The indenture governing the 2020 Senior Secured Notes (the “Indenture”) contains certain covenants that, among other things, limit the Company’s ability, and the ability of certain of its subsidiaries, to incur or guarantee additional indebtedness or issue preferred stock, pay distributions on, redeem or repurchase capital stock or redeem or repurchase subordinated debt, incur or suffer to exist liens securing indebtedness, make certain investments, engage in certain transactions with affiliates, consummate certain asset sales and effect a consolidation or merger, or sell, transfer, lease or otherwise dispose of all or substantially all assets. Pursuant to the Indenture, if our pro forma consolidated first lien net leverage ratio is no greater than 2.00 to 1.00, we can make restricted payments so long as no default or event of default has occurred and is continuing. If our pro forma consolidated first lien net leverage ratio is greater than 2.00 to 1.00, we can make restricted payments pursuant to certain baskets.
The Indenture contains events of default customary for agreements of its type (with customary grace periods, as applicable) and provides that, upon the occurrence of an event of default arising from certain events of bankruptcy or insolvency with respect to the Company or GrafTech Finance, all outstanding 2020 Senior Secured Notes will become due and payable immediately without further action or notice. If any other type of event of default occurs and is continuing, then the trustee or the holders of at least 30% in principal amount of the then outstanding 2020 Senior Secured Notes may declare all of the 2020 Senior Secured Notes to be due and payable immediately.
(5)Inventories
Inventories are comprised of the following:
March 31, 2023
December 31, 2022
(Dollars in thousands)
Inventories:
Raw materials and supplies
$
217,587
$
216,761
Work in process
206,732
192,821
Finished goods
44,290
38,159
Total
$
468,609
$
447,741
13
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(6)Interest Expense
The following table presents the components of interest expense:
Three Months Ended March 31,
2023
2022
(Dollars in thousands)
Interest incurred on debt
$
10,622
$
11,358
Accretion of original issue discount on 2018 Term Loan Facility
168
527
Amortization of debt issuance costs and modification costs
655
1,244
Unrealized mark-to-market loss (gain) on de-designated interest rate swap
1,361
(3,917)
Total interest expense
$
12,806
$
9,212
The 2020 Senior Secured Notes carry a fixed interest rate of 4.625%. The 2018 Term Loan Facility had an effective interest rate of 7.84% and 7.38% as of March 31, 2023 and December 31, 2022, respectively. The Company has interest rate swap contracts to fix its cash flows associated with the risk in variability in the one-month USD London Interbank Offered Rate (“USD LIBOR”) for the 2018 Term Loan Facility. The interest rate swaps fixed the cash flows associated with the payments on our 2018 Term Loan Facility to an effective fixed interest rate of 4.2% in the first quarters of 2023 and 2022. See Note 4, “Debt and Liquidity” for details of our debt and Note 9, “Fair Value Measurements and Derivative Instruments” for additional details on our interest rate swaps and embedded derivative.
In the first quarter of 2022, we made voluntary prepayments of $70.0 million under our 2018 Term Loan Facility. In connection with this, we recorded $0.3 million of accelerated accretion of the original issue discount and $0.5 million of accelerated amortization of the debt issuance cost. We did not make any voluntary prepayments under our 2018 Term Loan facility in the first quarter of 2023.
(7)Commitments and Contingencies
Legal Proceedings
We are involved in various investigations, lawsuits, claims, demands, labor disputes and other legal proceedings, including with respect to environmental and human exposure or other personal injury matters, arising out of or incidental to the conduct of our business. While it is not possible to determine the ultimate disposition of each of these matters and proceedings, we do not believe that their ultimate disposition will have a material adverse effect on our financial position, results of operations or cash flows. Additionally, we are involved in the following legal proceedings.
We are involved in certain arbitrations as respondents/counterclaimants, pending before the International Chamber of Commerce with a few customers who, among other things, have failed to perform under their LTAs and in certain instances are seeking to modify or frustrate their contractual commitments to us. In particular, Aperam South America LTDA, Aperam Sourcing S.C.A., ArcelorMittal Sourcing S.C.A., and ArcelorMittal Brasil S.A. (collectively, the “Claimants”) initiated a single arbitration proceeding against two of the Company’s subsidiaries in the International Chamber of Commerce in June 2020. The Claimants argue, among other things, that they should no longer be required to comply with the terms of their LTAs that they signed due to an alleged drop in market prices for graphite electrodes in January 2020. Alternatively, the Claimants argue that they should not be required to comply with the LTAs that they signed due to alleged market circumstances at the time of execution. In June 2021, the Claimants filed their statement of claim, seeking approximately $61.0 million plus interest in monetary relief and/or reimbursement in respect of several fixed price LTAs that were executed between such subsidiaries and the Claimants in 2017 and 2018. On December 16, 2022, the Claimants revised their calculation of alleged damages to approximately $178.9 million including interest, with damages covering the period from the first quarter of 2020 through the end of the third quarter of 2022 and interest covering the period from June 2020 through December 16, 2022. In March 2023, an International Chamber of Commerce hearing was held before the party-appointed sole arbitrator with the Claimants, the Company, and witnesses in attendance. On March 31, 2023, the Claimants further revised their calculation of alleged damages to approximately $171.7 million including interest, for the period covering the first quarter of 2020 through 2022. We expect the Claimants to provide a final calculation of alleged damages in June 2023. We believe we have valid defenses to these claims. We intend to vigorously defend them and enforce our rights under the LTAs.
14
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Pending litigation in Brazil has been brought by employees seeking to recover additional amounts and interest thereon under certain wage increase provisions applicable in 1989 and 1990 under collective bargaining agreements to which employers in the Bahia region of Brazil were a party (including our subsidiary in Brazil). Companies in Brazil have settled claims arising out of these provisions and, in May 2015, the litigation was remanded by the Brazilian Supreme Court in favor of the employees union. After denying an interim appeal by the Bahia region employers on June 26, 2019, the Brazilian Supreme Court finally ruled in favor of the employees union on September 26, 2019. The employers union has determined not to seek annulment of such decision. Separately, on October 1, 2015, a related action was filed by current and former employees against our subsidiary in Brazil to recover amounts under such provisions, plus interest thereon, which amounts together with interest could be material to us. If the Brazilian Supreme Court proceeding above had been determined in favor of the employers union, it would also have resolved this proceeding in our favor. In the first quarter of 2017, the state court initially ruled in favor of the employees. We appealed this state court ruling, and the appellate court issued a decision in our favor on May 19, 2020. The employees have further appealed and, on December 16, 2020, the court upheld the decision in favor of GrafTech Brazil. On February 22, 2021, the employees filed a further appeal and, on April 28, 2021, the court rejected the employees' appeal in favor of GrafTech Brazil. The employees filed a further appeal and on September 12, 2022, we filed our response in opposition. We intend to vigorously defend our position. As of March 31, 2023, we are unable to assess the potential loss associated with these proceedings as the claims do not currently specify the number of employees seeking damages or the amount of damages being sought.
Product Warranties
We generally sell products with a limited warranty. We accrue for known warranty claims if a loss is probable and can be reasonably estimated. We also accrue for estimated warranty claims incurred based on a historical claims charge analysis. Claims accrued but not yet paid and the related activity within the accrual for the three months ended March 31, 2023, are presented below:
(Dollars in thousands)
Balance as of December 31, 2022
$
820
Product warranty charges/adjustments
69
Payments and settlements
(148)
Balance as of March 31, 2023
$
741
Related Party Tax Receivable Agreement
On April 23, 2018, the Company entered into the tax receivable agreement ("Tax Receivable Agreement") that provides Brookfield, as the sole pre-IPO stockholder, the right to receive future payments from us for 85% of the amount of cash savings, if any, in U.S. federal income tax and Swiss tax that we and our subsidiaries realize as a result of the utilization of the pre-IPO tax assets. In addition, we will pay interest on the payments we will make to Brookfield with respect to the amount of these cash savings from the due date (without extensions) of our tax return where we realize these savings to the payment date. On April 10, 2023, the Tax Receivable Agreement was amended and restated to change the applicable interest rate from LIBOR plus 1.00% per year to the one-month period secured overnight financing rate administered by the Federal Reserve Bank of New York plus 1.10%. The term of the Tax Receivable Agreement commenced on April 23, 2018 and will continue until there is no potential for any future tax benefit payments.
As of March 31, 2023, the total Tax Receivable Agreement liability was $10.9 million, of which $5.1 million was classified as current liability "Related party payable - Tax Receivable Agreement" on the Condensed Consolidated Balance Sheets and $5.8 million of the liability was classified as a long-term liability in "Related party payable - Tax Receivable Agreement long-term" on the Condensed Consolidated Balance Sheets. As of December 31, 2022, the total Tax Receivable Agreement liability was $15.5 million, of which $4.6 million was classified as a current liability "Related party payable - Tax Receivable Agreement" on the Condensed Consolidated Balance Sheets, and $10.9 million of the liability was classified as a long-term liability in "Related party payable - Tax Receivable Agreement long-term" on the Condensed Consolidated Balance Sheets.
Mexico Value-Added Tax (“VAT”)
In July 2019, the Mexican Tax Authority (“MTA”) opened an audit of the VAT filings of one of the Company’s subsidiaries in Mexico for the period of January 1 to April 30, 2019. In September 2021, the MTA issued a tax assessment, claiming improper use of a certain VAT exemption rule for purchases from a foreign affiliate. The Company filed an administrative appeal against the tax assessment with the MTA’s appeals office. In November 2022, the MTA’s appeals office
15
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
concluded its review and confirmed the tax assessment. The Company believes that the purchases from a foreign affiliate are exempt from VAT back-up withholding and in December 2022, the Company filed a Claim for Nullity with the Chamber Specialized in exclusive resolution of substance of the Federal Court of Administrative Justice. As of March 31, 2023, the tax assessment for the four month period under audit amounted to approximately $25.0 million, including penalties, inflation and interest. Interest will continue to accrue up to five years and inflation will continue to accrue with the passage of time.
After the filing of the Claim for Nullity, in January 2023, the MTA opened another audit of the VAT filings of the same subsidiary in Mexico for the period January 1 to December 31, 2018. The MTA is alleging the same improper use of certain VAT exemption rules on purchases from a foreign affiliate and has provided notice of its intent to assess approximately $51.0 million, including penalties, inflation and interest. In Mexico, each tax assessment requires a separate claim. In the first quarter of 2023, the Company initiated a mediation process with the MTA to avoid the assessment being issued by the MTA. If the mediation process does not result in a satisfactory outcome, the Company intends to pursue administrative appeal procedures with the MTA to attempt to satisfactorily resolve this matter. The $51.0 million includes interest and inflation, which will continue to accrue with the passage of time.
The Company believes that its application of the VAT exemption rules is appropriate and, accordingly, does not believe that it is probable that it will incur a loss related to this matter for either of the two periods under the MTA’s audit. The Company intends to vigorously defend its position.
(8)Income Taxes
We compute and apply to ordinary income an estimated annual effective tax rate on a quarterly basis based on current and forecasted business levels and activities, including the mix of domestic and foreign results and enacted tax laws. The estimated annual effective tax rate is updated quarterly based on actual results and updated operating forecasts. Ordinary income refers to income before the provision for income taxes excluding significant, unusual or infrequently occurring items. The tax effect of an unusual or infrequently occurring item is recorded in the interim period in which it occurs as a discrete item of tax.
The following table summarizes the (benefit) provision for income taxes:
Three Months Ended March 31,
2023
2022
(Dollars in thousands)
(Benefit) provision for income taxes
$
(2,904)
$
19,797
Pre-tax (loss) income
(10,273)
143,980
Effective tax rate
28.3
%
13.7
%
The effective tax rate for the first quarter of 2023 varied from the U.S. statutory tax rate of 21% primarily due to worldwide earnings from various countries taxed at different rates. The effective tax rate for the first quarter of 2022 was lower than the U.S. statutory tax rate of 21% primarily due to worldwide earnings from various countries taxed at different rates, which was partially offset by the net combined impact related to the U.S. taxation of global intangible low taxed income (“GILTI”) and Foreign Tax Credits (“FTCs”).
The decrease in the provision for income taxes was primarily due to a reduction in pre-tax income.
On August 16, 2022, the U.S. enacted the Inflation Reduction Act of 2022, which includes a 15% minimum tax on book income of certain large corporations, a 1% excise tax on net stock repurchases after December 31, 2022, and several tax incentives to promote clean energy. The Company does not believe this legislation will have a material impact on its consolidated financial statements and will continue to assess the implications.
We file income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. All U.S. federal tax years prior to 2019 are generally closed by statute or have been audited and settled with the applicable domestic tax authorities. Other jurisdictions are generally closed for years prior to 2017.
We continue to assess the realization of our deferred tax assets based on determinations of whether it is more likely than not that deferred tax benefits will be realized through the generation of future taxable income. Appropriate consideration is given to all available evidence, both positive and negative, in assessing the need for a valuation allowance. Examples of
16
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
positive evidence would include a strong earnings history, an event or events that would increase our taxable income through a continued reduction of expenses, and tax planning strategies that would indicate an ability to realize deferred tax assets. In circumstances where the significant positive evidence does not outweigh the negative evidence in regards to whether or not a valuation allowance is required, we have established and maintained valuation allowances on those net deferred tax assets. There were no material changes to our valuation allowances in the first quarter of 2023.
(9)Fair Value Measurements and Derivative Instruments
In the normal course of business, we are exposed to certain risks related to fluctuations in currency exchange rates, commodity prices and interest rates. We use various derivative financial instruments, primarily foreign currency derivatives, commodity derivative contracts, and interest rate swaps as part of our overall strategy to manage risks from these market fluctuations.
Certain of our derivative contracts contain provisions that require us to provide collateral. Since the counterparties to these financial instruments are large commercial banks and similar financial institutions, we do not believe that we are exposed to material counterparty credit risk. We do not anticipate nonperformance by any of the counterparties to our instruments.
Foreign currency derivatives
We enter into foreign currency derivatives from time to time to attempt to manage exposure to changes in currency exchange rates. These foreign currency instruments, which include, but are not limited to, forward exchange contracts and purchased currency options, are used to hedge global currency exposures such as foreign currency denominated debt, receivables, payables, sales and purchases.
Foreign currency forward and swap contracts are used to mitigate the foreign exchange risk of balance sheet items. These derivatives are fair value hedges. Gains and losses from these derivatives are recorded in cost of goods sold and they are largely offset by the financial impact of translating foreign currency-denominated payables and receivables.
In the first quarter of 2022, we entered into foreign currency derivatives with maturities of one month to 12 months in order to protect against the risk that cash flows associated with certain sales and purchases denominated in a currency other than the U.S. dollar will be adversely affected by future changes in foreign exchange rates. These derivatives are designated as cash flow hedges. The resulting unrealized gains or losses from these derivatives are recorded in accumulated other comprehensive income ("AOCI") and subsequently, when realized, are reclassified to net sales or cost of goods sold in the Condensed Consolidated Statements of Operations when the hedged exposures affect earnings.
Commodity derivative contracts
From time to time, we enter into commodity derivative contracts for refined oil products. These contracts are entered into to protect against the risk that eventual cash flows related to these products will be adversely affected by future changes in prices. The unrealized gains or losses related to commodity derivative contracts designated as cash flow hedges are recorded in AOCI and subsequently, when realized, are reclassified to the Condensed Consolidated Statement of Operations when the hedged item impacts earnings, which is when the finished product is sold. The last of our commodity derivative contracts matured as of June 30, 2022 and we have not entered into any new contracts as of March 31, 2023.
Interest rate swap contracts
We utilize interest rate swaps to limit exposure to market fluctuations on our variable-rate debt. Each derivative agreement's unrealized gain or loss is recorded in AOCI and, when realized, is recorded to interest expense.
We entered into interest rate swap contracts that are "pay fixed, receive variable." Our risk management objective was to fix our cash flows associated with the risk of variability in the one-month USD LIBOR for a portion of our outstanding debt. It was expected that the swaps would fix the cash flows associated with the forecasted interest payments on our debt to an effective fixed interest rate of 4.2%, which could be lowered to 3.95% depending on credit ratings. Since their modification concurrent with the 2018 Term Loan Facility modification in the first quarter of 2021, the swaps contain an other-than-insignificant financing element. As such, they are considered hybrid instruments composed of a debt host and an embedded derivative and the associated cash (outflows)/inflows are classified as financing (use)/source of cash.
17
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The debt host portion amounted to a liability of $3.3 million as of March 31, 2023, with $2.3 million included in "Other accrued liabilities" and $1.0 million in "Other long-term obligations" on the Condensed Consolidated Balance Sheets. As of December 31, 2022, the debt host portion amounted to a liability of $3.8 million, with $2.3 million included in "Other accrued liabilities" and $1.5 million included in "Other long-term obligations" on the Condensed Consolidated Balance Sheets. The corresponding loss is accounted for in AOCI and is being amortized over the remaining life of the swaps. The embedded derivative is treated as a cash flow hedge.
In the first quarter of 2022, in connection with the repayment of principal on our 2018 Term Loan Facility discussed in Note 4, "Debt and Liquidity," and our probability assessment of the variable-rate debt remaining outstanding through the term of the swaps, we de-designated one interest rate swap contract with a $250.0 million notional amount, maturing in the third quarter of 2024. The fair value of the embedded derivative at the de-designation date was a gain of $6.6 million and was recorded in AOCI and will be amortized into interest expense over the remaining life of the swap.
In the third quarter of 2022, we redeemed $67.0 million of our $250.0 million notional amount de-designated interest rate swap. The change in fair value of the de-designated embedded derivative in the first quarter of 2023 resulted in a loss of $1.4 million compared to a gain of $3.9 million in the first quarter of 2022, recorded in interest expense in the Condensed Consolidated Statements of Operations.
All derivatives are recorded on the balance sheet at fair value. If the derivative is designated and effective as a cash flow hedge, changes in the fair value of the derivative are recognized in AOCI until the hedged item is recognized in earnings. The ineffective portion of a derivative's fair value, if any, is recognized in earnings immediately. If a derivative is not a hedge, changes in the fair value are adjusted through earnings. The fair values of the outstanding derivatives are recorded on the balance sheet as assets (if the derivatives are in a gain position) or liabilities (if the derivatives are in a loss position). The fair values will also be classified as short-term or long-term depending upon their maturity dates. The fair value of all of our derivatives was determined using Level 2 inputs.
18
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The notional amounts of our outstanding derivative instruments as of March 31, 2023 and December 31, 2022 were as follows:
March 31, 2023
December 31, 2022
Notional Amount
Notional Amount
(Dollars in thousands)
Derivative instruments designated as hedges:
Interest rate swap contracts
$
250,000
$
250,000
Derivative instruments not designated as hedges:
Foreign currency derivatives
$
37,332
$
70,420
Interest rate swap contracts
183,000
183,000
The following table summarizes the fair value of our outstanding derivatives designated as hedges (on a gross basis) and balance sheet classification as of March 31, 2023 and December 31, 2022:
March 31, 2023
December 31, 2022
Fair Value
Fair Value
(Dollars in thousands)
Prepaid and other current assets
Interest rate swap contracts
$
9,885
$
10,246
Total
$
9,885
$
10,246
Other assets
Interest rate swap contracts
$
3,191
$
5,575
Total
$
3,191
$
5,575
Net asset
$
13,076
$
15,821
As a result of the settlement of commodity derivative contracts and foreign currency derivatives, as of March 31, 2023, net realized pre-tax gains of $14.7 million and net realized pre-tax losses of $3.5 million were reported in AOCI and will be released to earnings within the following 12 months. No ineffectiveness expense was recorded in the first quarter of 2023 or 2022. See the table below for amounts recognized on the effective portion of our commodity derivative contracts in the Statement of Operations.
The realized (gains) losses on cash flow hedges are recognized in the Statements of Operations when the hedged item impacts earnings and are as follows for the periods ended March 31, 2023 and 2022:
Amount of (Gain)/Loss Recognized
Location of Realized (Gain)/Loss Recognized in the Condensed Consolidated Statement of Operations
Three Months Ended March 31,
2023
2022
Derivatives designated as cash flow hedges:
(Dollars in thousands)
Foreign currency derivatives
Cost of goods sold
$
2,040
$
—
Commodity derivative contracts
Cost of goods sold
(2,817)
(2,978)
Interest rate swap contracts
Interest expense
(2,445)
421
Pretax gains and losses on non-designated derivatives recognized in earnings are as follows:
19
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Amount of (Gain)/Loss Recognized
Location of (Gain)/Loss Recognized in the Condensed Consolidated Statement of Operations
Three Months Ended March 31,
2023
2022
Derivatives not designated as hedges:
(Dollars in thousands)
Foreign currency derivatives
Cost of goods sold, other expense (income), net
$
436
$
474
Interest rate swap contracts
Interest expense
1,361
(3,917)
The following table summarizes the fair value of our outstanding derivatives not designated as hedges (on a gross basis) and balance sheet classification as of March 31, 2023 and December 31, 2022:
March 31, 2023
December 31, 2022
Fair Value
Fair Value
(Dollars in thousands)
Prepaid and other current assets
Interest rate swap contracts
$
7,225
$
7,492
Foreign currency derivatives
160
92
Other assets
Interest rate swap contracts
2,327
4,071
Other accrued liabilities
Foreign currency derivatives
(96)
(282)
Net asset
$
9,616
$
11,373
(10)Accumulated Other Comprehensive Loss
The balance in our Accumulated other comprehensive loss is set forth in the following table:
March 31, 2023
December 31, 2022
(Dollars in thousands)
Foreign currency translation adjustments, net of tax
$
(24,731)
$
(29,354)
Commodity, interest rate, and foreign currency derivatives, net of tax
18,707
21,284
Total accumulated other comprehensive loss
$
(6,024)
$
(8,070)
20
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(11)(Loss) Earnings per Share
During the three months ended March 31, 2023, we did not repurchase any shares of our common stock. In the three months ended March 31, 2022, we repurchased 3,035,830 shares of our common stock for $30.0 million under our common stock repurchase program. The settled shares were subsequently retired.
The following table presents a reconciliation of the numerator and denominator of basic and diluted (loss) earnings per share for the three months ended March 31, 2023 and 2022:
Three Months Ended March 31,
2023
2022
(Dollars in thousands, except per share amounts)
Numerator for basic and diluted (loss) earnings per share:
Net (loss) income
$
(7,369)
$
124,183
Denominator:
Weighted average common shares outstanding for basic calculation
256,974,904
262,592,029
Add: Effect of equity awards
—
65,770
Weighted average common shares outstanding for diluted calculation
256,974,904
262,657,799
Basic (loss) earnings per share
$
(0.03)
$
0.47
Diluted (loss) earnings per share
$
(0.03)
$
0.47
Basic (loss) earnings per share is calculated by dividing net (loss) income by the weighted average number of common shares outstanding, which included 341,570 and 172,010 shares of participating securities in the three months ended March 31, 2023 and 2022, respectively. Diluted (loss) earnings per share is calculated by dividing net (loss) income by the sum of the weighted average number of common shares outstanding plus the additional common shares that would have been outstanding if potentially dilutive securities had been issued.
The weighted average common shares outstanding for the diluted (loss) earnings per share calculation for the three months ended March 31, 2023 excludes the dilutive effect of approximately 790 shares, primarily related to restricted stock units, as their inclusion would have been anti-dilutive due to the Company's net loss.
Additionally, the weighted average common shares outstanding for the diluted (loss) earnings per share calculation excludes consideration of 2,857,827 and 1,479,638 equivalent shares for the three months ended March 31, 2023 and 2022, respectively, as their effect would have been anti-dilutive.
(12) Stock-Based Compensation
The Human Resources and Compensation Committee of our Board of Directors granted 519,482 stock options, 665,417 restricted stock units (“RSUs”) and 542,743 performance stock units (“PSUs”), and our electing non-employee directors received 30,441 deferred share units (“DSUs”) during the three months ended March 31, 2023 under our Omnibus Equity Incentive Plan. The weighted average exercise price per share and weighted average fair value per share of the stock options granted in the three months ended March 31, 2023 was $5.51 and $3.01, respectively. We estimated the fair value of the stock options using the following assumptions in our Black-Scholes model:
Dividend yield
0.73%
Expected volatility
58.16%
Risk-free interest rate
4.04%
Expected term (in years)
6.0 years
We measure the fair value of grants of RSUs and DSUs based on the closing market price of a share of our common stock on the date of the grant. The weighted average fair value per share was $5.58 for RSUs and $4.86 for DSUs granted during the three months ended March 31, 2023.
21
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We measure the fair value of grants of PSUs using a monte carlo valuation. The weighted average fair value of the PSUs granted in the three months ended March 31, 2023 was $7.30 per share and will be expensed over a vesting period of three years. The final payout to holders of PSUs will be based upon the Company's total shareholder return relative to a peer group's performance measured at the end of each performance period.
In the three months ended March 31, 2023 and 2022, we recognized $0.8 million and $0.5 million, respectively, of stock-based compensation expense. The majority of the expense, $0.7 million and $0.4 million, respectively, was recorded in selling and administrative expense in the Condensed Consolidated Statements of Operations, with the remaining expense recorded in cost of goods sold.
As of March 31, 2023, the unrecognized compensation cost related to the unvested portion of all stock-based awards was approximately $14.0 million and is expected to be recognized over the remaining vesting period of the respective grants.
22
PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(13) Supplementary Balance Sheet Detail
Supplier Finance Program (“SFP”) Obligations
GrafTech Mexico S.A. De C.V. (“GrafTech Mexico”) participates in an electronic vendor voucher payment program supported by the Mexican Government through one of its national banks, whereby suppliers can factor their invoices through a financial intermediary. This program gives GrafTech Mexico’s suppliers the option to settle trade receivables by obtaining payment from the financial intermediary prior to the invoice due date for a discounted amount. The Company’s responsibility is limited to making payment on the terms originally negotiated with its supplier, regardless of whether the supplier elects to receive early payment. The range of payment terms the Company negotiates with its suppliers is consistent, irrespective of whether a supplier participates in the program.
As of March 31, 2023, $7.0 million of SFP obligations were included in accounts payable on the Condensed Consolidated Balance Sheets and upon settlement, are reflected as cash flow from operating activities in the Condensed Consolidated Statements of Cash Flows. We did not have a SFP obligation as of December 31, 2022.
23
PART I (CONT’D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The Company
We are a leading manufacturer of high-quality graphite electrode products essential to the production of EAF steel and other ferrous and non‑ferrous metals. We believe that we have the most competitive portfolio of low cost ultra-high power graphite electrode manufacturing facilities in the industry, including three of the highest capacity facilities in the world. We are the only large scale graphite electrode producer that is substantially vertically integrated into petroleum needle coke, our key raw material for graphite electrode manufacturing.
The environmental and economic advantages of electric arc furnace steel production position both that industry and the graphite electrode industry for continued long-term growth.
We believe GrafTech's leadership position and vertical integration are sustainable competitive advantages. The services and solutions we provide will position our customers and us for a better future.
Operational and Commercial Update
Sales volume for the first quarter of 2023 was 16.9 thousand metric tons (“MT”), consisting of 7.4 thousand MT of LTA volume and 9.5 thousand MT of non-LTA volume, and decreased 61% compared to the first quarter of 2022, primarily reflecting the residual impact of the suspension of our operations in Monterrey, Mexico that began near the end of the third quarter of 2022. Although the facility resumed production during the fourth quarter of 2022, the suspension coincided with a key commitment window for customer purchases covering the first six months of 2023. The resulting uncertainty during this timeframe limited our ability to enter into new customer commitments for the first half of 2023. In addition, the lower sales volume was partially attributable to softness in graphite electrode demand.
For the first quarter of 2023, the weighted-average realized price for our LTA volume was $9,000 per MT, a reduction of 6% compared to $9,600 per MT in the first quarter of 2022. For our non-LTA volume, the weighted-average realized price for graphite electrodes delivered and recognized in revenue in the first quarter of 2023 was $6,000 per MT, consistent with the weighted-average realized non-LTA price for 2022.
Production volume was 15.8 thousand MT in the first quarter of 2023, a decrease of 66% compared to the first quarter of 2022, as we proactively reduced production at our European graphite electrode manufacturing facilities to align our production volume with our evolving demand outlook.
Outlook
The suspension of our operations in Monterrey, Mexico in late 2022 will have a significant impact on our sales volume through the end of the second quarter of 2023. In addition, we anticipate continued soft demand for graphite electrodes due to ongoing economic uncertainty and geopolitical conflict. Reflecting these factors, we estimate our sales volume for the second quarter of 2023 will be in the range of 24 thousand MT to 27 thousand MT, with non-LTA pricing expected to decline slightly from first quarter 2023 levels. In the second half of the year, we anticipate sales volume levels will further recover, as we move past Monterrey suspension-driven uncertainty and anticipate that a gradual improvement in market conditions will strengthen demand for graphite electrodes. As a result, we currently estimate our sales volume for the full year of 2023 will be in the range of 100 thousand MT to 115 thousand MT.
For the full year of 2023, we also continue to expect a significant year-over-year increase in our cash cost of goods sold per MT as fixed costs are being recognized over a smaller volume base and reflecting the full-year impact of higher raw material costs that increased throughout 2022. In response to higher input costs, we are closely managing our operating costs and capital expenditures, as well as our working capital levels.
Looking ahead, we remain confident in our ability to overcome near-term challenges and are optimistic about the longer-term outlook for our business. We anticipate the steel industry’s accelerating efforts to decarbonize will lead to increased adoption of the electric arc furnace method of steelmaking, driving long-term demand growth for graphite electrodes. We also anticipate the demand for petroleum needle coke, the key raw material we use to produce our graphite electrodes, to accelerate driven by its use to produce synthetic graphite for use in lithium-ion batteries for the growing electric vehicle market. We believe that the actions we are taking, supported by a distinct set of capabilities, including our vertical integration into petroleum needle coke production via our Seadrift facility, will optimally position GrafTech to benefit from these sustainable industry tailwinds.
24
PART I (CONT’D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Steel market capacity utilization rates have been as follows:
Q1 2023
Q4 2022
Q1 2022
Global (ex-China) capacity utilization rate(1)
65%
64%
70%
U.S. steel market capacity utilization rate(2)
74%
72%
80%
(1) Source: World Steel Association, Metal Expert and GrafTech analysis, as of April 2023
(2)Source: American Iron and Steel Institute, as of April 2023
The table of estimated shipments of graphite electrodes under existing LTAs has been updated as follows to reflect our current expectations for the full years of 2023 and 2024:
2023 Outlook
2024 Outlook
Estimated LTA volume(1)
27-31
13-16
Estimated LTA revenue(2)
$235-$265
$100-$135(3)
(1) In thousands of MT
(2) In millions
(3) Includes expected termination fees from a few customers that have failed to meet certain obligations under their LTAs
We recorded 7.4 thousand MT of LTA volume and $69.9 million of LTA revenue in the three months ended March 31, 2023, and we expect to record 20 thousand to 24 thousand MT of LTA volume and approximately $165.0 million to $195.0 million of LTA revenue for the remainder of 2023.
The majority of the LTAs are defined as pre-determined fixed annual volume contracts while a small portion are defined with a specified volume range. For the years 2023 and through 2024, the contractual revenue amounts above are based upon the minimum volume for those contracts with specified ranges. The actual revenue realized from these contracted volumes may vary in timing and total due to contract non-performance, force majeure notices, arbitrations, credit risk associated with certain customers facing financial challenges and customer demand related to contracted volume ranges. The estimates of LTA volume and revenue as set forth above in the immediately preceding table includes our current expectations of termination fees from our customers who have failed to meet certain obligations under their LTAs.
Capital Structure and Capital Allocation
As of March 31, 2023, GrafTech had cash and cash equivalents of $135.4 million and gross debt of approximately $934.0 million, with these metrics relatively unchanged compared to the end of 2022. The Company's current capital allocation approach is focused on maintaining sufficient liquidity as we recover from the impact of the temporary suspension of our operations in Monterrey, Mexico, while making targeted investments to support long-term growth.
We continue to expect full year capital expenditures to be in the range of $55.0 million to $60.0 million for 2023.
Key metrics used by management to measure performance
In addition to measures of financial performance presented in our Condensed Consolidated Financial Statements in accordance with generally accepted accounting principles in the United States ("GAAP"), we use certain other financial measures and operating metrics to analyze the performance of our Company. Our “non-GAAP” financial measures consist of EBITDA, adjusted EBITDA, adjusted net (loss) income and adjusted (loss) earnings per share, which help us evaluate growth trends, establish budgets, assess operational efficiencies and evaluate our overall financial performance. Our key operating metrics consist of sales volume, production volume, production capacity and capacity utilization.
25
PART I (CONT’D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Key financial measures
Three Months Ended March 31,
(in thousands, except per share data)
2023
2022
Net sales
$
138,802
$
366,245
Net (loss) income
(7,369)
124,183
(Loss) earnings per share(1)
(0.03)
0.47
EBITDA(2)
12,938
167,528
Adjusted net (loss) income(2)
(5,549)
125,920
Adjusted (loss) earnings per share(1)(2)
(0.02)
0.48
Adjusted EBITDA(2)
15,115
169,600
(1) (Loss) earnings per share represents diluted (loss) earnings per share. Adjusted (loss) earnings per share represents adjusted diluted (loss) earnings per share.
(2) Non-GAAP financial measure; see below for information and reconciliations of EBITDA, adjusted EBITDA and adjusted net (loss) income to net (loss) income and adjusted (loss) earnings per share to (loss) earnings per share, the most directly comparable financial measures calculated and presented in accordance with GAAP.
Key operating measures
In addition to measures of financial performance presented in accordance with GAAP, we use certain operating metrics to analyze the performance of our Company. The key operating metrics consist of sales volume, production volume, production capacity and capacity utilization. These metrics align with management's assessment of our revenue performance and profit margin, and will help investors understand the factors that drive our profitability.
Sales volume reflects the total volume of graphite electrodes sold for which revenue has been recognized during the period. For a discussion of our revenue recognition policy, see “—Critical accounting policies—Revenue recognition” in our Annual Report on Form 10-K. Sales volume helps investors understand the factors that drive our net sales.
Production volume reflects graphite electrodes produced during the period. Production capacity reflects expected maximum production volume during the period depending on product mix and expected maintenance outage. Actual production may vary. Capacity utilization reflects production volume as a percentage of production capacity. Production volume, production capacity and capacity utilization help us understand the efficiency of our production, evaluate cost of goods sold and consider how to approach our contract initiative.
Three Months Ended March 31,
(in thousands, except utilization)
2023
2022
Sales volume (MT)
16.9
43.3
Production volume (MT)(1)
15.8
46.1
Total production capacity (MT)(2)(3)
58.0
58.0
Total capacity utilization(3)(4)
27
%
79
%
Production capacity excluding St. Marys (MT)(2)(5)
51.0
51.0
Capacity utilization excluding St. Marys(4)(5)
31
%
90
%
(1) Production volume reflects graphite electrodes we produced during the period.
(2) Production capacity reflects expected maximum production volume during the period depending on product mix and expected maintenance outage. Actual production may vary.
(3) Includes graphite electrode facilities in Calais, France; Monterrey, Mexico; Pamplona, Spain; and St. Marys, Pennsylvania.
(4) Capacity utilization reflects production volume as a percentage of production capacity.
(5) Our St. Marys, Pennsylvania facility graphitizes a limited number of electrodes and pins sourced from our Monterrey, Mexico facility.
26
PART I (CONT’D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Results of Operations
The Three Months Ended March 31, 2023 Compared to the Three Months Ended March 31, 2022
The table presented in our period-over-period comparisons summarizes our Condensed Consolidated Statements of Operations and illustrates key financial indicators used to assess the consolidated financial results. Throughout this "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Report ("MD&A"), insignificant changes may be deemed not meaningful and are generally excluded from the discussion.
Three Months Ended March 31,
Increase/ Decrease
% Change
2023
2022
(Dollars in thousands)
Net sales
$
138,802
$
366,245
$
(227,443)
(62)
%
Cost of goods sold
112,645
191,214
(78,569)
(41)
%
Gross profit
26,157
175,031
(148,874)
(85)
%
Research and development
1,192
880
312
35
%
Selling and administrative expenses
22,151
21,254
897
4
%
Operating income
2,814
152,897
(150,083)
(98)
%
Other expense (income), net
653
(197)
850
(431)
%
Interest expense
12,806
9,212
3,594
39
%
Interest income
(372)
(98)
(274)
280
%
(Loss) income before (benefit) provision for income taxes
(10,273)
143,980
(154,253)
(107)
%
(Benefit) provision for income taxes
(2,904)
19,797
(22,701)
(115)
%
Net (loss) income
$
(7,369)
$
124,183
$
(131,552)
(106)
%
Net sales decreased $227.4 million, or 62%, compared to the first quarter of 2022, primarily reflecting lower sales volume, as well as a shift in the mix of our business from volume derived from LTAs to volume derived from non-LTAs.
Cost of goods sold decreased $78.6 million, or 41%, compared to the first quarter of 2022, primarily reflecting lower sales volume, partially offset by an increase in our costs as higher priced inventory was sold during the first quarter of 2023, reflecting the full-year impact of raw material, energy and freight cost increases that occurred throughout 2022. In addition, due to the reduced production levels in the first quarter of 2023, we recorded excess fixed manufacturing costs of approximately $12.6 million, including $2.8 million of depreciation, that would have otherwise been inventoried.
Selling and administrative expenses increased $0.9 million, or 4%, compared to the first quarter of 2022, primarily reflecting increased administrative spending, partially offset by reduced selling expenses driven by reduced sales volume.
Interest expense increased $3.6 million, or 39%, compared to the first quarter of 2022 primarily due the recognition of a $1.4 million mark-to-market loss in the first quarter of 2023, compared to a $3.9 million mark-to-market gain recorded in the first quarter of 2022 related to our de-designated interest rate swap.
The following table summarizes the (benefit) provision for income taxes:
Three Months Ended March 31,
2023
2022
(Dollars in thousands)
(Benefit) provision for income taxes
$
(2,904)
$
19,797
Pre-tax (loss) income
(10,273)
143,980
Effective tax rate
28.3
%
13.7
%
27
PART I (CONT’D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
The reduction in the provision for income taxes decreased in the first quarter of 2023 compared to the first quarter of 2022 primarily due to a decrease in pre-tax income.
The effective tax rate for the first quarter of 2023 varied from the U.S. statutory tax rate of 21% primarily due to worldwide earnings from various countries taxed at different rates. The effective tax rate for the first quarter of 2022 was lower than the U.S. statutory tax rate of 21% primarily due to worldwide earnings from various countries taxed at different rates, which was partially offset by the net combined impact related to the U.S. taxation of GILTI and FTCs.
Effects of Changes in Currency Exchange Rates
When the currencies of non-U.S. countries in which we have a manufacturing facility decline (or increase) in value relative to the U.S. dollar, this has the effect of reducing (or increasing) the U.S. dollar equivalent cost of goods sold and other expenses with respect to those facilities. In certain countries in which we have manufacturing facilities, and in certain export markets, we sell in currencies other than the U.S. dollar. Accordingly, when these currencies increase (or decline) in value relative to the U.S. dollar, this has the effect of increasing (or reducing) net sales. The result of these effects is to increase (or decrease) operating and net (loss) income.
Many of the non-U.S. countries in which we have a manufacturing facility have been subject to significant economic and political changes, which have significantly impacted currency exchange rates. We cannot predict changes in currency exchange rates in the future or whether those changes will have net positive or negative impacts on our net sales, cost of goods sold or net (loss) income.
The impact of these changes in the average exchange rates of other currencies against the U.S. dollar on our net sales was a decrease of $1.2 million for the first quarter ended March 31, 2023, compared to the same period of 2022. The impact of these changes on our cost of goods sold was an increase of $2.6 million for the three months ended March 31, 2023, compared to the same period in 2022.
We have in the past and may in the future use various financial instruments to manage certain exposures to risks caused by currency exchange rate changes, as described under “Part I, Item 3–Quantitative and Qualitative Disclosures about Market Risk.”
Liquidity and Capital Resources
Our sources of funds have consisted principally of cash flow from operations and debt, including our credit facilities (subject to continued compliance with the financial covenants and representations). Our uses of those funds (other than for operations) have consisted principally of dividends, capital expenditures, scheduled debt repayments, optional debt repayments, stock repurchases and other obligations. Disruptions in the U.S. and international financial markets could adversely affect our liquidity and the cost and availability of financing to us in the future.
We believe that we have adequate liquidity to meet our needs for at least the next twelve months and for the foreseeable future thereafter. As of March 31, 2023, we had liquidity of $462.4 million, consisting of $327.0 million of availability under our 2018 Revolving Credit Facility and cash and cash equivalents of $135.4 million. We remain subject to continued compliance with the financial covenant in our 2018 Revolving Credit Facility (see below and Note 4, "Debt and Liquidity") and our future operating performance could result in the reduction of the availability under our 2018 Revolving Credit Facility. We expect our operating cash flow to be positive for 2023 and do not anticipate the need to borrow against our 2018 Revolving Credit Facility. We had gross long-term debt of $933.9 million and gross short-term debt of $0.1 million as of March 31, 2023. As of December 31, 2022, we had liquidity of $461.6 million consisting of $327.0 million available under our 2018 Revolving Credit Facility (subject to continued compliance with the financial covenants and representations) and cash and cash equivalents of $134.6 million. We had gross long-term debt of $933.9 million and gross short-term debt of $0.1 million as of December 31, 2022.
As of March 31, 2023 and December 31, 2022, $80.0 million and $92.3 million, respectively, of our cash and cash equivalents were located outside of the U.S. We repatriate funds from our foreign subsidiaries through dividends. All of our subsidiaries face the customary statutory limitation that distributed dividends cannot exceed the amount of retained and current earnings. Upon repatriation to the U.S., the foreign source portion of dividends we receive from our foreign subsidiaries are not subject to U.S. federal income tax because the amounts were either previously taxed or are exempted from tax by Section 245A of the Internal Revenue Service Code (the "Code").
28
PART I (CONT’D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Cash flow and plans to manage liquidity. Our cash flow typically fluctuates significantly between quarters due to various factors. These factors include customer order patterns, fluctuations in working capital requirements, timing of tax and interest payments and other factors.
Debt Structure
We had total availability under the 2018 Revolving Credit Facility of $327.0 million as of March 31, 2023 and December 31, 2022. The balance consisted of the $330.0 million limit reduced by $3.0 million of outstanding letters of credit in both periods.
2018 Term Loan and 2018 Revolving Credit Facility
In February 2018, the Company entered into the 2018 Credit Agreement, which provides for (i) the $2.3 billion 2018 Term Loan Facility after giving effect to the June 2018 amendment (the “First Amendment”) that increased the aggregate principal amount of the 2018 Term Loan Facility from $1.5 billion to $2.3 billion and (ii) the $330 million 2018 Revolving Credit Facility after giving effect to the May 2022 amendment that increased the revolving commitments under the 2018 Credit Agreement by $80.0 million from $250.0 million. GrafTech Finance is the sole borrower under the 2018 Term Loan Facility while GrafTech Finance, GrafTech Switzerland SA (“Swissco”) and GrafTech Luxembourg II S.à r.l. (“Luxembourg Holdco” and, together with GrafTech Finance and Swissco, the “Co-Borrowers”) are co-borrowers under the 2018 Revolving Credit Facility. The 2018 Term Loan Facility and the 2018 Revolving Credit Facility mature on February 12, 2025 and May 31, 2027, respectively.
The 2018 Term Loan Facility bears interest, at our option, at a rate equal to either (i) the Adjusted LIBO Rate (as defined in the 2018 Credit Agreement), plus an applicable margin equal to 3.00% per annum following an amendment in February 2021 (the “Second Amendment”) that decreased the Applicable Rate (as defined in the 2018 Credit Agreement) by 0.50% for each pricing level or (ii) the ABR Rate (as defined in the 2018 Credit Agreement), plus an applicable margin equal to 2.00% per annum following the Second Amendment, in each case with one step down of 25 basis points based on achievement of certain public ratings of the 2018 Term Loan Facility. The Second Amendment also decreased the interest rate floor from 1.0% to 0.50% for the 2018 Term Loan Facility.
The 2018 Revolving Credit Facility bears interest, at our option, at a rate equal to either (i) the Adjusted Term SOFR Rate and Adjusted EURIBOR Rate (each, as defined in the 2018 Credit Agreement), plus an applicable margin initially equal to 3.00% per annum or (ii) the ABR Rate, plus an applicable margin initially equal to 2.00% per annum, in each case with two 25 basis point step downs based on achievement of certain senior secured first lien net leverage ratios. In addition, we are required to pay a quarterly commitment fee on the unused commitments under the 2018 Revolving Credit Facility in an amount equal to 0.25% per annum.
The Senior Secured Credit Facilities are guaranteed by each of our domestic subsidiaries, subject to certain customary exceptions, and by GrafTech Luxembourg I S.à r.l., a Luxembourg société à responsabilité limitée and an indirect wholly owned subsidiary of GrafTech, Luxembourg HoldCo, and Swissco (collectively, the “Guarantors”) with respect to all obligations under the 2018 Credit Agreement of each of our foreign subsidiaries that is a Controlled Foreign Corporation (within the meaning of Section 956 of the Code).
All obligations under the 2018 Credit Agreement are secured, subject to certain exceptions, by: (i) a pledge of all of the equity securities of each domestic Guarantor and of each other direct, wholly owned domestic subsidiary of GrafTech and any Guarantor, (ii) a pledge on no more than 65% of the equity interests of each subsidiary that is a Controlled Foreign Corporation (within the meaning of Section 956 of the Code), and (iii) security interests in, and mortgages on, personal property and material real property of each domestic Guarantor, subject to permitted liens and certain exceptions specified in the 2018 Credit Agreement. The obligations of each foreign subsidiary of GrafTech that is a Controlled Foreign Corporation under the 2018 Revolving Credit Facility are secured by (i) a pledge of all of the equity securities of each Guarantor that is a Controlled Foreign Corporation and of each direct, wholly owned subsidiary of any Guarantor that is a Controlled Foreign Corporation, and (ii) security interests in certain receivables and personal property of each Guarantor that is a Controlled Foreign Corporation, subject to permitted liens and certain exceptions specified in the 2018 Credit Agreement.
The 2018 Term Loan Facility amortizes at a rate of $112.5 million a year payable in equal quarterly installments, with the remainder due at maturity. The Co-Borrowers are permitted to make voluntary prepayments at any time without premium or penalty. GrafTech Finance is required to make prepayments under the 2018 Term Loan Facility (without payment of a premium) with (i) net cash proceeds from non-ordinary course asset sales (subject to customary reinvestment rights and other customary exceptions and exclusions), and (ii) commencing with the Company’s fiscal year ended December 31, 2019, 75% of
29
PART I (CONT’D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Excess Cash Flow (as defined in the 2018 Credit Agreement), subject to step-downs to 50% and 0% of Excess Cash Flow based on achievement of a senior secured first lien net leverage ratio greater than 1.25 to 1.00 but less than or equal to 1.75 to 1.00 and less than or equal to 1.25 to 1.00, respectively. Scheduled quarterly amortization payments of the 2018 Term Loan Facility during any calendar year reduce, on a dollar-for-dollar basis, the amount of the required Excess Cash Flow prepayment for such calendar year, and the aggregate amount of Excess Cash Flow prepayments for any calendar year reduce subsequent quarterly amortization payments of the 2018 Term Loan Facility as directed by GrafTech Finance. As of March 31, 2023, we have satisfied all required amortization installments through the maturity date.
The 2018 Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants applicable to GrafTech and restricted subsidiaries, including, among other things, restrictions on indebtedness, liens, investments, fundamental changes, dispositions, and dividends and other distributions. The 2018 Credit Agreement contains a financial covenant that requires GrafTech to maintain a senior secured first lien net leverage ratio not greater than 4.00 to 1.00 when the aggregate principal amount of borrowings under the 2018 Revolving Credit Facility and outstanding letters of credit issued under the 2018 Revolving Credit Facility (except for undrawn letters of credit in an aggregate amount equal to or less than $35.0 million), taken together, exceed 35% of the total amount of commitments under the 2018 Revolving Credit Facility. The 2018 Credit Agreement also contains customary events of default. We were in compliance with all of our debt covenants as of March 31, 2023 and December 31, 2022.
2020 Senior Secured Notes
In December 2020, GrafTech Finance issued $500 million aggregate principal amount of the 2020 Senior Secured Notes at an issue price of 100% of the principal amount thereof in a private offering to qualified institutional buyers in accordance with Rule 144A under the Securities Act of 1933 (the "Securities Act") and to non-U.S. persons outside the United States under Regulation S under the Securities Act.
The 2020 Senior Secured Notes were issued pursuant to the Indenture among GrafTech Finance, as issuer, the Company, as a guarantor, the other subsidiaries of the Company named therein as guarantors and U.S. Bank National Association, as trustee and notes collateral agent.
The 2020 Senior Secured Notes are guaranteed on a senior secured basis by the Company and all of its existing and future direct and indirect U.S. subsidiaries that guarantee, or borrow under, the credit facilities under its 2018 Credit Agreement. The 2020 Senior Secured Notes are secured on a pari passu basis by the collateral securing the term loans under the 2018 Credit Agreement. GrafTech Finance, the Company and the other guarantors granted a security interest in such collateral, consisting of substantially all of their respective assets, as security for the obligations of GrafTech Finance, the Company and the other guarantors under the 2020 Senior Secured Notes and the Indenture pursuant to a collateral agreement, dated as of December 22, 2020 (the “Collateral Agreement”), among GrafTech Finance, the Company, the other subsidiaries of the Company named therein as grantors and U.S. Bank National Association, as collateral agent.
The 2020 Senior Secured Notes bear interest at the rate of 4.625% per annum, which accrues from December 22, 2020 and is payable in arrears on June 15 and December 15 of each year, commencing on June 15, 2021. The 2020 Senior Secured Notes will mature on December 15, 2028, unless earlier redeemed or repurchased, and are subject to the terms and conditions set forth in the Indenture.
GrafTech Finance may redeem some or all of the 2020 Senior Secured Notes at the redemption prices and on the terms specified in the Indenture. If the Company or GrafTech Finance experiences specific kinds of changes in control or the Company or any of its restricted subsidiaries sells certain of its assets, then GrafTech Finance must offer to repurchase the 2020 Senior Secured Notes on the terms set forth in the Indenture.
The Indenture contains certain covenants that, among other things, limit the Company’s ability, and the ability of certain of its subsidiaries, to incur or guarantee additional indebtedness or issue preferred stock, pay distributions on, redeem or repurchase capital stock or redeem or repurchase subordinated debt, incur or suffer to exist liens securing indebtedness, make certain investments, engage in certain transactions with affiliates, consummate certain asset sales and effect a consolidation or merger, or sell, transfer, lease or otherwise dispose of all or substantially all assets. The Indenture contains events of default customary for agreements of its type (with customary grace periods, as applicable) and provides that, upon the occurrence of an event of default arising from certain events of bankruptcy or insolvency with respect to the Company or GrafTech Finance, all outstanding 2020 Senior Secured Notes will become due and payable immediately without further action or notice. If any other
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type of event of default occurs and is continuing, then the trustee or the holders of at least 30% in principal amount of the then outstanding 2020 Senior Secured Notes may declare all of the 2020 Senior Secured Notes to be due and payable immediately.
The entirety of the 2020 Senior Secured Notes proceeds was used to pay down a portion of our 2018 Term Loan Facility.
Uses of Liquidity
In July 2019, our Board of Directors authorized a program to repurchase up to $100.0 million of our outstanding common stock. In November 2021, our Board of Directors authorized the repurchase of an additional $150.0 million of stock repurchases under this program. We may purchase shares from time to time on the open market, including under Rule 10b5-1 and/or Rule 10b-18 plans. The amount and timing of repurchases are subject to a variety of factors including liquidity, stock price, applicable legal requirements, other business objectives and market conditions. In the first three months of 2023, we did not repurchase any shares of our common stock. As of March 31, 2023, we had $99.0 million remaining under our stock repurchase authorization.
We currently pay a quarterly dividend of $0.01 per share, or $0.04 on an annualized basis. There can be no assurance that we will pay dividends in the future in these amounts or at all. Our Board of Directors may change the timing and amount of any future dividend payments or eliminate the payment of future dividends in its sole discretion, without any prior notice to our stockholders. Our ability to pay dividends will depend upon many factors, including our financial position and liquidity, results of operations, legal requirements, restrictions that may be imposed by the terms of our current and future credit facilities and other debt obligations and other factors deemed relevant by our Board of Directors.
In 2022, we voluntarily repaid $110.0 million of principal of our 2018 Term Loan Facility. There were no voluntary repayments of debt during the first quarter of 2023.
Potential uses of our liquidity include dividends, share repurchases, capital expenditures, scheduled debt repayments, optional debt repayments, refinancing of our credit facilities and other general purposes. Any such potential uses of our liquidity may be funded by existing available liquidity, the incurrence of new secured or unsecured loans or capital market issuances. We continue to monitor the loan and debt capital markets for opportunities to proactively refinance or otherwise extend the maturity of our 2018 Term Loan Facility. An improving economy, while resulting in improved results of operations, could increase our cash requirements to purchase inventories, make capital expenditures and fund payables and other obligations until increased accounts receivable are converted into cash. A downturn, including any recession or potential resurgence of the COVID-19 pandemic, could significantly and negatively impact our results of operations and cash flows, which, coupled with increased borrowings, could negatively impact our credit ratings, our ability to comply with debt covenants, our ability to secure additional financing and the cost of such financing, if available.
In order to seek to minimize our credit risks, we may reduce our sales of, or refuse to sell (except for prepayment, cash on delivery or under letters of credit or parent guarantees), our products to some customers and potential customers. Our unrecovered trade receivables worldwide have not been material during the last two years individually or in the aggregate.
We manage our capital expenditures by taking into account quality, plant reliability, safety, environmental and regulatory requirements, prudent or essential maintenance requirements, global economic conditions, available capital resources, liquidity, long-term business strategy and return on invested capital for the relevant expenditures, cost of capital and return on invested capital of the Company as a whole and other factors. Capital expenditures totaled $25.3 million in the three months ended March 31, 2023. We continue to expect full-year capital expenditures to be in the range of $55.0 million to $60.0 million for 2023.
In the event that operating cash flows fail to provide sufficient liquidity to meet our business needs, including capital expenditures, any such shortfall would need to be made up by increased borrowings under our 2018 Revolving Credit Facility, to the extent available. The Company also maintains access to capital markets and may issue debt or equity securities from time to time, which may provide an additional source of liquidity.
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Cash Flows
The following table summarizes our cash flow activities:
Three Months Ended March 31,
2023
2022
(in thousands)
Cash flow provided by (used in):
Operating activities
$
24,798
$
146,316
Investing activities
(25,179)
(16,782)
Financing activities
807
(103,517)
Net change in cash and cash equivalents
$
426
$
26,017
Operating Activities
Cash provided by operating activities totaled $24.8 million in the first three months of 2023 compared to $146.3 million in the prior-year period. The decrease in operating cash flow was primarily due to the $131.6 million reduction in net income in the first quarter of 2023 versus the first quarter of 2022. Partially offsetting reduced net income was an increase in cash provided by working capital of $13.1 million. Cash flow provided by accounts receivable increased $63.6 million, compared to the first three months of 2022, primarily due to reduced sales volumes. Cash flow provided by prepaid expenses and other current assets increased $17.9 million, compared to the first three months of 2022, primarily due to timing of payments. Cash flow used for inventories decreased $7.3 million, compared to the first three months of 2022, driven by reduced volume. Cash flow used for accounts payable and accruals was $12.5 million in the first three months of 2023 compared to a source of cash of $57.0 million in the first three months of 2022 primarily due to a reduced amount of customer pre-payments in the first quarter of 2023 versus the first quarter of 2022.
Investing Activities
Net cash used in investing activities was $25.2 million in the three months ended March 31, 2023 compared to $16.8 million in the three months ended March 31, 2022. The increase is primarily due to increased capital expenditures.
Financing Activities
Net cash provided by financing activities was $0.8 million for the three months ended March 31, 2023 compared to $103.5 million used in financing activities in the first three months of 2022. The decrease was primarily due to $70.0 million of debt repayments and $30.0 million of stock repurchases made in the first three months of 2022, which did not re-occur in the first quarter 2023.
Related Party Transactions
We have engaged in transactions with affiliates or related parties in the three months ended March 31, 2023 and we expect to continue to do so in the future. These transactions include ongoing obligations under the Tax Receivable Agreement, Stockholders Rights Agreement and Registration Rights Agreement, each with Brookfield.
Description of Our Financing Structure
We discuss our financing structure in more detail in Note 4, "Debt and Liquidity" in the Notes to the Condensed Consolidated Financial Statements.
Non-GAAP financial measures
In addition to providing results that are determined in accordance with GAAP, we have provided certain financial measures that are not in accordance with GAAP. EBITDA, adjusted EBITDA, adjusted net (loss) income, adjusted (loss) earnings per share, free cash flow, adjusted free cash flow and cash cost of goods sold per MT are non-GAAP financial measures. We define EBITDA, a non‑GAAP financial measure, as net (loss) income plus interest expense, minus interest income, plus income taxes and depreciation and amortization. We define adjusted EBITDA as EBITDA plus any pension and
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other post-employment benefit ("OPEB") plan expenses (benefits), non‑cash losses from foreign currency remeasurement of non‑operating assets and liabilities in our foreign subsidiaries where the functional currency is the U.S. dollar, stock-based compensation expense, non-cash fixed asset write-offs and related party payable - Tax Receivable Agreement adjustments. Adjusted EBITDA is the primary metric used by our management and our Board of Directors to establish budgets and operational goals for managing our business and evaluating our performance.
We monitor adjusted EBITDA as a supplement to our GAAP measures, and believe it is useful to present to investors, because we believe that it facilitates evaluation of our period‑to‑period operating performance by eliminating items that are not operational in nature, allowing comparison of our recurring core business operating results over multiple periods unaffected by differences in capital structure, capital investment cycles and fixed asset base. In addition, we believe adjusted EBITDA and similar measures are widely used by investors, securities analysts, ratings agencies, and other parties in evaluating companies in our industry as a measure of financial performance and debt‑service capabilities.
Our use of adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
•adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
•adjusted EBITDA does not reflect our cash expenditures for capital equipment or other contractual commitments, including any capital expenditure requirements to augment or replace our capital assets;
•adjusted EBITDA does not reflect the interest expense or the cash requirements necessary to service interest or principal payments on our indebtedness;
•adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us;
•adjusted EBITDA does not reflect expenses or benefits relating to our pension and OPEB plans;
•adjusted EBITDA does not reflect the non‑cash gains or losses from foreign currency remeasurement of non‑operating assets and liabilities in our foreign subsidiaries where the functional currency is the U.S. dollar;
•adjusted EBITDA does not reflect stock-based compensation expense;
•adjusted EBITDA does not reflect the non-cash write-off of fixed assets;
•adjusted EBITDA does not reflect related party payable - Tax Receivable Agreement adjustments; and
•other companies, including companies in our industry, may calculate EBITDA and adjusted EBITDA differently, which reduces its usefulness as a comparative measure.
We define adjusted net (loss) income, a non‑GAAP financial measure, as net (loss) income and exclude the items used to calculate adjusted EBITDA, less the tax effect of those adjustments. We define adjusted (loss) earnings per share, a non‑GAAP financial measure, as adjusted net (loss) income divided by the weighted average diluted common shares outstanding during the period. We believe adjusted net (loss) income and adjusted (loss) earnings per share are useful to present to investors because we believe that they assist investors’ understanding of the underlying operational profitability of the Company.
Free cash flow and adjusted free cash flow, non-GAAP financial measures, are metrics used by our management and our Board of Directors to analyze cash flows generated from operations. We define free cash flow as net cash provided by operating activities less capital expenditures. We define adjusted free cash flow as free cash flow adjusted by payments made or received from the settlement of interest rate swap contracts and payments of the Change in Control charges that were triggered as a result of the ownership of our largest stockholder falling below 30% of our total outstanding shares. We believe these free cash flow metrics are useful to present to investors because we believe that they facilitate comparison of the Company’s performance with its competitors. For purposes of this release, a Change in Control occurred when Brookfield and any affiliates thereof ceased to own stock of the Company that constitutes at least thirty percent (30%) or thirty-five percent (35%), as applicable, of the total fair market value or total voting power of the stock of the Company (the "Change in Control").
We define cash cost of goods sold per MT as cost of goods sold less depreciation and amortization and less cost of goods sold associated with the portion of our sales that consists of deliveries of by-products of the manufacturing processes, with this total divided by our sales volume measured in MT. We believe this is an important measure as it is used by our management and Board of Directors to evaluate our costs on a per MT basis.
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In evaluating EBITDA, adjusted EBITDA, adjusted net (loss) income and adjusted (loss) earnings per share, you should be aware that in the future, we will incur expenses similar to the adjustments in the reconciliations presented below. Our presentations of EBITDA, adjusted EBITDA, adjusted net (loss) income and adjusted (loss) earnings per share, should not be construed as suggesting that our future results will be unaffected by these expenses or any unusual or non‑recurring items. When evaluating our performance, you should consider EBITDA, adjusted EBITDA, adjusted net (loss) income and adjusted (loss) earnings per share, alongside other measures of financial performance and liquidity, including our net (loss) income and (loss) earnings per share, respectively, and other GAAP measures.
The following tables reconcile our non-GAAP key financial measures to the most directly comparable GAAP measures:
Reconciliation of Net (Loss) Income to Adjusted Net (Loss) Income
Three Months Ended March 31,
2023
2022
(Dollars in thousands, except per share data)
Net (loss) income
$
(7,369)
$
124,183
Diluted (loss) income per common share:
Net (loss) income per share
$
(0.03)
$
0.47
Weighted average shares outstanding
256,974,904
262,657,799
Adjustments, pre-tax:
Pension and OPEB plan expenses(1)
918
551
Non-cash losses on foreign currency remeasurement(2)
447
1,236
Stock-based compensation expense(3)
796
465
Related party payable - Tax Receivable Agreement adjustment(4)
16
(180)
Total non-GAAP adjustments pre-tax
2,177
2,072
Income tax impact on non-GAAP adjustments(5)
357
335
Adjusted net (loss) income
$
(5,549)
$
125,920
(1)Net periodic benefit cost for our pension and OPEB plans.
(2)Non-cash losses from foreign currency remeasurement of non-operating assets and liabilities of our non-U.S. subsidiaries where the functional currency is the U.S. dollar.
(3)Non-cash expense for stock-based compensation grants.
(4)Non-cash expense adjustment for future payment to our sole pre-IPO stockholder for tax assets that are expected to be utilized.
(5)The tax impact on the non-GAAP adjustments is affected by their tax deductibility and the applicable jurisdictional tax rates.
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Reconciliation of (Loss) Earnings per share to Adjusted (Loss) Earnings per share
Three Months Ended March 31,
2023
2022
(Loss) Earnings per share
$
(0.03)
$
0.47
Adjustments per share:
Pension and OPEB plan expenses(1)
0.01
—
Non-cash losses on foreign currency remeasurement(2)
—
0.01
Stock-based compensation expense(3)
—
—
Related party payable - Tax Receivable Agreement adjustment(4)
—
—
Total non-GAAP adjustments pre-tax per share
0.01
0.01
Income tax impact on non-GAAP adjustments per share(5)
—
—
Adjusted (loss) earnings per share
$
(0.02)
$
0.48
(1)Net periodic benefit cost for our pension and OPEB plans.
(2)Non-cash losses from foreign currency remeasurement of non-operating assets and liabilities of our non-U.S. subsidiaries where the functional currency is the U.S. dollar.
(3)Non-cash expense for stock-based compensation grants.
(4)Non-cash expense adjustment for future payment to our sole pre-IPO stockholder for tax assets that are expected to be utilized.
(5)The tax impact on the non-GAAP adjustments is affected by their tax deductibility and the applicable jurisdictional tax rates.
Reconciliation of Net (Loss) Income to Adjusted EBITDA
Three Months Ended March 31,
2023
2022
(Dollars in thousands)
Net (loss) income
$
(7,369)
$
124,183
Add:
Depreciation and amortization
10,777
14,434
Interest expense
12,806
9,212
Interest income
(372)
(98)
Income taxes
(2,904)
19,797
EBITDA
12,938
167,528
Adjustments:
Pension and OPEB plan expenses(1)
918
551
Non-cash losses on foreign currency remeasurement(2)
447
1,236
Stock-based compensation expense(3)
796
465
Related party payable - Tax Receivable Agreement adjustment(4)
16
(180)
Adjusted EBITDA
$
15,115
$
169,600
(1)Net periodic benefit cost for our pension and OPEB plans.
(2)Non-cash losses from foreign currency remeasurement of non-operating assets and liabilities of our non-U.S. subsidiaries where the functional currency is the U.S. dollar.
(3)Non-cash expense for stock-based compensation grants.
(4)Non-cash expense adjustment for future payment to our sole pre-IPO stockholder for tax assets that are expected to be utilized.
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PART I (CONT’D)
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Reconciliation of Net Cash Provided by Operating Activities to Free Cash Flow and Adjusted Free Cash Flow
Three Months Ended March 31,
2023
2022
(Dollars in thousands)
Net cash provided by operating activities
$
24,798
$
146,316
Capital expenditures
(25,271)
(16,855)
Free cash flow
(473)
129,461
Interest rate swap settlements(1)
3,630
(887)
Change in Control payment(2)
—
443
Adjusted free cash flow
$
3,157
$
129,017
(1) Receipt (payment) of cash related to the monthly settlement of our outstanding interest rate swap contracts.
(2) In the second quarter of 2021, we incurred pre-tax Change in Control charges of $88 million as a result of the ownership of our largest stockholder, Brookfield, moving below 30% of our total shares outstanding. Of the $88 million in pre-tax Change in Control charges, $73 million were cash and $15 million were non-cash. An aggregate of $72 million of the cash charges have been paid through the first quarter of 2023 and an additional $1 million will be paid in subsequent quarters, as a result of the timing of related payroll tax payments.
Reconciliation of Cost of Goods Sold to Cash Cost of Goods Sold per MT
Three Months Ended March 31,
2023
2022
(Dollars in thousands)
Cost of goods sold
$
112,645
$
191,214
Less:
Depreciation and amortization(1)
9,065
12,733
Cost of goods sold - by-products and other(2)
8,332
12,469
Cash cost of goods sold
95,248
166,012
Sales volume (in thousands of MT)
16.9
43.3
Cash cost of goods sold per MT
$
5,636
$
3,834
(1) Reflects the portion of depreciation and amortization that is recognized in cost of goods sold.
(2) Primarily reflects cost of goods sold associated with the portion of our sales that consists of deliveries of by-products of the manufacturing processes.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risks, primarily from changes in interest rates, currency exchange rates, energy commodity prices and commercial energy rates. From time to time, we enter into transactions that have been authorized according to documented policies and procedures in order to manage these risks. These transactions primarily relate to financial instruments described below. Since the counterparties to these financial instruments are large commercial banks and similar financial institutions, we do not believe that we are exposed to material counterparty credit risk. We do not use financial instruments for trading purposes.
Our exposure to changes in interest rates results primarily from floating rate long-term debt tied to the Adjusted LIBO Rate, SOFR Rate or EURIBOR Rate.
Our exposure to changes in currency exchange rates results primarily from:
•sales made by our subsidiaries in currencies other than local currencies;
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•raw material purchases made by our foreign subsidiaries in currencies other than local currencies; and
•investments in and intercompany loans to our foreign subsidiaries and our share of the earnings of those subsidiaries, to the extent denominated in currencies other than the U.S. dollar.
Our exposure to changes in energy commodity prices and commercial energy rates results primarily from the purchase or sale of refined oil products and the purchase of natural gas and electricity for use in our manufacturing operations.
Interest rate risk management. We periodically enter into agreements with financial institutions that are intended to limit our exposure to additional interest expense due to increases in variable interest rates. These instruments effectively cap our interest rate exposure. As of March 31, 2023 and December 31, 2022, we recorded unrealized pre-tax gains of $22.6 million and $27.4 million, respectively, on our interest rate swaps.
Currency rate management. We enter into foreign currency derivatives from time to time to attempt to manage exposure to changes in currency exchange rates. These foreign currency derivatives, which include, but are not limited to, forward exchange contracts and purchased currency options, attempt to hedge global currency exposures. Forward exchange contracts are agreements to exchange different currencies at a specified future date and at a specified rate. Purchased currency options are instruments which give the holder the right, but not the obligation, to exchange different currencies at a specified rate at a specified date or over a range of specified dates. Forward exchange contracts and purchased currency options are carried at fair value.
The outstanding foreign currency derivatives represented a $0.1 million unrealized pre-tax net gain as of March 31, 2023 and a net unrealized pre-tax loss of $0.2 million as of December 31, 2022.
Energy commodity management. We have previously entered into commodity derivative contracts to effectively fix some or all of our exposure to refined oil products. As of March 31, 2023 and December 31, 2022, there were no commodity derivative contracts outstanding.
Sensitivity analysis. We use sensitivity analysis to quantify potential impacts that market rate changes may have on the underlying exposures as well as on the fair values of our derivatives. The sensitivity analysis for the derivatives represents the hypothetical changes in value of the hedge position and does not reflect the related gain or loss on the forecasted underlying transaction.
A hypothetical increase in interest rates of 100 basis points (1%) would have increased our interest expense, net of the impact of our interest rate swap, by an insignificant amount for the three months ended March 31, 2023. The same 100 basis point increase would have resulted in an increase of $3.0 million in the fair value of our interest rate swap portfolio.
As of March 31, 2023, a 10% appreciation or depreciation in the value of the U.S. dollar against foreign currencies from the prevailing market rates would have resulted in a corresponding decrease of $1.4 million or a corresponding increase of $1.4 million, respectively, in the fair value of the foreign currency hedge portfolio.
For further information related to the financial instruments described above, see Note 9, "Fair Value Measurements and Derivative Instruments" in the Notes to the Condensed Consolidated Financial Statements.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. Management is responsible for establishing and maintaining adequate disclosure controls and procedures. Disclosure controls and procedures are designed to ensure that information required to be disclosed by a reporting company in the reports that it files or submits under Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by it in the reports that it files under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2023. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that these controls and procedures were effective as of March 31, 2023.
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Changes in Internal Control over Financial Reporting. There have been no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Item 1. Legal Proceedings
We are involved in various investigations, lawsuits, claims, demands, labor disputes and other legal proceedings, including with respect to environmental and human exposure or other personal injury matters, arising out of or incidental to the conduct of our business. While it is not possible to determine the ultimate disposition of each of these matters and proceedings, we do not believe that their ultimate disposition will have a material adverse effect on our financial position, results of operations or cash flows. Additionally, we are involved in the following legal proceedings.
Arbitrations
We are involved in certain arbitrations as respondents/counterclaimants, pending before the International Chamber of Commerce with a few customers who, among other things, have failed to perform under their LTAs and in certain instances are seeking to modify or frustrate their contractual commitments to us. In particular, Aperam South America LTDA, Aperam Sourcing S.C.A., ArcelorMittal Sourcing S.C.A., and ArcelorMittal Brasil S.A. (collectively, the “Claimants”) initiated a single arbitration proceeding against two of the Company’s subsidiaries in the International Chamber of Commerce in June 2020. The Claimants argue, among other things, that they should no longer be required to comply with the terms of the LTAs that they signed due to an alleged drop in market prices for graphite electrodes in January 2020. Alternatively, the Claimants argue that they should not be required to comply with the LTAs that they signed due to alleged market circumstances at the time of execution. In June 2021, the Claimants filed their statement of claim, seeking approximately $61.0 million plus interest in monetary relief and/or reimbursement in respect of several fixed price LTAs that were executed between such subsidiaries and the Claimants in 2017 and 2018. On December 16, 2022, the Claimants revised their calculation of alleged damages to approximately $178.9 million including interest, with damages covering the period from the first quarter of 2020 through the end of the third quarter of 2022 and interest covering the period from June 2020 through December 16, 2022. In March 2023, an International Chamber of Commerce hearing was held before the party-appointed sole arbitrator with the Claimants, the Company, and witnesses in attendance. On March 31, 2023, the Claimants further revised their calculation of alleged damages to approximately $171.7 million, including interest, for the period covering the first quarter of 2020 through 2022. We expect the Claimants to provide a final calculation of alleged damages in June 2023. We believe we have valid defenses to these claims. We intend to vigorously defend them and enforce our rights under the LTAs.
Monterrey, Mexico Suspension of Operations
Background
On September 15, 2022, inspectors from the State Attorney’s Office for the Secretary of Environment of the State of Nuevo León, Mexico visited GrafTech México graphite electrode manufacturing facility located in Monterrey, Mexico to inspect GrafTech Mexico’s facility and certain of the facility’s environmental and operating permits. At the conclusion of the inspection, the inspectors issued a Record of Inspection providing for the results of the inspection, their observations, and the imposition of a temporary suspension of GrafTech Mexico’s facilities within seven days. In parallel, the Director of Comprehensive Atmospheric Management of the Undersecretary of Climate Change and Air Quality of the Ministry of the Environment of the State of Nuevo León formally denied GrafTech Mexico's previously requested modification to its operating license stating that such license was no longer valid. On September 22, 2022, GrafTech Mexico submitted observations and responses to the Record of Inspection, requested an extension of the shutdown of the facility until October 7, 2022, and requested a clarification of the scope of the shutdown. On September 23, 2022, inspectors from the State Attorney’s Office for the Secretary of Environment visited GrafTech Mexico’s manufacturing facility to verify the information presented in GrafTech Mexico’s observations and responses submitted on September 22, 2022. On October 4, 2022, the State Attorney’s Office for the Secretary of Environment granted an extension of the shutdown of the facility until October 7, 2022 and clarified the suspension permitting GrafTech Mexico to perform several activities, including extracting or withdrawing finished or unfinished product. On November 17, 2022, the State Attorney’s Office for the Secretary of Environment lifted the suspension notice, subject to the completion of certain agreed-upon activities, including the submission of an environmental impact study with respect to the facility’s operations, allowing the Monterrey facility to resume operations. Notwithstanding that the suspension notice has been conditionally lifted and that the Monterrey facility has resumed operations, GrafTech Mexico believes it is prudent to continue to pursue the related legal proceedings set forth below, particularly the amparo proceeding and the nullity proceeding.
On September 20, 2022, GrafTech Mexico filed an amparo proceeding before the First District Court for Administrative Matters of the State of Nuevo León arguing that the measure imposed by the Ministry of the Environment of the State of Nuevo León ordering a complete temporary suspension of operations violated GrafTech Mexico’s constitutional rights and requested a provisional injunction, and a definitive injunction that would last through the decision on the merits. The provisional injunction was denied by the court on September 26, 2022. On October 3, 2022, GrafTech Mexico appealed this decision before the Third Collegiate Court in Administrative Matters of the Fourth Circuit (Nuevo León), which appeal was also denied on October 24, 2022. On November 8, 2022, the judge denied the definitive injunction, and on November 23, 2022, GrafTech Mexico appealed this decision. With respect to the decision on the merits, on December 20, 2022, the judge reviewed all filings submitted during the proceeding. We expect a decision on the merits no later than June 2023, which will be subject to appeal by the parties.
Nullity Proceeding
Separately, on September 28, 2022, GrafTech Mexico filed a nullity proceeding with the Court of Administrative Justice of the State of Nuevo León requesting the court to set aside the determination of the Ministry of the Environment of the State of Nuevo León that the previously requested modification to the operating license was denied because GrafTech Mexico no longer had a valid operating license. On October 13, 2022, the court admitted the nullity proceeding and granted GrafTech Mexico’s request for a preliminary injunction effectively deeming GrafTech Mexico’s operating license valid pending the conclusion of the nullity proceeding. On October 27, 2022, the Ministry of the Environment of the State of Nuevo León challenged the court's decision granting GrafTech Mexico a preliminary injunction. GrafTech Mexico received notice of such challenge on October 28, 2022 and filed its response on November 17, 2022. On December 2, 2022, the Ministry of the Environment of the State of Nuevo León responded to GrafTech's petition, arguing that the Ministry's actions were legally permissible. GrafTech Mexico filed final pleadings on January 17, 2023. On February 27, 2023, the court upheld the injunction in favor of GrafTech Mexico. On April 25, 2023, the court issued a ruling effectively re-affirming the validity of GrafTech Mexico’s operating license and rejected the Ministry of the Environment of the State of Nuevo León’s determination that GrafTech Mexico no longer had a valid operating license. The court’s decision is subject to appeal by the Ministry of the Environment of the State of Nuevo León.
Administrative Proceeding
On November 17, 2022, the State Attorney’s Office for the Secretary of Environment issued a summons opening an administrative proceeding against GrafTech Mexico, citing the lack of an environmental impact authorization and environmental risk study with respect to the facility's operations. The summons ordered GrafTech Mexico to submit an environmental impact authorization and risk study within 30 business days. GrafTech Mexico submitted its environmental impact authorization and risk study for the full site on November 25, 2022, and filed its response to the summons on December 2, 2022. Once the State Attorney's Office for the Secretary of Environment initiates the summary argument period, GrafTech Mexico will have three business days to provide its summary arguments. A final resolution is expected to be issued within fifteen business days from submission of the summary arguments, but can be extended up to an additional three months and is subject to appeal.
Pending litigation in Brazil has been brought by employees seeking to recover additional amounts and interest thereon under certain wage increase provisions applicable in 1989 and 1990 under collective bargaining agreements to which employers in the Bahia region of Brazil were a party (including our subsidiary in Brazil). Companies in Brazil have settled claims arising out of these provisions and, in May 2015, the litigation was remanded by the Brazilian Supreme Court in favor of the employees union. After denying an interim appeal by the Bahia region employers on June 26, 2019, the Brazilian Supreme Court finally ruled in favor of the employees union on September 26, 2019. The employers union has determined not to seek annulment of such decision. Separately, on October 1, 2015, a related action was filed by current and former employees against our subsidiary in Brazil to recover amounts under such provisions, plus interest thereon, which amounts together with interest could be material to us. If the Brazilian Supreme Court proceeding above had been determined in favor of the employers union, it would also have resolved this proceeding in our favor. In the first quarter of 2017, the state court initially ruled in favor of the employees. We appealed this state court ruling, and the appellate court issued a decision in our favor on May 19, 2020. The employees have further appealed and, on December 16, 2020, the court upheld the decision in favor of GrafTech Brazil. On February 22, 2021, the employees filed a further appeal and, on April 28, 2021, the court rejected the employees' appeal in favor of GrafTech Brazil. The employees filed a further appeal and on September 12, 2022, we filed our response in opposition. We intend to vigorously defend our position. As of March 31, 2023, we are unable to assess the potential loss associated with these proceedings as the claims do not currently specify the number of employees seeking damages or the amount of damages being sought.
Mexico VAT
In July 2019, the MTA opened an audit of the VAT filings of one of the Company’s subsidiaries in Mexico for the period of January 1 to April 30, 2019. In September 2021, the MTA issued a tax assessment, claiming improper use of a certain VAT exemption rule for purchases from a foreign affiliate. The Company filed an administrative appeal against the tax assessment with the MTA’s appeals office. In November 2022, the MTA’s appeals office concluded its review and confirmed the tax assessment. The Company believes that the purchases from a foreign affiliate are exempt from VAT back-up withholding and in December 2022, the Company filed a Claim for Nullity with the Chamber Specialized in exclusive resolution of substance of the Federal Court of Administrative Justice. As of March 31, 2023, the tax assessment for the four month period under audit amounted to approximately $25.0 million, including penalties, inflation and interest. Interest will continue to accrue up to five years and inflation will continue to accrue with the passage of time.
After the filing of the Claim for Nullity, in January 2023, the MTA opened another audit of the VAT filings of the same subsidiary in Mexico for the period January 1 to December 31, 2018. The MTA is alleging the same improper use of certain VAT exemption rules on purchases from a foreign affiliate and has provided notice of its intent to assess approximately $51.0 million, including penalties, inflation and interest. In Mexico, each tax assessment requires a separate claim. In the first quarter of 2023, the Company initiated a mediation process with the MTA to avoid the assessment being issued by the MTA. If the mediation process does not result in a satisfactory outcome, the Company intends to pursue administrative appeal procedures with the MTA to attempt to satisfactorily resolve this matter. The $51.0 million includes interest and inflation, which will continue to accrue with the passage of time.
Item 1A. Risk Factors
There have been no material changes to the Risk Factors disclosed in Part 1 - Item 1A., “Risk Factors,” in our Annual Report on Form 10-K filed on February 14, 2023. You should not interpret the disclosure of any risk factor to imply that the risk has not already materialized.
The following financial information from GrafTech International Ltd.'s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2023 formatted in Inline XBRL (Extensible Business Reporting Language) includes: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income, (iii) the Condensed Consolidated Statements of Cash Flows, (iv) the Consolidated Statements of Stockholders' Equity, and (v) Notes to the Condensed Consolidated Financial Statements.
104
Cover Page Interactive Data file (formatted as Inline XBRL and contained in Exhibit 101).
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
GRAFTECH INTERNATIONAL LTD.
Date:
April 28, 2023
By:
/s/ Timothy K. Flanagan
Timothy K. Flanagan
Chief Financial Officer, Vice President Finance and Treasurer (Principal Financial and Accounting Officer)
