GrafTech International Ltd.  (NYSE:EAF)

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Q4 2018 Earnings Conference Call
Feb. 08, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Lisa, and I'll be your conference operator today. At this time, I would like to welcome everyone to the GrafTech Full Year and Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions) Thank you.

Meredith Bandy, Vice President of Investor Relations, you may begin your conference.

Meredith Bandy -- Vice President, Investor Relations and Corporate Communications

Hi. Thank you, Lisa. Good morning and welcome to GrafTech's fourth quarter conference call. On the call with me today is Chief Executive Officer, David Rintoul; and Chief Financial Officer, Quinn Coburn.

Turning to our first slide. As a reminder, some of the matters discussed on this call may include forward-looking statements regarding, among other things, results, performance, and strategies. These statements are based on current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from those indicated by forward-looking statements are shown here.

We will also discuss certain non-GAAP financial measures for which you will find reconciliations in these slides. The slides are posted on our website at graftech.com in the Investor Relations section. For your reference, a replay of the call will also be available on the website.

With that, I'm pleased to turn the call over to Dave.

David J. Rintoul -- President and Chief Executive Officer

Thank you, Meredith, and good morning, everyone. I will begin the call with a discussion of our safety performance and 2018 highlights, Quinn Coburn will then cover the financial aspects of our business, I will then conclude our prepared remarks with a discussion on the overall and steel market, after which we will open the call for questions.

Without exception, a safe plant is an efficient plant. We finished 2018 with a total injury rate of 1.49 near GrafTech's all-time lows. We recognize that our focus must remain on continuous improvement of our safety performance to drive toward our ultimate goal of zero injuries. That means every worker going home safely every day. I would like to take this opportunity to thank our team for their focus on our safety mission while attaining excellent 2018 financial results.

Turning over to slide three for an update of our 2018 results and the current business environment. GrafTech delivered record operational and financial results in 2018. Our operations ran at extremely high levels throughout the year, producing 179,000 tonnes of graphite electrodes and 111,000 tonnes of needle coke.

In 2018, GrafTech earned net income of $854 million, adjusted EBITDA from continuing operations of $1.2 billion, and generated free cash flow of $768 million. We also delivered on our promise to return cash to shareholders introducing a quarterly dividend, buying back $225 million of shares, and paying a $204 million special dividend at year-end.

Market fundamentals for our business remain solid. Our Q4 weighted average price was approximately $9,950 per metric ton. During the fourth quarter, we sold spot business at prices that averaged approximately $15,000 per metric ton. Currently, we're seeing spot and short-term contract prices of approximately $12,000 per metric ton. While off recent highs, the market for graphite electrodes remained strong.

At the same time steel market fundamentals remained positive. Demand for high-quality, ultra-high power electrodes, GrafTech's primary product, remained solid. Our debottlenecking projects are now complete with the ramp up well under way. We increased our annual production capacity to about 200,000 tonnes. The total capital cost of this debottlenecking was just over $40 million or $1,200 per tonnes of annual capacity, which represents about 10% of the cost of a greenfield replacement. As we ramp up, we would expect the utilization rate in the mid-90% range. I want to take this opportunity to congratulate and thank all of the employees involved in these projects for delivering them on time and on budget.

The finishing operations of our St. Marys plants are currently operating at varying levels to support overall flexibility of our manufacturing footprint. We will ramp up production at St. Marys if required by the market at any point in the future. St. Marys can be thought of as essentially the equivalent of a peaking plant, and we will operate in that fashion.

GrafTech is substantially vertically integrated into petroleum needle coke with our wholly owned subsidiary or our subsidiary Seadrift facility. The unique competitive position differentiates us from our competitors and gives us a secure low-cost, high-quality supply of petroleum needle coke. Including production from our previously announced efficiency improvement project, Seadrift's 2019 production will increase to approximately 125,000 metric tons. Seadrift will produce about 70% of our long-run needle coke requirements. We purchase the remaining 30% from suppliers.

This vertical integration aligns with our commercial strategy to sell graphite electrodes on long-term contracts. These contracts provide strong earnings visibility and reduce our exposure to graphite electrode spot price fluctuations.

At this point I'll turn it over to Quinn on slide four for a financial and results update.

Quinn J. Coburn -- Vice President and Chief Financial Officer

Okay. Thanks, Dave. As Dave mentioned, we're pleased to report another strong quarter of financial performance. Fourth quarter revenues of $533 million were more than double the prior year quarter, reflecting higher sales volumes and higher pricing. During the quarter we sold 53,000 tonnes of graphite electrodes, up from the prior year period, due to inventory changes and benefits from our debottlenecking. Historically Q4 tends to be our highest volume quarter, while Q1 tends to be our lightest. Therefore, we would expect Q1 sales volumes to be sequentially lower due to typical seasonality.

As Dave mentioned, GrafTech's fourth quarter average realized price was $9,950 per metric ton. As a reminder, the average realized price reflects a combination of long-term contract pricing, carryover short-term contracts from last year, and spot volumes. Approximately, 68% (ph) of our fourth quarter net sales were to customers with long-term agreements.

Now turning to slide five. Our higher revenues translated into higher earnings and cash flows in the quarter. Fourth quarter net income totaled $230 million, or $0.79 per diluted share, more than four times the prior year period results. During the fourth quarter 2018, net cash provided by operating activities increased to $224 million and free cash flow increased to $204 million. That's the third consecutive quarter with free cash flow in excess of $200 million.

Compared to the prior, year earnings, adjusted EBITDA from continuing operations, and free cash flow, all benefited from higher sales volumes and pricing. This more than offset higher raw materials cost specifically related to third-party needle coke cost. These higher third-party needle coke costs will continue to impact our cost of goods sold. We estimate that increased third-party needle coke costs will impact our Q1 2019 EBITDA by approximately $13 million compared to Q4 2018.

Now turning to slide six. I'll quickly walk you through 2018 adjusted EBITDA from continuing operations. We began with $854 million of net income, add back $66 million of depreciation and amortization, add back $133 million of net interest expense, and $135 million related to income taxes and the previously disclosed tax receivable agreement with our majority shareholder. Finally, we add back other adjustments of $16 million, the largest of which was $5 million of IPO-related expenses, $5 million of non-cash fixed asset write-offs, and about $4 million of pension expenses.

As a reminder, at the time of our IPO, GrafTech entered into a Tax Receivable Agreement, or a TRA, with our majority shareholder Brookfield. Under the TRA, Brookfield will receive 85% of the benefit of certain pre-IPO tax assets, while GrafTech will retain 15% of that benefit. At the time of the IPO, these tax assets were valued at zero on our balance sheet with no value recognized for the TRA liability. Due to the improved profitability and business conditions, we were able to record positive asset values for these tax assets during 2018. This triggered a corresponding liability for the TRA. These two items are directly related and largely offset. Looking ahead to 2019, depreciation and interest expense should be similar to 2018, and our all-in tax rate is expected to be in the mid-to-high teens.

Now turning to slide seven for a review of GrafTech's financial policy. We ended Q4 with total liquidity of nearly $300 million, including cash and equivalents of $50 million. In 2018 our capital expenditures were $68 million, in line with previous guidance and that represents just over 8% of our operating cash flow.

Now turning to page eight for more detail on our shareholder returns. In 2018 GrafTech returned a significant portion of our free cash flow to shareholders. Capital allocation since our April 2018 IPO included $56 million in debt repayment representing required amortization of our term loan; $69 million in regular quarterly dividends. These are designed to be sustainable over the cycle and in line with the typical market yield; a $225 million share repurchase. This was designed to be accretive to all shareholders while managing overhang risk and preserving liquidity in our shares; and finally a $203 million special dividend, an efficient way to return cash to shareholders while preserving liquidity in our shares. This represents approximately 84% of free cash flow returned to shareholders since our IPO.

Moving forward, we will continue to focus on returning cash to shareholders, but we'll also increase our debt repayments. Yesterday our board approved a first quarter 2019 debt repayment of approximately $100 million in addition to the required repayment of $28 million. We plan to make further quarterly debt repayments in 2019. We have significant visibility to our future free cash flows which allow us to continue to manage our debt levels prudently.

Now turning to slide number nine. GrafTech has continued to sign additional long-term contracts with strategic customers that value a secure supply. As a result of this recent effort, GrafTech has added an aggregate amount of approximately 40,000 metric tons for 2019 through 2023. We've updated our disclosure in the chart on the right-hand side of slide number nine. We have over 70% of our 2019 production capacity sold under long-term take-or-pay contracts at pricing averaging above $9,800 per metric ton.

Now I'll turn it back to Dave.

David J. Rintoul -- President and Chief Executive Officer

Thanks, Quinn. Graphite electrodes are vital to our customers' operations and the EAF steel-making trends remain positive. Demand for steel remained strong in our key markets. Capacity utilization in steel plants is high, and steel-consuming end markets are growing in our key markets.

Global steel production growth also remains robust, particularly outside of China, where EAFs have picked up the slack from falling Chinese exports. Chinese steel exports remain subdued as China reduces blast furnace steel-making and EAFs continue to take share, particularly in China, due to the more resilient and environmentally friendly EAF steel-making business model.

In summary, GrafTech is a leading provider of highly engineered graphite electrode services, solutions, and products to the growing electric arc furnace steel market. We delivered strong 2018 results, and we continue to execute our strategy to deliver long-term sustainable value. Ongoing operational improvements and vertical integration give GrafTech economies a scale and a competitive cost structure. This in turn enables us to offer secure, long-term contracts to our customers and strong earnings visibilities.

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

Questions and Answers:

Operator

Thank you. (Operator Instructions) And our first question comes from the line of David Gagliano from BMO Capital Markets. Your line is open.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Okay, great. Thanks for taking my questions and thank you for the increased visibility on the current markets. Very helpful. In terms of my questions, first of all I didn't get -- 2019 expected CapEx, I didn't quite pick up that number.

Quinn J. Coburn -- Vice President and Chief Financial Officer

Yes. Sure, Dave. We would expect 2019 CapEx to be roughly the same as 2018.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Okay, great. And then in terms of the contract signings, the 40,000 signed from '19 to 2023, I haven't had a chance to try and tease out the average price versus comparing the old tonnage versus new. So can you just tell us what was the average price for that 40,000 metric ton signed during the quarter?

Quinn J. Coburn -- Vice President and Chief Financial Officer

Yes. Sure, Dave. I mean for competitive reasons we're not giving the exact price, but we did update that table. They were attractive prices. They were definitely higher than the current LTAs. And like we said, we've updated the table to try to give you the current view and I'm sure you can kind of back into an approximation of that. We were very -- the bottom line is we were very pleased with the outcome of that initiative and those were good attractive prices.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Okay. No worries. I'll (inaudible). And then just real quick. Last two quarters we did get a special dividend and a buyback after earnings. One quarter was buyback; one quarter was special, whatever. This quarter looks like free cash flow was even higher. Any reason we should not expect another special and/or buyback this quarter?

Quinn J. Coburn -- Vice President and Chief Financial Officer

Yeah. So, as we mentioned, we will absolutely continue to focus on cash returns to the shareholders. But this quarter we are initiating increased debt repayment, so the additional $100 million on top of the $28 million required repayment. And then, of course, we have the normal quarterly dividend that we paid. And going forward, like I said, we'll continue to have a mix of both. We would continue to expect future debt repayments probably roughly in the same amount in future quarters as this quarter.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Okay. That's helpful. Thanks.

Operator

Our next question comes from the line of Arun Viswanathan from RBC Capital Markets. Your line is open.

Arun Viswanathan -- RBC Capital Markets LLC -- Analyst

Hey, guys. Good morning.

David J. Rintoul -- President and Chief Executive Officer

Good morning.

Quinn J. Coburn -- Vice President and Chief Financial Officer

Good morning.

Arun Viswanathan -- RBC Capital Markets LLC -- Analyst

Just wanted to get a little bit more understanding on both the long-term contracts as well as the spot market price development. What do you think is driving the reduction in the spot price to that $12,000 level or the near-term contracts? And I guess are you still seeing good acceptance of your longer-term contracts? I know you've signed up the 40,000 tonnes, but do you sense a willingness among customers to accept that say $10,000 average price because the sense is that spot prices will remain well above that. I'm just asking because we have seen this decline in the last couple months. Thanks.

David J. Rintoul -- President and Chief Executive Officer

Well, look, in regards to the spot market, I think it's important to always recognize that 70% of our product is in the long-term contract business. A smaller portion of what we do is actually in the spot market. And we think that's a good strategy. In terms of commenting, I think all markets ebb and flow based upon where particular supply and demand dynamics might be. We're on this call this morning recognizing what we're aware of at this point in time. It's not for us to try and predict where that might go into the future. Obviously as on our side of the financial equation, we would hope that the things will remain prosperous (ph). That's no big surprise.

Then regarding the LTAs, we have a nice match that we've tried to maintain in terms of our vertical integration and we're happy with the outcome of where the LTAs have taken us with a slight increase that matches our increase in needle coke capacity. And every customer has to judge for themselves at any point in time whether that arrangement makes sense for them. But again to reiterate, we're pleased with where we have ended up on that front because it matches up nicely with our vertical integration.

Arun Viswanathan -- RBC Capital Markets LLC -- Analyst

Great, thanks. And I also wanted to understand a little bit more on your comments around new capacity. I guess you noted that the debottlenecking costed you about $1,200 a tonne. That's 10% of actual kind of greenfield addition, so maybe in that $10,000 to $12,000 per tonne range. I guess, A, Is that range right for greenfield? And then maybe you can just comment and just give us a little bit more detail on your thinking around St. Marys. I guess we have seen some other additions coming to market, including your debottlenecking and then the SDK Ridgeville (ph) addition as well as Sangraf. So how are you thinking about the supply demand and as well as replacement cost? And when would it make sense to potentially restart the idle St. Marys plant? Thanks.

Quinn J. Coburn -- Vice President and Chief Financial Officer

So on the greenfield, Arun, yeah, we think $10,000 per metric ton is about the right number. The last two big greenfield/brownfield expansions that were done by SDK and SGL were approximately -- actually a little bit more than $10,000 per tonne. So we see that as the right number.

David J. Rintoul -- President and Chief Executive Officer

On the St. Marys question, we've tried to use a bit on an analogy in the script to assist your thinking on that front that of a peaking plant. We will use St. Marys to allow us flexibility and variability. We expect the degree to which we run that will move up and down based upon the market dynamics, not unlike that of, again, the analogy of a peaking plant.

Arun Viswanathan -- RBC Capital Markets LLC -- Analyst

Great, thanks. And if I may ask one more just on needle coke. It appears that there's still some constraints there that's resulting in a relatively tight market and higher pricing there. Any developments that you would want to touch upon there? Do you see any additions coming in needle coke on the petroleum side that would add capacity there and potentially loosen things up? Or do you see a continued tight market on needle coke? And if so, are there any other options to increase your vertical integration or at least secure more needle coke at attractive prices? Or how should we think about needle coke going forward?

David J. Rintoul -- President and Chief Executive Officer

Well, look, we're pretty comfortable with our strategic position on needle coke where we can with the changes we're -- and improvements we're going to make in 2019 where we can produce 70% of our needle coke needs that matches even at the middle debottlenecking, higher debottlenecking rate on our graphite electrodes side. Relative to increases in the marketplace what I can tell you is -- I can only tell you what we know and that is we have secured the needle coke that we need for 2019 and comfortable with that from a supply and reliability perspective. Beyond that others would have to -- in the business would have to comment on whether they're bringing on more capacity or not. We're not aware of anything beyond what's in the public media at this point.

Arun Viswanathan -- RBC Capital Markets LLC -- Analyst

Okay. Thanks, guys.

Operator

Our next question comes from the line of Michael Gambardella from J.P. Morgan. Your line is open.

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

Yes, good morning. Just wanted to ask about the ...

Quinn J. Coburn -- Vice President and Chief Financial Officer

Good morning.

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

... incremental 40,000 tonnes that you put on long-term contracts. I just wanted to be clear if all of that is being sourced with your captive needle coke?

Quinn J. Coburn -- Vice President and Chief Financial Officer

So, Mike, the majority I would say would be sourced with captive needle coke, yes, because we were able to increase -- as we mentioned in the script, we were able to increase the Seadrift needle coke production from 111,000 tonne this year to 125,000 tonne, and part of that -- a good portion of that increase was due to a little bit of debottlenecking at Seadrift. And so that matched up nicely then with the increase in the long-term contracts.

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

But (inaudible) some of the long-term contracts are kind of exposed on the needle coke side now?

Quinn J. Coburn -- Vice President and Chief Financial Officer

Sorry, could you repeat the question, Mike. You were breaking up a bit there?

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

Yeah. I just -- in the past you said you would match your long-term contract volumes with what you could supply with captive petroleum needle coke? And is that not the case anymore?

Quinn J. Coburn -- Vice President and Chief Financial Officer

No, that's correct. You see the tonnes we report are a little bit higher than the Seadrift production. We did use a little bit of regular coke in there to supply the LTAs. And then there's just maybe a little bit of more LTAs than there is captive just a little bit, but largely speaking it matches up.

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

And then -- OK, could you comment -- in the past you've commented on your merchant petroleum needle coke general pricing? And how much needle coke do you have for 2019 captive and merchant? What kind of production numbers of electrodes would that allow you to produce in '19?

Quinn J. Coburn -- Vice President and Chief Financial Officer

Yeah. So again you were breaking up a little bit, but let me -- I think I got the question right. So I'll just repeat the question. I believe you asked how much needle coke do we have between our captive needle coke and what we've procured, and how much would that allow us to produce in 2019. So a couple of things. We mentioned that our capacity is now around 200,000 tonnes. We would expect to run that capacity in the mid-90% range. And Dave mentioned that we have procured adequate needle coke for that level of production for 2019.

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

And the procurement needle coke pricing, you mentioned that...

Quinn J. Coburn -- Vice President and Chief Financial Officer

Right. Good question. We have given that in the past. For competitive reasons, we're choosing not to do that going forward, but I did try to quantify for you the impact on our cost of goods sold quarter-over-quarter of what that increased pricing will do. Keep in mind that the price of needle coke has been increasing quarter-over-quarter for over 1.5 year now. There's about a three- to six-month lag from the time of the increase to when it rolls through cost of goods sold. So we'll continue to see cost of goods sold being impacted for a few quarters here. But, yeah, so we've tried to give you a guidance on that, but for competitive reasons we've backed away from giving the exact price.

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

So the $13 million impact in the first quarter, we should not assume that's equal over the four quarters of the year?

Quinn J. Coburn -- Vice President and Chief Financial Officer

I think you'll see it increase a little bit more Q2 versus Q1 and then it will depend -- we'll give additional insight after that.

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

Okay. All right, thanks a lot.

Quinn J. Coburn -- Vice President and Chief Financial Officer

You bet.

Operator

Our final question today will come from the line of David Gagliano from BMO Capital Markets. Your line is open.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

All right, great. I just have three quick followups hopefully. Just first of all, near term any -- should we be expecting any sales from inventories in the first quarter like we saw in the fourth quarter?

Quinn J. Coburn -- Vice President and Chief Financial Officer

Yeah. No, I wouldn't expect that, David. And as I mentioned on the call, typically Q1 is our -- if you go back and look over the past 10 years, Q4 is about 27% of our total year. Q1 tends to be about 23% of our total year. There's no absolute reason for that. It's just the typical buying patterns of our customers. And so we would expect to see that typical seasonality. Like I said Q4 we had nice demand. We did draw down on inventories. We would not expect to draw down on inventories in Q1.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Okay. That's helpful. Thank you. And then just a couple bigger picture questions. First of all, there had been some talk of graphite electrodes in India kind of looking for a home, excessive inventories that kind of thing. Is that at all affecting your business or have you seen that anywhere here in North America?

David J. Rintoul -- President and Chief Executive Officer

So certainly there is a number of producers in the world that bring electrodes to the market and the Indians are among those. We're seeing a little bit of their presence beyond say Q4. Some of the impacts of that we think are related to sanctions issues and tariff issues. Sanction issues are in the Middle East areas as well as tariff issues within India is our belief. But we do think the net-net of all of that is a temporary dislocation that will work itself out in the coming quarters because we think it's close to a net zero gain. So, yeah, there is some momentary we think near-term dislocation but I believe that it will settle out over the longer-term because the places they left will be supplied by somebody.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Okay. Just within that context, we're into February now. So the prepared remarks commentary on spot market prices are holding around $12,000 I think was the comment. And that is still the case even with this inventory challenge? Is that correct?

David J. Rintoul -- President and Chief Executive Officer

That's the pricing that we transacted at in the recent weeks, if you will. To Quinn's earlier point, we're going to be very careful not be speculative or try and predict where the future is going. So we're communicating on the best information we have on that with the limited amount of spot that we in fact put into the marketplace.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Okay. That's helpful. Thank you. And then just last question I think for me. Just wanted to get your thoughts, over the last six months obviously there's been quite a bit of mini mills still making greefield expansion announcements in the US. On our numbers it adds up to over 20% growth in mini mill deal making over the next few years in the US. When would you expect to start to see some of that potential benefit in your business? And have you had any very early discussions with anybody regarding that longer-term opportunity?

David J. Rintoul -- President and Chief Executive Officer

Well, look, the folks that initiated or announced those expansions which is all good for us and our industry, particularly SDI and Nucor, have a track record of bringing these assets online pretty expeditiously. I believe I read something in this past week out of SDI they were talking we've done this before in 18 to 24 months. We don't see any reason why we wouldn't do that kind of thing again. And they have a track record of that. So if they strike an arc in 18 to 24 months, they would need electrodes to do so. And in some cases we have had discussions about supplying them. I shouldn't leave off my friends at Bluescope because they've got some plans as well. So, look, all of those are good for us. And as I said, in some cases (technical difficulty) they would have for those new plants.

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Okay, great. That's helpful. Thank you very much.

Operator

I will now turn the call back to Mr. Rintoul for closing remarks.

David J. Rintoul -- President and Chief Executive Officer

Thank you, Lisa. In conclusion, GrafTech is well positioned to leverage our unique competitive position and execute our strategy in a structurally improved industry. We will continue to maximize the value of our vertical integration and low-cost production base to provide industry-leading services, solutions, and products to our customers. Thank you for your interest in GrafTech, and we look forward to speaking with you next quarter. Have a good day.

Operator

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

Duration: 36 minutes

Call participants:

Meredith Bandy -- Vice President, Investor Relations and Corporate Communications

David J. Rintoul -- President and Chief Executive Officer

Quinn J. Coburn -- Vice President and Chief Financial Officer

David Gagliano -- BMO Capital Markets Ltd. -- Analyst

Arun Viswanathan -- RBC Capital Markets LLC -- Analyst

Michael Gambardella -- JP Morgan Securities LLC -- Analyst

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