GRAFTECH INTERNATIONAL: Discussion and analysis by management of the financial situation and the results of operations (form 10-Q)
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The CompanyGrafTech is a leading manufacturer of graphite electrodes, the critical consumable for the electric arc furnace industry. We are the only graphite electrode producer that is substantially vertically integrated into petroleum needle coke, a key raw material for graphite electrodes. Vertical integration has allowed us to adopt a commercial strategy with long-term, fixed price, fixed volume, take-or-pay contracts ("LTAs") providing earnings stability and visibility. These contracts define volumes and prices, along with price-escalation mechanisms for inflation, and include significant termination payments (typically, 50% to 70% of remaining contracted revenue) and, in certain cases, parent guarantees and collateral arrangements to manage our customer credit risk. The environmental and economic advantages of electric arc furnace steel production positions both that industry and the graphite electrode industry for continued long-term growth. We believeGrafTech's leadership position, strong cash flows, and advantaged low cost structure and vertical integration are sustainable competitive advantages. The services and solutions we provide will position our customers and us for a better future. Commercial Update and OutlookGrafTech reported strong sales volumes of 43 thousand metric tons ("MT") in the second quarter of 2021, consisting of LTA volumes of 27 thousand MT, at an average approximate price of$9,500 per MT, and non-LTA volumes of 16 thousand MT, at an average approximate price of$4,100 per MT. Sales volumes increased 16% and 39% compared to the first quarter of 2021 and second quarter of 2020, respectively. As previously reported, spot prices negotiated during the first quarter of 2021 reached a recent low and have steadily improved since that time. Accordingly, non-LTA prices for our graphite electrodes to be delivered and realized in income in the second half of 2021 are improving. We expect this improvement in non-LTA pricing to continue into 2022. In the third quarter of 2021, we expect realized prices for non-LTA volumes to be up approximately 10%-12% compared to the second quarter. Production volume of 44 thousand MT in the second quarter of 2021 represented an increase of 22% and 33% compared to the first quarter of 2021 and the second quarter of 2020, respectively. The estimated shipments of graphite electrodes for the final two years of the initial term under our LTAs and for the years 2023 through 2024 remain unchanged from our prior estimate as follows: 2021 2022 2023 through 2024 Estimated LTA volume (thousands of 98-108 95-105 35-45 metric tons) Estimated LTA revenue (in millions)$925-$1,025 $910-$1,010 $350-$450 (1) (1) Includes expected termination fees from a few customers that have failed to meet certain obligations under their LTAs Global steel market capacity utilization rates have continued to improve sequentially: Q2 2021 Q1 2021 Q2 2020 Global steel market (ex-China ) capacity utilization rates (1) 75% 73% 56% U.S. steel market capacity utilization rates (2) 80% 77% 56% 1 Source:World Steel Association and Metal Expert 2 Source:American Iron and Steel Institute Capital Structure and Capital Allocation As ofJune 30, 2021 ,GrafTech had cash and cash equivalents of$114 million and total debt of approximately$1.2 billion . We continue to make progress in reducing our long-term debt, repaying$50 million in the second quarter, for a total 25 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
debt repayment of
Our full year 2021 capital expenditure range expectations are unchanged, between$55 and$65 million . Key metrics used by management to measure performance In addition to measures of financial performance presented in our Consolidated Financial Statements in accordance with GAAP, we use certain other financial measures and operating metrics to analyze the performance of our company. The "non-GAAP" financial measures consist of EBITDA, adjusted EBITDA, adjusted net income and adjusted EPS. which help us evaluate growth trends, establish budgets, assess operational efficiencies and evaluate our overall financial performance. The key operating metrics consist of sales volume, production volume, production capacity and capacity utilization. Key financial measures For the Three Months Ended For the Six Months June 30, Ended June 30, (in thousands), except per share data 2021 2020 2021 2020 Net sales$ 330,750 $ 280,718 $ 635,147 $ 599,364 Net income$ 28,165 $ 92,776 $ 126,964 $ 215,044 Earnings per share(1)$ 0.11 $ 0.35 $ 0.47 $ 0.80 EBITDA(2)$ 68,017 $ 147,645 $ 221,742 $ 332,674 Adjusted net income(2)$ 114,487 $ 96,005 $ 214,367 $ 212,235 Adjusted earnings per share(1)(2)$ 0.43 $ 0.36 $ 0.80 $ 0.79 Adjusted EBITDA (2)$ 159,903 $ 151,125 $ 314,948 $ 330,303 (1) Earnings per share represents diluted earnings per share. Adjusted earnings per share represents adjusted diluted earnings per share. (2) Non-GAAP financial measures; see below for information and reconciliations of EBITDA, adjusted EBITDA, adjusted net income, and adjusted EPS to net income, the most directly comparable financial measure calculated and presented in accordance with GAAP. Key operating metrics For the Three Months Ended For the Six Months June 30, Ended June 30, (in thousands, except utilization) 2021 2020 2021 2020 Sales volume (MT)(1) 43 31 80 65 Production volume (MT)(2) 44 33 80 66 Production capacity excluding St. Marys (MT)(3)(4) 51 51 102 102 Capacity utilization excluding St. Marys (3)(5) 86 % 65 % 78 % 65 % Total production capacity (MT)(4)(6) 58 58 116 116 Total capacity utilization(5)(6) 76 % 57 % 69 % 57 % (1) Sales volume reflects only graphite electrodes manufactured byGrafTech . (2) Production volume reflects graphite electrodes we produced during the period. (3) In the first quarter of 2018, ourSt. Marys facility began graphitizing a limited amount of electrodes sourced from ourMonterrey, Mexico facility. (4) Production capacity reflects expected maximum production volume during the period under normal operating conditions, standard product mix and expected maintenance outage. Actual production may vary. (5) Capacity utilization reflects production volume as a percentage of production capacity. (6) Includes graphite electrode facilities in Calais,France ;Monterrey, Mexico ;Pamplona ,Spain andSt. Marys, Pennsylvania . 26 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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 income, and adjusted EPS are nonÂGAAP financial measures. We define EBITDA, a nonÂGAAP financial measure, as net income or loss plus interest expense, minus interest income, plus income taxes, and depreciation and amortization. We define adjusted EBITDA as EBITDA adjusted for any pension and other post employment benefit ("OPEB") plan expenses or gains, initial and follow-on public offering and related expenses, nonÂcash gains or losses from foreign currency remeasurement of nonÂoperating assets and liabilities in our foreign subsidiaries where the functional currency is theU.S. dollar, related party Tax Receivable Agreement (as defined below) adjustments, stock-based compensation, nonÂcash fixed asset writeÂoffs and 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. 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 periodÂtoÂperiod 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 debtÂservice 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 relating to our pension and OPEB plans; •adjusted EBITDA does not reflect the nonÂcash gains or losses from foreign currency remeasurement of nonÂoperating assets and liabilities in our foreign subsidiaries where the functional currency is theU.S. dollar; •adjusted EBITDA does not reflect initial and follow-on public offering and related expenses; •adjusted EBITDA does not reflect related party Tax Receivable Agreement adjustments; •adjusted EBITDA does not reflect stock-based compensation or the nonÂcash writeÂoff of fixed assets; •adjusted EBITDA does not reflect the Change in Control charges; 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 income, a nonÂGAAP financial measure, as net income or loss and excluding the items used to calculate adjusted EBITDA, less the tax effect of those adjustments. We define adjusted EPS, a nonÂGAAP financial measure, as adjusted net income divided by the weighted average of diluted common shares outstanding during the period. We believe adjusted net income and adjusted EPS are useful to present to investors because we believe that they assist investors' understanding of the underlying operational profitability of the Company. In evaluating EBITDA, adjusted EBITDA, adjusted net income, adjusted EPS, you should be aware that in the future, we will incur expenses similar to the adjustments in the reconciliation below, other than change in control charges. Our presentations of EBITDA, adjusted EBITDA, adjusted net income and adjusted EPS should not be construed as suggesting that our future results will be unaffected by these expenses or any unusual or nonÂrecurring items. When evaluating our performance, you should consider EBITDA, adjusted EBITDA, adjusted net income, and adjusted EPS alongside other financial performance measures, including our net income, EPS and other GAAP measures. 27 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES The following tables reconcile our non-GAAP key financial measures to the most directly comparable GAAP measures: Reconciliation of Net Income to Adjusted Net Income For the Three Months Ended For the Six Months June 30, Ended June 30, 2021 2020 2021 2020 (in thousands,
except per share data)
Net income$ 28,165 $ 92,776 $ 126,964 $ 215,044 Adjustments, pre-tax: Pension and OPEB plan expenses (1) 430 541 861 1,083 Initial and follow-on public offering and related expenses (2) 241 - 663 4 Non-cash loss (gain) on foreign currency remeasurement (3) 2,255 2,222 1,907 (1,239) Stock-based compensation (4) 550 717 1,318 1,127 Non-cash fixed asset write-off (5) 313 - 313 - Related party Tax Receivable Agreement adjustment (6) - - 47 (3,346) Change in Control LTIP award (7) 73,384 - 73,384 - Change in control stock-based compensation acceleration (7) 14,713 - 14,713 - Total non-GAAP adjustments pre-tax 91,886 3,480 93,206 (2,371) Income tax impact on non-GAAP adjustments 5,564 251 5,803 438 Adjusted net income$ 114,487 $ 96,005
(1)Service and interest cost of our OPEB plans. Also includes a mark-to-market loss (gain) for plan assets as of December of each year. (2)Legal, accounting, printing and registration fees associated with the initial and follow-on public offering and related expenses. (3)Non-cash gains and losses from foreign currency remeasurement of non-operating assets and liabilities of our non-U.S. subsidiaries where the functional currency is theU.S. dollar. (4)Non-cash expense for stock-based compensation grants. (5)Non-cash write-off of fixed assets. (6)Non-cash expense adjustment for future payment to our sole pre-IPO stockholder for tax assets that are expected to be utilized. (7)In the second quarter of 2021, we incurred change in control charges as a result of the ownership of our largest stockholder, Brookfield, moving below 30% of our shares outstanding. 28 -------------------------------------------------------------------------------- PART I (CONT'D)GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Reconciliation of EPS to Adjusted EPS
For the Three Months For the Six Months Ended
Ended June 30, June 30,
2021 2020 2021 2020
EPS $ 0.11 $ 0.35 $ 0.47 $ 0.80
Adjustments per share:
Pension and OPEB plan expenses (1) - - - -
Initial and follow-on public offering and related
expenses (2) - - - -
Non-cash gains and losses on foreign currency
remeasurement (3) 0.01 0.01 0.01 -
Stock-based compensation (4) - - 0.01 -
Non-cash fixed asset write-off (5) - - - -
Related party Tax Receivable Agreement adjustment
(6) - - - (0.01)
Change in control LTIP award (7) 0.27 - 0.27 -
Change in control stock-based compensation
acceleration (7) 0.06 - 0.06 -
Total non-GAAP adjustments pre-tax per share 0.34 0.01 0.35 (0.01)
Income tax impact on non-GAAP adjustments per
share 0.02 - 0.02 -
Adjusted EPS $ 0.43 $ 0.36 $ 0.80 $ 0.79
(1)Service and interest cost of our OPEB plans. Also includes a mark-to-market
loss (gain) for plan assets as of December of each year.
(2)Legal, accounting, printing and registration fees associated with the initial
and follow-on public offering and related expenses.
(3)Non-cash gains and 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.
(4)Non-cash expense for stock-based compensation grants.
(5)Non-cash fixed asset write-off recorded for obsolete assets.
(6)Non-cash expense adjustment for future payment to our sole pre-IPO
stockholder for tax assets that are expected to be utilized.
(7)In the second quarter of 2021, we incurred Change in Control charges as a
result of the ownership of our largest shareholder, Brookfield, moving below 30%
of our total shares outstanding.
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PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
For the Three Months Ended For the Six Months
June 30, Ended June 30,
2021 2020 2021 2020
(in thousands)
Net income $ 28,165 $ 92,776 $ 126,964 $ 215,044
Add:
Depreciation and amortization 16,292 14,549 32,831 28,833
Interest expense 15,994 20,880 38,161 46,552
Interest income (199) (348) (236) (1,489)
Income taxes 7,765 19,788 24,022 43,734
EBITDA 68,017 147,645 221,742 332,674
Adjustments:
Pension and OPEB plan expenses (1) 430 541 861 1,083
Initial and follow-on public offering and related
expenses (2) 241 - 663 4
Non-cash loss (gain) on foreign currency
remeasurement (3) 2,255 2,222 1,907 (1,239)
Stock-based compensation (4) 550 717 1,318 1,127
Non-cash fixed asset write-off (5) 313 - 313 -
Related party Tax Receivable Agreement adjustment
(6) - - 47 (3,346)
Change in Control LTIP award (7) 73,384 - 73,384 -
Change in control stock-based compensation
acceleration (7) 14,713 - 14,713 -
Adjusted EBITDA $ 159,903 $ 151,125 $ 314,948 $ 330,303
(1)Service and interest cost of our OPEB plans. Also includes a mark-to-market
loss (gain) for plan assets as of December of each year.
(2)Legal, accounting, printing and registration fees associated with the initial
and follow-on public offering and related expenses.
(3)Non-cash gains and 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.
(4)Non-cash expense for stock-based compensation grants.
(5)Non-cash write-off of fixed assets.
(6)Non-cash expense adjustment for future payment to our sole pre-IPO
stockholder for tax assets that are expected to be utilized.
(7)In the second quarter of 2021, we incurred change in control charges as a
result of the ownership of our largest shareholder, Brookfield, moving below 30%
of our shares outstanding.
Key operating metrics
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 only graphite electrodes manufactured by GrafTech . For a
discussion of our revenue recognition policy, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations-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 under normal operating conditions, standard product mix and expected
maintenance downtime. 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 sales and consider how to approach our contract initiative.
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PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Results of Operations
The Three Months Ended June 30, 2021 Compared to the Three Months Ended June 30,
2020
The tables presented in our period-over-period comparisons summarize our
Condensed Consolidated Statements of Operations and illustrate key financial
indicators used to assess the consolidated financial results. Throughout our
Management's Discussion and Analysis ("MD&A"), insignificant changes may be
deemed not meaningful and are generally excluded from the discussion.
For the Three Months Ended June
30, Increase/
2021 2020 Decrease % Change
(Dollars in thousands)
Net sales $ 330,750 $ 280,718 $ 50,032 18 %
Cost of sales 201,867 130,600 71,267 55 %
Gross profit 128,883 150,118 (21,235) (14) %
Research and development 1,018 710 308 43 %
Selling and administrative expenses 75,783 16,001 59,782 374 %
Operating income 52,082 133,407 (81,325) (61) %
Other expense (income), net 357 311 46 15 %
Interest expense 15,994 20,880 (4,886) (23) %
Interest income (199) (348) 149 (43) %
Income before provision for income taxes 35,930 112,564 (76,634) (68) %
Provision for income taxes 7,765 19,788 (12,023) (61) %
Net income $ 28,165 $ 92,776 $ (64,611) (70) %
Net sales. Net sales increased from $280.7 million in the three months ended
June 30, 2020 to $330.8 million in the three months ended June 30, 2021 . The
second quarter of 2020 was impacted by market conditions, including COVID-19.
Stronger demand for our products in the second quarter of 2021 resulted in a 39%
increase in sales volume compared to the same period of 2020. Partially
offsetting the increased volume was a decrease in non-LTA sales prices, as the
sales prices we realized in the second quarter of 2021 were primarily negotiated
late in the fourth quarter of 2020 as well as in the first quarter of 2021. The
sales price of graphite electrodes have increased since the first quarter of
2021 and we expect this to positively impact our second half 2021 results.
Cost of sales. We experienced an increase in cost of sales from $130.6 million
in the three months ended June 30, 2020 to $201.9 million in the three months
ended June 30, 2021 , primarily due to the 39% increase in sales volume of
manufactured electrodes. Additionally, cost of sales in the second quarter of
2021 was impacted by a one-time Long-term Incentive Plan ("LTIP") charge of
$30.7 million resulting from a Change in Control after our largest stockholder's
ownership of our common stock was reduced below 30% of our outstanding common
stock.
Selling and administrative expenses. Selling and administrative expenses
increased from $16.0 million in the three months ended June 30, 2020 to
$75.8 million in the three months ended June 30, 2021 primarily due to the
aforementioned Change in Control resulting in $42.6 million of one-time LTIP
expense within selling and administrative expense. Additionally, the Change in
Control resulted in $12.9 million of one-time accelerated stock based
compensation expense.
Interest expense. Interest expense decreased from $20.9 million in the three
months ended June 30, 2020 to $16.0 million in the three months ended June 30,
2021 , primarily due to lower interest rates and lower average borrowings.
Partially offsetting these decreases was the absence of a $3.3 million benefit
in 2020 resulting from discounts on debt repurchases.
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PART I (CONT'D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Provision for income taxes. The following table summarizes the expense for
income taxes:
For the Three months ended June 30,
2021 2020
(Dollars in thousands)
Tax expense $ 7,765 $ 19,788
Pretax income 35,930 112,564
Effective tax rates 21.6 % 17.6 % The effective tax rate for the three months endedJune 30, 2021 was 21.6%. This rate differs from theU.S. statutory 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 theU.S. taxation of global intangible low taxed income ("GILTI") and Foreign Tax Credits ("FTCs"). A portion of the one-time Change in Control charges recorded in the quarter was not deductible and contributed to the increase in the effective rate. We expect the full year effective tax rate to be approximately 16% to 17%. The effective tax rate for the three months endedJune 30, 2020 was 17.6%. This rate differs from theU.S. statutory rate of 21% primarily due to worldwide earnings from various countries taxed at different rates. Tax expense decreased from$19.8 million for the three months endedJune 30, 2020 to$7.8 million for the three months endedJune 30, 2021 . This change is primarily related to a reduction in pretax income, worldwide earnings from various countries taxed at different rates and theU.S. taxation of GILTI. The Six Months EndedJune 30, 2021 Compared to the Six Months EndedJune 30, 2020 The tables presented in our period-over-period comparisons summarize our Condensed Consolidated Statements of Operations and illustrate key financial indicators used to assess the consolidated financial results. Throughout our MD&A, insignificant changes may be deemed not meaningful and are generally excluded from the discussion. For the Six Months Ended June 30, Increase/ 2021 2020 Decrease % Change (Dollars in thousands) Net sales$ 635,147 $ 599,364 $ 35,783 6 % Cost of sales 348,263 269,517 78,746 29 % Gross profit 286,884 329,847 (42,963) (13) % Research and development 1,987 1,422 565 40 % Selling and administrative expenses 95,936 30,933 65,003 210 % Operating income 188,961 297,492 (108,531) (36) % Other (income) expense 3 (3,003) 3,006 (100) % Related party Tax Receivable Agreement expense (benefit) 47 (3,346) 3,393 N/A Interest expense 38,161 46,552 (8,391) (18) % Interest income (236) (1,489) 1,253 (84) % Income before provision for income taxes 150,986 258,778 (107,792) (42) % Provision for income taxes 24,022 43,734 (19,712) (45) % Net income from continuing operations 126,964 215,044 (88,080) (41) % Net income$ 126,964 $ 215,044 $ (88,080) (41) % Net sales. Net sales increased by$35.8 million , or 6%, from$599.4 million in the six months endedJune 30, 2020 to$635.1 million in the six months endedJune 30, 2021 . Higher net sales reflect a 23% increase in sales volume driven primarily by improved customer demand. The same period of 2020 was impacted by market conditions, including COVID-19. Lower realized prices for the six months endedJune 30, 2021 partially offset the increased volume. Spot prices for graphite electrodes 32 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES declined throughout 2020 and did not begin to increase until the first quarter of 2021. We expect this increase in the price of electrodes to favorably impact our results in the second half of 2021. Cost of sales. Cost of sales increased by$78.7 million , or 29%, from$269.5 million in the six months endedJune 30, 2020 to$348.3 million in the six months endedJune 30, 2021 . This increase was primarily due to the 23% increase in sales volume of manufactured electrodes. Additionally, cost of sales for the six months endedJune 30, 2021 was impacted by a one-time LTIP charge of$30.7 million resulting from a Change in Control after our largest stockholder's ownership of our common stock was reduced below 30% of our outstanding common stock. Selling and administrative expenses. Selling and administrative expenses increased from$30.9 million in the six months endedJune 30, 2020 to$95.9 million in the six months endedJune 30, 2021 primarily due to the aforementioned Change in Control resulting in$42.6 million of one-time LTIP expense. Additionally, the Change in Control resulted in$12.9 million of one-time accelerated stock based compensation expense. Other (income) expense. Other income decreased from income of$3.0 million in the six months endedJune 30, 2020 to income of zero in the six months endedJune 30, 2021 . This change was primarily due to 2020 advantageous non-cash foreign currency impacts on non-operating assets and liabilities in the six months endedJune 30, 2020 that did not recur in the same period of 2021. Related party Tax Receivable Agreement expense (benefit). During the first quarter of 2020, the Company recorded an adjustment to our related-party payable-Tax Receivable Agreement liability resulting in a benefit of$3.3 million due to the revised profit expectation for the year 2020, primarily caused by market conditions and the COVID-19 pandemic. Interest expense. Interest expense decreased by$8.4 million from$46.6 million in the six months endedJune 30, 2020 to$38.2 million in the same period of 2021, primarily due to lower interest rates and lower average borrowings. Partially offsetting these decreases was$2.0 million of accelerated amortization of deferred financing fees and original issue discounts in the six months endedJune 30, 2021 resulting from prepayments on our term loan and the the absence of a$3.3 million benefit in 2020 resulting from discounts on debt repurchases. Provision for income taxes. The following table summarizes the expense for income taxes: For the Six Months Ended June 30, 2021 2020 (Dollars in thousands) Tax expense$ 24,022 $ 43,734 Pre-tax income 150,986 258,778 Effective tax rates 15.9 % 16.9 % The effective tax rate for the six months endedJune 30, 2021 was 15.9%. This rate differs from theU.S. statutory rate of 21% primarily due to worldwide earnings from various countries taxed at different rates, partially offset by the net combined impact related to theU.S. taxation of GILTI and FTCs. For the six months endedJune 30, 2020 , the effective tax rate of 16.9% differs from theU.S. statutory rate of 21% primarily due to worldwide earnings from various countries taxed at different rates. The tax expense decreased from$43.7 million for the six months endedJune 30, 2020 to$24.0 million for the six months endedJune 30, 2021 . This change is primarily related to the reduction in pretax income, worldwide earnings from various countries taxed at different rates and theU.S. taxation of GILTI.GrafTech has considered the tax impact of COVID-19 legislation, including theU.S. Coronavirus Aid, Relief and Economic Security (CARES) Act and has concluded that there is no material tax impact. The Company continues to monitor the tax effects of any legislative changes. 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 theU.S. dollar, this has the effect of reducing (or increasing) theU.S. dollar equivalent cost of sales and other 33 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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 theU.S. dollar. Accordingly, when these currencies increase (or decline) in value relative to theU.S. dollar, this has the effect of increasing (or reducing) net sales. The result of these effects is to increase (or decrease) operating profit and net 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 sales or net income. The impact of these changes in the average exchange rates of other currencies against theU.S. dollar on our net sales was an increase of$4.3 million and$9.0 million for the three and six months endedJune 30, 2021 , respectively, compared to the same period of 2020. The impact of these changes on our cost of sales was an increase of$8.1 million and$11.5 million for the three and six months endedJune 30, 2021 , respectively, compared to the same period of 2020. 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, share repurchases and other obligations. Disruptions in theU.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. As ofJune 30, 2021 , we had liquidity of$360.5 million , consisting of$246.4 million of availability under our 2018 Revolving Credit Facility (subject to continued compliance with the financial covenants and representations) and cash and cash equivalents of$114.1 million . We had long-term debt of$1,224.9 million and short-term debt of$0.1 million as ofJune 30, 2021 . As ofDecember 31, 2020 , we had liquidity of$391.8 million consisting of$246.4 million available on our 2018 Revolving Credit Facility (subject to continued compliance with the financial covenants and representations) and cash and cash equivalents of$145.4 million . We had long-term debt of$1,420.0 million and short-term debt of$0.1 million as ofDecember 31, 2020 . As ofJune 30, 2021 andDecember 31, 2020 ,$84.1 million and$114.6 million , respectively, of our cash and cash equivalents were located outside of theU.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. In addition, for our subsidiary inSouth Africa , theSouth Africa Central Bank requires that certain solvency and liquidity ratios remain above defined levels after the dividend distribution, which historically has not materially affected our ability to repatriate cash from this jurisdiction. The cash and cash equivalents balances inSouth Africa were$2.6 million and$1.6 million as ofJune 30, 2021 andDecember 31, 2020 , respectively. Upon repatriation to theU.S. , the foreign source portion of dividends we receive from our foreign subsidiaries is no longer subject toU.S. federal income tax as a result of The Tax Cuts and Jobs Act of 2017. 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 payments, timing of capital expenditures, acquisitions, divestitures and other factors. Cash flow from operations is expected to remain at positive sustained levels due to the predictable earnings generated by our LTAs with our customers. Debt Structure We had availability under the 2018 Revolving Credit Facility of$246.4 million as ofJune 30, 2021 andDecember 31, 2020 , which consisted of the$250 million limit reduced by$3.6 million of outstanding letters of credit. InFebruary 2018 , the Company entered into a credit agreement (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 theJune 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$250 million senior secured revolving credit facility (the "2018 Revolving Credit Facility" and, 34 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 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 onFebruary 12, 2025 andFebruary 12, 2023 , 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 inFebruary 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 LIBO Rate, plus an applicable margin initially equal to 3.75% per annum or (ii) the ABR Rate, plus an applicable margin initially equal to 2.75% 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 byGrafTech Luxembourg I S.à .r.l., a Luxembourg société à responsabilité limitée and an indirect wholly owned subsidiary ofGrafTech , 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 aControlled 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 ofGrafTech and any Guarantor, (ii) a pledge on no more than 65% of the equity interests of each subsidiary that is aControlled 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 ofGrafTech that is aControlled 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 aControlled Foreign Corporation and of each direct, wholly owned subsidiary of any Guarantor that is aControlled Foreign Corporation , and (ii) security interests in certain receivables and personal property of each Guarantor that is aControlled 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 endedDecember 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 ofJune 30, 2021 , we have satisfied all amortization requirements through prepayments through the maturity date. The 2018 Credit Agreement contains customary representations and warranties and customary affirmative and negative covenants applicable toGrafTech 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 requiresGrafTech to maintain a senior secured first lien net leverage ratio not greater than 4.00:1.00 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 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. 35 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES 2020 Senior Notes OnDecember 22, 2020 , GrafTech Finance issued$500 million aggregate principal amount of the 2020 Senior 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 and to non-U.S. persons outsidethe United States under Regulation S under the Securities Act. The 2020 Senior Notes were issued pursuant to the indenture amongGrafTech Finance, as issuer, the Company, as a guarantor, the other subsidiaries of the Company named therein as guarantors andU.S. Bank National Association , as trustee and notes collateral agent. The 2020 Senior Notes are guaranteed on a senior secured basis by the Company and all of its existing and future direct and indirectU.S. subsidiaries that guarantee, or borrow under, the credit facilities under its 2018 Credit Agreement. The 2020 Senior 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 Notes and the Indenture pursuant to a collateral agreement, dated as ofDecember 22, 2020 (the "Collateral Agreement"), among GrafTech Finance, the Company, the other subsidiaries of the Company named therein as grantors andU.S. Bank National Association , as collateral agent. The 2020 Senior Notes bear interest at the rate of 4.625% per annum, which accrues fromDecember 22, 2020 and is payable in arrears onJune 15 andDecember 15 of each year, commencing onJune 15, 2021 . The 2020 Senior Notes will mature onDecember 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 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, thenGrafTech Finance must offer to repurchase the 2020 Senior 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 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 Notes may declare all of the Senior Notes to be due and payable immediately. The entirety of the 2020 Senior Notes proceeds was used to pay down a portion of our 2018 Term Loans. Uses of Liquidity OnJuly 30, 2019 , our Board of Directors authorized a program to repurchase up to$100 million of our outstanding common stock. 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. We have repurchased 4,333,259 shares of common stock for a total purchase price of$41.0 million under this program since inception. There were no shares repurchased under this program during the six months endedJune 30, 2021 . We currently pay a quarterly dividend of$0.01 per share, or$0.04 on an annualized basis. We review our capital structure with the Board of Directors on an ongoing 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. 36 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES During 2020, we reduced our long-term debt principal by$400 million . During the six months endedJune 30, 2021 , we repaid an additional$200 million of principal of our 2018 Term Loans. We continue to prioritize balance sheet flexibility and debt repayment. We anticipate using a majority of the cash flow that we generate in 2021 to repay debt, but we will continue to examine opportunities to repurchase our common stock. Potential uses of our liquidity include dividends, share repurchases, capital expenditures, acquisitions, scheduled debt repayments, optional debt repayments, and other general purposes. 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 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. During the second quarter of 2021, the Company paid out$61.5 million under its LTIP resulting from a Change in Control provision upon Brookfield's ownership of the Company's common stock falling below 30% of our total outstanding shares, which occurred in the second quarter of 2021. The remaining$11.9 million related to payroll taxes will be paid out in the third quarter of 2021. For details of the LTIP, see Note 7 "Contingencies" to the Notes to Condensed Consolidated Financial Statements. 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$26.1 million in the six months endedJune 30, 2021 . We are managing inventory levels to match demand. In the event that operating cash flows fail to provide sufficient liquidity to meet our business needs, including capital expenditures, any such shortfall would need to be made up by increased borrowings under our 2018 Revolving Credit Facility, to the extent available. Cash Flows The following table summarizes our cash flow activities: For the Six Months Ended June 30, 2021 2020 (in millions) Cash flow provided by (used in): Operating activities$ 208.8 $ 287.7 Investing activities$ (25.8) $ (24.3) Financing activities$ (214.6) $ (155.7) Operating Activities Cash flow from operating activities represents cash receipts and cash disbursements related to all of our activities other than investing and financing activities. Operating cash flow is derived by adjusting net income (loss) for: •Non-cash items such as depreciation and amortization, impairment, post retirement obligations, and severance and pension plan changes; •Gains and losses attributed to investing and financing activities such as gains and losses on the sale of assets, loan modification charges and unrealized currency transaction gains and losses; and 37 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES •Changes in operating assets and liabilities, which reflect timing differences between the receipt and payment of cash associated with transactions and when they are recognized in results of operations. The net impact of the changes in working capital (operating assets and liabilities), which are discussed in more detail below, include the impact of changes in: receivables, inventories, prepaid expenses, accounts payable, accrued liabilities, accrued taxes, interest payable and payments of other current liabilities. During the six months endedJune 30, 2021 , changes in working capital resulted in a net source of funds of$50.4 million , which was impacted by: •net cash inflows in accounts receivable of$9.3 million from the decrease in accounts receivable due to the timing of sales; •net cash inflows due to decreased inventory of$7.8 million resulting from lower costs and quantities on hand; •net cash outflows from decreased income taxes payable of$17.8 million resulting from tax payments, partially offset by 2021 income tax accruals; •net cash inflows from increases in accounts payable and accruals of$62.7 million , due to increased raw material purchases, increased deferred revenue liabilities related to customer prepayments, and timing of payments of payroll taxes; and Uses of cash in the six months endedJune 30, 2021 included payments under our LTIP of$61.5 million , payments under our tax receivable agreement, datedApril 23, 2018 ("TRA"), cash taxes paid of$44.6 million , cash paid for interest of$30.5 million , and contributions to pension and other benefit plans of$2.3 million . During the six months endedJune 30, 2020 , changes in working capital resulted in a net source of funds of$61.9 million , which was impacted by: •net cash inflows in accounts receivable of$58.7 million from the decrease in accounts receivable due to lower sales; •net cash inflows of$6.1 million from the decrease in other current assets primarily due to value-added tax refunds received from foreign governments; •net cash inflows from increased income taxes payable of$25.1 million resulting from our ability to defer a$50.0 million tax payment in a foreign jurisdiction resulting from government enacted COVID-19 relief, partially offset by lower required tax payments due to lower profitability; and •net cash outflows from decreases in accounts payable and accruals of$25.0 million , due to lower purchases of third-party needle coke and timing of payments. Uses of cash in the six months endedJune 30, 2020 included payments under the TRA of$27.9 million , cash paid for interest of$46.1 million and taxes paid of$4.9 million , and contributions to pension and other benefit plans of$1.8 million . Investing Activities Net cash used in investing activities was$25.8 million during the six months endedJune 30, 2021 , resulting from capital expenditures. Net cash used in investing activities was$24.3 million during the six months endedJune 30, 2020 , resulting from capital expenditures. Financing Activities Net cash outflow from financing activities was$214.6 million during the six months endedJune 30, 2021 , which was the result of the repayment of$200.0 million of principal on our 2018 Term Loan Facility, taxes paid related to stock awards vesting of$4.1 million ,$2.1 million of interest rate swap settlements,$1.6 million of debt modification costs from our term loan repricing,$1.4 million of debt issuance costs from our 2020 Senior Note Issuance and$5.3 million of total dividends to stockholders. 38 -------------------------------------------------------------------------------- PART I (CONT'D) GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES Net cash outflow from financing activities was$155.7 million during the six months endedJune 30, 2020 , which was the result of the repayment of$100.0 million on our 2018 Term Loan Facility,$25.5 million of total dividends to stockholders and$30.1 million of stock repurchases. Related Party Transactions We have engaged in transactions with affiliates or related parties during 2021 and we expect to continue to do so in the future. These transactions include ongoing obligations under the TRA, Stockholders Rights Agreement and Registration Rights Agreement, each with Brookfield. Recent Accounting Pronouncements We discuss recently adopted accounting standards in Note 1, "Organization and Summary of Significant Accounting Policies" of the Notes to Condensed Consolidated Financial Statements. Description of Our Financing Structure We discuss our financing structure in more detail in Note 4, "Debt and Liquidity" of the Notes to Condensed Consolidated Financial Statements.
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