GrafTech International Ltd. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Amounts are in U.S. dollars; financial statements are unaudited. Following Brookfield’s August 2015 acquisition, 2016 “Successor” results use a new accounting basis and are not fully comparable with 2015 “Predecessor” results. Engineered Solutions was reclassified as discontinued operations in Q2 2016.
Business context and performance
GrafTech manufactures graphite and carbon products. Industrial Materials, now the continuing business, comprises graphite electrodes and needle coke. The company began a strategic review of Engineered Solutions, which includes advanced materials and refractory products, and expects the process to be completed within 12 months.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Continuing net sales | $115.4 million | $125.8 million | $210.9 million | $288.3 million |
| Gross profit (loss) | $(8.4) million | $14.2 million | $(21.4) million | $30.7 million |
| Operating loss | $(22.6) million | $(6.6) million | $(50.0) million | $(47.2) million |
| Loss from continuing operations | $(22.3) million | $(17.1) million | $(56.1) million | $(66.6) million |
| Net loss | $(128.4) million | $(22.8) million | $(164.8) million | $(78.4) million |
Continuing gross margins were approximately negative 7.3% in Q2 and negative 10.1% for the first half, versus approximately 11.3% and 10.7% in the respective 2015 periods. The 2016 gross losses include graphite-electrode inventory valuation charges of $3.5 million in Q2 and $14.6 million year to date. Q2 electrode selling prices fell 28% year over year while volumes rose 31%; for the first half, weighted-average electrode prices fell 25%. Management attributed weaker sales to soft steel-market demand, especially in electric-arc-furnace markets.
Discontinued Engineered Solutions generated sales of $29.9 million in Q2 and $59.0 million in the first half, compared with $39.3 million and $84.0 million in 2015. Its 2016 losses included a $105.6 million impairment charge recorded to reflect estimated fair value less disposal costs. Management said the charge could later be partially offset by gains, depending on how the business is divested; estimates may change until the divestiture is completed.
Cash flow, debt and liquidity
- First-half operating cash flow was $11.2 million, down from $24.2 million. Working capital provided $24.5 million, principally from inventory reductions. Capital expenditures were $15.1 million, versus $25.6 million a year earlier.
- Cash and cash equivalents were $13.4 million at June 30, 2016, compared with $6.9 million at year-end 2015. Total debt was $380.5 million: $16.5 million short-term and $364.0 million long-term. Debt fair value was reported at $335.4 million.
- The $225 million revolving facility had $72.0 million borrowed and $13.5 million of letters of credit outstanding. The term loan had $37.0 million outstanding; both facilities mature in April 2019. Senior Notes carry a 6.375% fixed rate and mature in November 2020.
- An April 2016 credit amendment requires minimum liquidity above $25 million, directs proceeds from qualifying Engineered Solutions asset sales to debt repayment, restricts dividends and adds or revises covenants. The company reported covenant compliance at June 30 and said it had full access to the revolver, subject to the liquidity requirement.
Outlook, risks and other notable matters
Management stated that liquidity was adequate, while noting that economic volatility could require additional revolver borrowings and that operating downturns could pressure cash flow, covenant compliance, credit ratings and financing access. No specific company earnings or revenue guidance is provided in the supplied filing text. Management cited the IMF’s July 2016 global-growth estimates of 3.1% for 2016 and 3.4% for 2017, and the World Steel Association’s forecast of a 0.8% decline in global steel demand in 2016.
- Key operating risks include weak steel and graphite-electrode demand, pricing pressure and industry overcapacity; the company recorded inventory write-downs amid falling electrode prices.
- The strategic review and planned sale of Engineered Solutions are uncertain: the company gave no assurance that sales would close, on what terms, or for what proceeds. Asset-sale proceeds are subject to debt repayment requirements.
- Brexit-related currency volatility was identified as a risk; a significantly weaker pound could adversely affect the company. The company also cited foreign-exchange, energy, interest-rate, supply-chain, customer-credit and covenant risks.
- Legal proceedings, investigations and environmental matters are ongoing; management did not believe their ultimate disposition would materially adversely affect financial position, results or cash flows. A Brazil labor-related dispute is among the disclosed risk factors.
- Disclosure controls were assessed as effective at the reasonable-assurance level, with no material quarterly change in internal control over financial reporting reported.
Most important facts for investors to verify
- Whether the $105.6 million Engineered Solutions impairment and the estimated sale values reflect final divestiture assumptions, and whether any impairment is later offset by gains.
- Recent graphite-electrode prices, volumes and demand trends, and whether lower prices could prompt additional inventory write-downs.
- Liquidity headroom and compliance with the amended revolver’s minimum-liquidity and EBITDA covenants as operating results and asset-sale proceeds evolve.
- Cash generation excluding working-capital movements, and the company’s ability to fund operations, capital needs and debt service.
- How the predecessor/successor accounting basis and discontinued-operations reclassification affect comparisons with prior periods.