GrafTech International Ltd. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. GrafTech manufactures graphite and carbon-based products through its Industrial Materials and Engineered Solutions segments. Financial amounts below are in U.S. dollars; statements are unaudited.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $284.2 million | $301.4 million | $565.0 million | $555.1 million |
| Gross profit / margin | $18.0 million / 6.3% | $48.9 million / 16.2% | $43.6 million / 7.7% | $97.5 million / 17.6% |
| Operating income (loss) | $(139.5) million | $16.0 million | $(146.6) million | $31.7 million |
| Net income (loss) | $(155.4) million | $4.4 million | $(167.0) million | $8.6 million |
| Basic and diluted EPS | $(1.14) | $0.03 | $(1.23) | $0.06 |
| Operating cash flow | Not separately stated for the quarter | $55.9 million | $11.6 million |
- Second-quarter sales fell 6%; first-half sales rose 2%. Gross margin contracted sharply, reflecting pricing pressure and rationalization-related costs.
- Q2 included a $121.6 million long-lived-asset impairment, plus $10.6 million of related charges, primarily inventory write-downs. The six-month results also include these charges.
- First-half operating cash flow increased to $55.9 million, including a $30.4 million working-capital source. Capital expenditures were $46.5 million; operating cash flow less capital expenditures was approximately $9.4 million.
- At June 30, cash was $20.7 million, current assets $742.4 million and current liabilities $187.6 million. Long-term debt was $551.5 million, with short-term debt of $0.1 million. Stockholders’ equity was $1.16 billion.
Material changes and business developments
- Industrial Materials: Q2 sales declined 11% to $206.7 million; first-half sales declined 3% to $425.4 million. Lower realized electrode prices drove the weakness: weighted-average electrode selling prices excluding currency were down approximately 12% in Q2 and 14% for the first half year over year. First-half volume rose 9%.
- Engineered Solutions: Q2 sales grew 11% to $77.5 million; first-half sales grew 21% to $139.5 million, supported by high-temperature furnace systems and thermal solutions. However, management cited pricing pressure, order delays and cancellations, and higher costs for new product introductions.
- GrafTech announced plans to cease isomolded graphite production and pursue alternative supply arrangements amid excess capacity, deteriorating pricing and competitive pressure in solar-related markets. The impairment included $0.4 million of goodwill written off.
- The 2013 Industrial Materials restructuring, including closures in Brazil and South Africa and a Russian machine shop, was substantially complete. The company reported expected annual savings of approximately $75 million, with about $50 million expected in 2014.
- Management also described an evaluation of the business structure and support needs across both segments, with potential workforce and other cost-reduction actions under consideration.
Outlook, liquidity, risks and unusual items
- Management’s 2014 EBITDA target remained $135 million to $150 million, but it warned of increased risk from weaker Q2 results, delayed Engineered Solutions orders, customer order delays and cancellations, and geopolitical developments. The filing’s reconciliation projected a full-year net loss of $158 million to $169 million; EBITDA is a non-GAAP measure.
- The new Engineered Solutions actions were expected to produce approximately $16 million of annual savings (the six-month MD&A states $15 million), with about $1 million expected in 2014. The company estimated approximately $12 million of additional severance and related charges, around $7 million cash, mostly during 2014. The differing annual savings estimates merit verification.
- A $57.0 million non-cash tax valuation allowance was recorded against U.S. deferred tax assets because recent losses weakened the evidence for future realization. It contributed to the unusual tax result despite the reported pretax loss.
- GrafTech had $299 million of unused revolving-facility capacity after covenant restrictions and letters of credit. The amended $470 million facility matures in April 2019; $68 million was drawn at quarter-end. The company reported covenant compliance and expected compliance through December 31, 2014, subject to operating results and cash flows.
- Other debt includes $300 million of 6.375% senior notes due 2020 and senior subordinated notes with a $181.7 million carrying value, due 2015. The notes are non-interest-bearing contractually but accrete interest for accounting purposes.
- Risks highlighted include graphite-electrode and needle-coke pricing, order patterns, restructuring execution, customer concentration and cancellations, covenant compliance, raw-material and energy costs, foreign exchange, and the possibility of further impairments or restructuring. An EPA reporting allegation involving the Seadrift subsidiary was in settlement discussions; penalties were not expected to be material. Management said other pending legal matters were not expected to have a material adverse effect.
- Management reported effective disclosure controls as of June 30, 2014, with no material changes to internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether the $135–$150 million 2014 EBITDA target remains achievable given reported order delays, cancellations and increased risk.
- Actual realization and timing of restructuring savings, cash outlays and any further charges; reconcile the $15 million and $16 million Engineered Solutions savings estimates.
- Whether continued pricing and margin pressure in Industrial Materials and Engineered Solutions affects liquidity, covenant headroom or the need for additional borrowing.
- Assumptions supporting the $121.6 million impairment and the recoverability of remaining goodwill and deferred tax assets.
- Progress on the Seadrift EPA matter and any material developments in other contingencies.