GrafTech International Ltd. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. Unaudited consolidated results; comparisons are with the corresponding 2010 periods. Financial amounts below are in millions of U.S. dollars unless stated otherwise.
Business context
GrafTech manufactures graphite and carbon products. Industrial Materials serves mainly the steel industry; Engineered Solutions serves transportation, solar, oil and gas, and electronics markets. The company attributed increased sales to an economic recovery and acquisitions, including Seadrift and St. Marys (acquired in November 2010) and Micron Research (acquired in February 2011).
Key financial results
| Metric | Q2 2010 | Q2 2011 | H1 2010 | H1 2011 |
|---|---|---|---|---|
| Net sales | $254.9 | $320.2 | $470.5 | $626.4 |
| Gross profit | $75.9 | $75.2 | $145.2 | $148.1 |
| Gross margin | 29.8% | 23.5% | 30.9% | 23.6% |
| Operating income | $40.8 | $39.6 | $85.4 | $77.2 |
| Operating margin | 16.0% | 12.4% | 18.2% | 12.3% |
| Net income | $40.7 | $28.6 | $75.7 | $55.8 |
| Diluted EPS | $0.34 | $0.20 | $0.63 | $0.38 |
| Operating cash flow | Not presented quarterly | $13.9 | $(18.0) | |
| Capital expenditures | Not presented quarterly | $30.3 | $61.8 |
Q2 sales rose 26%, but gross profit was slightly lower as cost of sales grew faster than revenue. H1 sales rose 33%, while operating income fell 10% and net income fell 26%. Industrial Materials sales grew 29% in Q2 and 36% in H1; Engineered Solutions sales grew 9% and 17%, respectively. Acquisitions contributed $55.7 million of Q2 and $121.1 million of H1 sales; excluding acquired sales, management reported increases of $9.7 million and $34.8 million, primarily from volume.
Higher needle-coke and other input costs, unfavorable currency effects on costs, and purchase-accounting adjustments pressured margins; management said these cost increases could not yet be passed on to customers. Industrial Materials segment operating income declined to $32.1 million in Q2 from $35.4 million and to $66.3 million in H1 from $78.3 million. Engineered Solutions operating income increased to $7.4 million in Q2 from $5.4 million and to $10.9 million in H1 from $7.1 million. Diluted weighted-average shares increased from 121.1 million to 146.0 million for Q2, chiefly reflecting acquisition-related share issuance.
Cash, debt and liquidity
- Cash was $9.3 million at June 30, down from $13.1 million at December 31, 2010. Current assets were $676.4 million and current liabilities $221.0 million; working capital was approximately $455.4 million.
- Total debt was $360.4 million at June 30, including $11.6 million short-term and $348.7 million long-term debt. Supply-chain financing liability was another $23.6 million. Long-term debt increased from $275.8 million at year-end, primarily reflecting acquisition financing.
- The revolving facility had $201.4 million drawn and $52.5 million available after letters of credit. It matures in April 2013; the company reported covenant compliance at June 30 and expected compliance through maturity, subject to operating results and cash flows.
- H1 operating cash use of $18.0 million reflected a $123.0 million working-capital use, including higher receivables and inventory. Investing cash use was $64.8 million; financing provided $78.7 million, primarily from net revolver borrowings of $68.0 million and short-term debt borrowings of $11.4 million.
Outlook, commentary and notable items
- For 2011, assuming the economic forecasts described in the filing materialize, management forecast EBITDA of approximately $285 million (operating income of $200 million plus depreciation and amortization of approximately $85 million), overhead expense of $145–$155 million, interest expense of $18–$20 million, capital expenditures of $145–$160 million, an effective tax rate of 22%–24%, and operating cash flow of $150–$180 million. Management cautioned that results could differ materially.
- The company announced price increases for premium-grade needle coke in June and graphite electrodes in early July. It did not expect a material 2011 earnings effect because most 2011 business was booked; the increases were intended to support margins into 2012.
- GrafTech changed its pension accounting effective January 1, 2011, retrospectively recognizing actuarial gains and losses more promptly. It reported that without the changes, Q2 net income would have been $27.4 million rather than $28.6 million, and H1 net income $53.4 million rather than $55.8 million. The new revenue-recognition standard had no material effect.
- The Seadrift turnaround was completed in May; $5.0 million of costs were deferred and $0.4 million amortized in H1. The Micron Research acquisition cost $6.5 million in cash. Acquired-intangible amortization and noncash discount amortization on acquisition-related subordinated notes contributed to higher expenses.
- Risks include steel and electrode demand, pricing and competition; needle-coke, energy and other input costs and supply; foreign-exchange and interest-rate exposure; working-capital needs and access to financing; pension funding and valuation assumptions; and execution and integration of acquisitions. A Brazilian wage-increase litigation matter could become substantial if a prior favorable ruling is reversed. The company said the ultimate disposition of its other legal matters was not expected to materially adversely affect results or cash flows.
Important facts for investors to verify
- Whether price increases and cost-management actions restore Industrial Materials margins as input costs rise.
- How much sales growth and future profitability are attributable to acquisitions versus organic volume, pricing and currency effects.
- Whether working capital converts to cash and the company achieves its $150–$180 million operating-cash-flow outlook alongside planned capital spending.
- Debt, revolver availability, interest costs and covenant headroom, particularly if cash flow weakens.
- Assumptions behind the 2011 outlook, pension funding exposure, and the status of the Brazilian wage litigation and tax audits.