GrafTech International Ltd. — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; unaudited, with comparison to Q1 2009. GrafTech manufactures graphite electrodes and refractory products in its Industrial Materials segment and advanced graphite and natural graphite products in Engineered Solutions.
Financial performance
| Metric | Q1 2009 | Q1 2010 |
|---|---|---|
| Net sales | $134.0 million | $215.7 million |
| Gross profit / margin | $32.1 million / 24.0% | $68.1 million / 31.6% |
| Operating income / margin | $8.4 million / 6.3% | $43.1 million / 20.0% |
| Income before taxes | $13.6 million | $45.2 million |
| Net income | $8.5 million | $33.5 million |
| Diluted earnings per share | $0.07 | $0.28 |
| Cash from operating activities | $14.3 million | $20.4 million |
| Capital expenditures | $12.6 million | $10.8 million |
Sales increased 61% year over year. Industrial Materials sales rose 75% to $182.4 million, mainly from higher electrode volumes; Engineered Solutions sales increased 13% to $33.2 million. Operating income growth was concentrated in Industrial Materials: $41.8 million versus $6.8 million. Engineered Solutions operating income declined to $1.2 million from $1.6 million.
At March 31, cash and equivalents were $88.5 million, versus $50.2 million at year-end 2009. Current assets were $479.9 million and current liabilities $215.9 million. Total debt was approximately $1.3 million long-term, with no short-term debt or revolver borrowings; the separate supply-chain financing liability was $39.1 million. The company reported $209.5 million available under its then-existing revolving facility, net of letters of credit. Operating cash flow was partly offset by working-capital investment, including a $21.0 million inventory cash outflow. Financing provided $23.0 million, principally from supply-chain financing; investing used $4.5 million, including $10.8 million of capital spending and $6.0 million received from repayment of a Seadrift loan.
The effective tax rate was 25.8%, compared with 37.9% in Q1 2009. Management attributed the decrease primarily to jurisdictional income shifts, currency movements, and use of tax attributes and valuation allowances.
Material changes and management commentary
- Management attributed the sales recovery to improving steel production and customers ending inventory destocking and resuming orders. It cited global steel capacity utilization of about 80% in Q1 2010, versus an estimated 65% in Q1 2009.
- Higher sales volume and improved fixed-cost absorption supported margins. However, the cost of needle coke used in production began reflecting material acquired at prices about 50% above the coke used during 2009. Management said the negotiated 2010 price per metric ton from its largest supplier was flat with 2009.
- Currency effects raised Industrial Materials costs by $17.0 million and sales by $2.4 million year over year. Currency gains recorded in other income declined to $3.7 million from $6.4 million.
- Cash-flow working capital was a use of $13.3 million in the cash-flow statement, largely reflecting increased inventory and receivables as sales recovered. Supply-chain financing liability increased from $14.4 million at year-end to $39.1 million.
Outlook, transactions and risks
Conditional on the economic forecasts described in the filing, management’s 2010 outlook was operating income of $170–$180 million, overhead expense of $105–$110 million, capital expenditures of $70–$75 million, depreciation of approximately $38 million, an effective tax rate of 24%–27%, and operating cash flow of $100–$110 million. Management expected improved electrode volumes, but warned that higher raw-material costs would largely offset the benefit; it also expected softer electrode pricing in subsequent quarters.
On April 29, 2010, after quarter-end, GrafTech completed refinancing its revolving facility: the replacement facility has $260 million of initial commitments and matures April 29, 2013, with an accordion that can bring aggregate facilities to $390 million, subject to conditions. It has financial covenants, including minimum interest coverage and maximum net senior secured leverage requirements.
Also announced April 29, GrafTech agreed to acquire the remaining interest in Seadrift and acquire C/G Electrodes, subject to customary closing conditions, including antitrust review; the C/G transaction is contingent on closing the Seadrift acquisition. Stated consideration includes cash, 12 million shares for each acquisition, and $100 million of non-interest-bearing subordinated notes for each. Management expected to fund approximately $185 million of cash consideration with revolver borrowings and the balance from cash on hand. These were pending transactions, not completed at the filing date.
Key risks include weak or volatile steel and electrode demand and pricing, raw-material and energy costs and supply, foreign exchange movements, customer credit and liquidity, pension obligations, tax uncertainties, and acquisition execution and financing. The filing notes that Seadrift had generated a loss in the reported quarter and that GrafTech had recorded substantial impairment charges on the investment in 2008 and 2009; further impairment could be required if forecasts are not achieved. GrafTech said it did not believe outstanding legal matters would materially adversely affect its financial position, results, or cash flows. The company reported disclosure controls effective at the reasonable-assurance level and no material change in internal controls during the quarter.
Investor verification priorities
- Track order volumes and realized electrode prices against the expected recovery and management’s warning of softer pricing.
- Assess whether higher needle-coke costs, currency movements, and working-capital needs affect margins and cash conversion.
- Verify closing, final terms, funding, dilution, and integration progress for the Seadrift and C/G acquisitions.
- Monitor revolver availability, covenant headroom, supply-chain financing, and the effect of acquisition borrowing and subordinated notes on leverage.
- Review Seadrift’s operating performance and valuation assumptions for possible additional impairment, and follow tax audits and unrecognized tax benefits.