GrafTech International Ltd. — Q1 2012 Form 10-Q
Business context and reporting period. Unaudited results for the three months ended March 31, 2012, compared with Q1 2011. GrafTech manufactures graphite and carbon-based products. Its Industrial Materials segment serves primarily the steel industry; Engineered Solutions serves electronics, industrial, energy, transportation and defense markets.
Financial performance
| Metric | Q1 2011 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $306.1 million | $240.9 million | Down 21% |
| Gross profit / margin | $72.9 million / 23.8% | $66.9 million / 27.8% | Profit down 8%; margin up |
| Operating income / margin | $37.6 million / 12.3% | $24.0 million / 10.0% | Down 36% |
| Net income | $27.3 million | $17.5 million | Down 36% |
| Diluted earnings per share | $0.19 | $0.12 | Down 37% |
| Cash from operations | $(1.1) million | $(15.4) million | Greater cash use |
| Capital expenditures | $23.8 million | $31.4 million | Increased |
Segment results. Industrial Materials sales declined 27% to $193.0 million, with operating income down to $24.9 million from $34.2 million. Engineered Solutions sales rose 12% to $47.9 million, but the segment recorded a $0.9 million operating loss versus $3.4 million of income a year earlier.
Cash, debt and liquidity. At March 31, cash was $12.8 million, long-term debt was $443.2 million, and balance-sheet short-term debt was $11.2 million. The MD&A separately reports short-term debt of $35.8 million; the filing text does not clearly reconcile that figure with the balance sheet. The company had $270 million available under its revolving facility, with $292.3 million drawn, and reported compliance with its covenants. Current assets were $786.7 million and current liabilities $260.0 million. Inventory increased to $555.0 million from $444.1 million at year-end.
Material changes and management commentary
- Lower Industrial Materials volume, principally graphite electrode customer destocking and weaker European demand, drove the sales decline. Industrial Materials price/mix and currency partly offset volume weakness; average electrode selling prices rose about 3% year over year.
- Engineered Solutions growth included the October 2011 acquisition of Fiber Materials, Inc. (FMI). The segment’s loss reflected weaker solar demand and higher growth-support costs, partly offset by advanced consumer electronics growth.
- Gross margin improved despite lower sales, supported by lower overhead application rates following higher production in Q4 2011, lower foreign-currency costs and the absence of prior-year acquisition inventory step-up costs. Q1 2012 also included $3.3 million of severance charges.
- Other income included $4.0 million of insurance reimbursements for 2011 flood damage at the Clarksburg facility.
- Operating cash use reflected a $100.7 million inventory increase, partially offset by $67.1 million of cash inflow from lower receivables. Financing activities provided $43.4 million, including $53.0 million of net revolving-facility borrowings.
Outlook, risks and contingencies
Management’s 2012 targets were EBITDA of $250–$290 million, operating income of $160–$200 million, overhead expense of about $170 million, interest expense of $18–$22 million, a 23%–25% effective tax rate, and operating cash flow of $140–$170 million. Capital expenditure guidance was reduced to $125–$145 million from $140–$160 million; D&A guidance was reduced to about $90 million from $95 million.
Management cited weak global and European economic conditions, slower steel production, European debt concerns, customer destocking, possible pressure on product prices, and raw-material and energy costs as significant uncertainties. Other disclosed risks include foreign-exchange and commodity movements, supply interruptions, competition, capacity and customer-demand changes, and the ability to meet debt covenants. The company uses currency and commodity derivatives to manage exposures.
GrafTech stated that it did not expect pending legal matters to have a material adverse effect. It reported $18.3 million of unrecognized tax benefits, ongoing U.S. federal, Swiss and Italian tax audits, and uncertainty around valuation allowances for certain deferred tax assets. Warranty accruals were $1.6 million at quarter-end. The revolving-facility amendment and restatement in April 2012 added European subsidiaries to the structure; the company said financial terms and covenants were otherwise unchanged.
Key investor verification points
- Whether electrode customer destocking and European weakness persisted, and how they affected volume, pricing and margins.
- Whether the large inventory build was subsequently converted to sales and cash, and whether working-capital needs aligned with management’s cash-flow target.
- Progress in restoring Engineered Solutions profitability, including FMI integration and exposure to solar demand.
- Reconciliation of the MD&A’s $35.8 million short-term-debt figure with the balance-sheet presentation.
- Compliance with revolving-facility covenants, available borrowing capacity, and achievement of the 2012 guidance, including reduced capital spending.
- Developments in tax audits, deferred-tax-asset valuation allowances, legal matters and the company’s commodity and currency exposures.