GrafTech International Ltd. — Form 10-Q Summary
Reporting period: Quarter ended September 30, 2010; comparative results are for the three and nine months ended September 30, 2009. Financial statements are unaudited. GrafTech manufactures graphite electrodes and refractory products (Industrial Materials) and advanced graphite and natural graphite products (Engineered Solutions).
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $255.2 million | $164.9 million | $725.8 million | $456.7 million |
| Gross profit | $75.0 million | $46.5 million | $217.9 million | $124.3 million |
| Gross margin | 29.4% | 28.2% | 30.0% | 27.2% |
| Operating income | $40.9 million | $25.1 million | $123.2 million | $53.0 million |
| Net income (loss) | $24.6 million | $6.9 million | $97.5 million | ($21.8 million) |
| Diluted EPS | $0.20 | $0.06 | $0.80 | ($0.18) |
- Sales and segments: Q3 sales rose 55% year over year; nine-month sales rose 59%. Industrial Materials sales increased 52% and 62%, respectively; Engineered Solutions sales increased 67% and 48%. Growth primarily reflected higher volumes as customers replenished inventories and steel production recovered.
- Margins and costs: Nine-month operating income more than doubled. Higher production volumes improved fixed-cost absorption, while higher-cost needle coke pressured costs. GrafTech said the needle coke used in 2010 production was purchased at prices about 45% above the cost used in the first nine months of 2009. Electrode average selling prices, excluding currency, declined about 9% in Q3 and 6% for the nine-month period.
- Cash flow: Nine-month cash from operations was $54.0 million, down from $121.7 million. Increased receivables and inventory used $42.3 million and $39.0 million of cash, respectively, as sales and production rose. Investing used $44.7 million, including $51.5 million of capital expenditures; financing provided $5.7 million. Cash increased to $66.5 million from $50.2 million at year-end 2009.
- Liquidity and debt: At September 30, cash was $66.5 million, total current assets $521.9 million and current liabilities $194.9 million. Long-term debt was $1.4 million; supply-chain financing liabilities were $25.5 million. The $260 million revolving facility, refinanced in April and due in 2013, had no borrowings and $257.5 million available after letters of credit. GrafTech reported compliance with its covenants.
- Other financial items: Q3 other expense was $10.1 million, largely currency losses; nine-month other income was $1.7 million, reflecting currency gains. The effective tax rate was 21.9% for Q3 2010 and 22.3% for the nine-month period.
Material changes and unusual items
- Compared with 2009, the nine-month period benefited from the absence of the $52.8 million noncash impairment of the Seadrift investment recorded in 2009, alongside stronger operating results and improved Seadrift earnings.
- Q3 2010 selling and administrative expense included $5.7 million of acquisition costs; nine-month expense included $12.3 million. Management said Q3 results exceeded expectations partly because of favorable currency movements, refractories shipment timing and a lower tax rate.
- GrafTech’s 18.9% Seadrift investment generated $3.8 million of equity earnings in the first nine months of 2010. Seadrift repaid GrafTech’s $6.0 million loan in March 2010.
Outlook, risks and contingencies
- Management expected Q4 graphite electrode volume to be flat to down from Q3 as customer operating rates softened; it expected Engineered Solutions demand to remain solid and Q4 operating income to decline slightly from Q3. Electrode pricing was expected to remain relatively flat.
- For full-year 2010, excluding the proposed acquisitions and related transaction costs, guidance was operating income of $175–$180 million; overhead expense of $110–$112 million; capital expenditures of $75–$80 million; depreciation of about $40 million; effective tax rate of 21%–23%; and operating cash flow of $100–$110 million. Operating-income guidance was raised from $170–$180 million; overhead guidance was raised from $105–$110 million.
- GrafTech had agreed to acquire the remaining Seadrift interests and C/G Electrodes. Consideration included cash, 12 million shares and $100 million of non-interest-bearing subordinated notes for each transaction. The company anticipated about $185 million of revolver borrowings for the cash consideration. Both acquisitions remained subject to closing conditions and DOJ antitrust review; a Second Request had extended the review. Management expected closing in 2010, but completion was not assured.
- ConocoPhillips’ needle-coke supply agreements were to terminate December 31, 2010. Replacement arrangements were required for three years at market-based prices and declining quantities, while GrafTech negotiated future supply. The company’s reliance on a major supplier, raw-material prices and the ability to pass cost increases to customers are material risks.
- Other disclosed risks include weaker-than-expected steel demand, acquisition financing and integration, covenant or liquidity pressure, customer credit quality, currency movements, pension obligations, and a possible work stoppage at the Clarksburg facility while labor negotiations continued. GrafTech said it was not aware of legal matters expected to materially adversely affect its financial position, results or cash flows.
Important facts for investors to verify
- Whether the Seadrift and C/G acquisitions closed, their final financing and share issuance, and any integration costs or realized benefits.
- Whether replacement needle-coke supply agreements were completed on adequate volumes and acceptable market-based pricing.
- Whether steel and EAF operating rates, electrode volumes and pricing developed in line with management’s Q4 and full-year expectations.
- Whether working-capital demands—particularly receivables and inventories—allowed GrafTech to achieve its operating-cash-flow guidance.
- Whether GrafTech remained within its revolving-credit covenants and maintained liquidity after acquisition-related borrowing.
- Tax uncertainties: $19.9 million of unrecognized tax benefits were reported; GrafTech was under IRS audit for 2007 and an Italian audit for 2006.