GrafTech International Ltd. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. GrafTech manufactures graphite and carbon products, including graphite electrodes, needle coke and engineered materials. Brookfield acquired the company in August 2015; accordingly, Q1 2016 is reported on a “Successor” accounting basis and Q1 2015 on a “Predecessor” basis. The company cautions that the periods are not directly comparable because acquisition accounting reset asset values and affected expenses.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $124.7 million | $207.2 million |
| Gross profit (loss) | $(9.9) million | $20.8 million |
| Operating loss | $(29.6) million | $(45.8) million |
| Net loss | $(36.4) million | $(55.6) million |
| Operating cash flow | $9.7 million | $22.7 million |
| Capital expenditures | $8.4 million | $13.6 million |
- Revenue declined about 40% year over year. Reported gross margin was approximately negative 7.9% in Q1 2016 versus positive 10.0% in Q1 2015; the 2016 result included an $11.5 million inventory valuation charge.
- Industrial Materials sales fell to $95.6 million from $162.5 million. The company attributed the decline primarily to a 25% drop in graphite-electrode volume and a 20% reduction in weighted-average selling price, reflecting softer steel-market demand.
- Engineered Solutions sales were $29.1 million, down from $44.7 million, mainly due to lower prices and volumes in thermal solutions and weaker oil-and-gas drilling demand. Segment operating losses were $20.2 million for Industrial Materials and $0.9 million for Engineered Solutions.
- Operating loss narrowed year over year, but included no repeat of the prior-year $35.4 million needle-coke goodwill impairment. Lower volumes and the 2016 inventory charge weighed on gross profit. Selling and administrative expense fell to $18.1 million from $26.3 million, primarily from cost reductions and lower headcount.
- Cash and cash equivalents were $9.8 million at quarter end. Total debt was $369.8 million, including $9.8 million short-term and $360.0 million long-term debt; stockholders’ equity was $786.8 million. Cash from operations decreased from $22.7 million to $9.7 million.
- At March 31, the company reported $90 million of unused revolving capacity after covenant restrictions and letters of credit, and said it was in compliance with applicable credit-facility covenants. The reported debt fair value was $277.4 million versus book value of $369.8 million.
Material changes, outlook and risks
- On February 26, 2016, GrafTech announced a realignment of its two segments, moving refractory products to Engineered Solutions and assigning advanced materials to the segment where produced. It also began reviewing strategic alternatives for Engineered Solutions. The review was at an early stage at quarter end; no transaction was assured.
- Subsequent event: On April 27, 2016, the company amended its revolving credit facility, permanently reducing its size from $375 million to $225 million. The amendment requires minimum liquidity above $25 million, directs proceeds from certain Engineered Solutions asset sales to debt repayment, tightens restrictions on certain financial and business actions, and establishes interim minimum-EBITDA covenant thresholds. The company said it then had full access to the amended facility subject to the minimum-liquidity requirement. Engineered Solutions qualified as available for sale as of that date; its March 31 net assets were approximately $183 million.
- Management stated it believed liquidity was adequate, while noting that weak operating cash flow could require additional borrowing. A downturn could pressure cash flow, covenant compliance, credit ratings and access to financing. Sale proceeds from Engineered Solutions were expected to be used to repay facility borrowings, but the company gave no assurance a sale would occur or on what terms.
- The filing provides no specific company earnings or revenue guidance. Management cited a weak global environment; the World Steel Association forecast global steel demand to decrease 0.8% in 2016. Key risks include continued graphite-electrode price and volume pressure, customer order changes, competition and capacity, raw-material and energy costs, foreign exchange, and the company’s debt and covenant position.
- Other items: the Q1 effective tax rate was 1.9%, with no tax benefit recognized on certain U.S. and Swiss losses because of valuation allowances. The company reported $3.9 million of unrecognized tax benefits. It did not expect pending legal matters, individually or collectively, to materially affect its financial position, results or cash flows. Management concluded disclosure controls were effective as of March 31, 2016.
Important facts for investors to verify
- How much of the reported year-over-year performance change reflects operating conditions versus the predecessor/successor accounting-basis change.
- Graphite-electrode prices, volumes, inventory valuation effects and demand trends in steel markets.
- Compliance with the amended facility’s minimum-liquidity and interim EBITDA covenants, and borrowing availability after the facility reduction.
- Whether the Engineered Solutions strategic review leads to a sale, the terms and proceeds, and the resulting effects on earnings, liquidity and debt.
- Cash generation, working-capital movements and required capital spending relative to debt service and liquidity needs.