Business context and reporting period
GrafTech International Ltd. manufactures graphite, carbon and related products. Its two reportable segments are Industrial Materials, serving primarily steel markets, and Engineered Solutions, serving electronics, industrial, energy, transportation and defense markets. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2015; comparisons below are with the corresponding 2014 periods.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $165.1m | $284.2m | $372.3m | $565.0m |
| Gross profit / margin | $15.9m / 9.7% | $18.0m / 6.3% | $36.7m / 9.9% | $43.6m / 7.7% |
| Operating loss | ($13.0m) | ($139.5m) | ($58.8m) | ($146.6m) |
| Net loss | ($22.8m) | ($155.4m) | ($78.4m) | ($167.0m) |
| Loss per share, basic and diluted | ($0.17) | ($1.14) | ($0.57) | ($1.23) |
| Operating cash flow | Not separately presented for the quarter | $24.2m | $55.9m |
All amounts are U.S. dollars. Segment sales declined in Q2 by 40% in Industrial Materials and 48% in Engineered Solutions. For the first half, they declined 32% and 41%, respectively. Lower volumes were the largest driver, alongside lower prices and unfavorable currency effects.
At June 30, 2015, cash was $14.5m; current assets were $589.8m and current liabilities $330.4m. Total debt was $548.6m: $199.2m short-term and $349.3m long-term. The company reported $258m of available revolving capacity after restrictions and letters of credit, plus a $40m delayed-draw term facility. It reported compliance with debt covenants. Total assets were $1.713bn and stockholders’ equity $909.5m.
First-half investing cash outflow was $32.8m, including $25.6m of capital expenditures and $7.8m of derivative settlements. Financing provided $6.8m. Cash declined from $17.6m at year-end to $14.5m at June 30.
Material changes versus the prior comparable period
- Revenue contracted sharply amid weak steel and electric-arc-furnace demand, lower graphite electrode prices, foreign-exchange headwinds, weaker advanced consumer electronics and oil-and-gas demand, and the loss of sales to a customer that filed for bankruptcy.
- Gross margin improved year over year, while operating losses narrowed substantially. The comparison reflects a $121.6m long-lived-asset impairment recorded in Q2 2014; Q2 2015 had no impairment charge.
- First-half 2015 included a $35.4m goodwill impairment that fully impaired goodwill in the needle coke reporting unit, following further market-price declines and the company’s reassessment of expected cash flows.
- Cost reductions lowered selling and administrative expenses and helped offset part of the revenue decline. First-half rationalization charges were $4.3m, versus $0.9m in the prior-year period.
Outlook, transactions, risks and unusual items
- Management said market conditions remained challenging and did not expect significant improvement in results in the second half of 2015. Industrial Materials pricing was expected to be lower year over year, with volumes under pressure; Engineered Solutions also faced weak demand and pricing.
- The company said it was on track for approximately $50m of 2015 cash savings, but savings would not fully offset weaker pricing and volumes. Graphite electrode production averaged approximately 84% in the first half and was expected to fall to approximately 60% in the second half. 2015 capital expenditures were estimated at $50m–$55m, approximately $30m below the prior year.
- On May 17, 2015, GrafTech agreed to a Brookfield-affiliated cash tender offer for any and all common shares at $5.05 per share. The offer was extended after quarter-end, with an August 13, 2015 expiration stated in the filing, subject to conditions and regulatory approvals. A related $150m convertible preferred-stock investment was also pending. Proceeds were intended, together with other resources, to repay the senior subordinated notes due November 2015.
- The preferred stock would carry a cumulative 7% annual dividend and conversion and other rights. The proposed transactions could accelerate certain equity awards and compensation, trigger debt change-in-control provisions, or require note repurchases. The company disclosed that it intended to obtain relevant waivers; completion and related financing outcomes were not assured.
- At June 30, the senior subordinated notes had a $194.4m carrying value and $200m face amount, due November 2015. On July 9, the company notified holders of its intent to prepay or redeem them following receipt of preferred-stock proceeds. A July 28 credit-agreement amendment excluded Brookfield’s acquisition from specified change-in-control provisions and provided for covenant changes and a reduction in facility size from $400m to $375m upon the acquisition.
- Putative shareholder class actions challenged the proposed transaction and related disclosures; defendants said they considered the claims without merit and intended to defend them. The filing also disclosed a potential $20m termination fee under specified circumstances and reimbursement of Brookfield expenses up to $0.5m.
- Management cited weak global steel production, excess capacity and Chinese steel exports, as well as risks from demand, prices, currencies, raw materials, customer credit, covenants, refinancing, litigation and transaction approvals. Management stated that disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- Whether the Brookfield tender offer and preferred-stock investment closed, on what final terms, and whether required approvals and financing conditions were satisfied.
- Whether the $200m face amount of senior subordinated notes was repaid or redeemed, and the resulting cash, debt, interest and covenant position.
- Actual second-half demand, pricing, production rates and delivery of the targeted $50m in cash savings and $50m–$55m capital expenditure plan.
- Whether continued needle coke price weakness or other market changes led to further impairments, cash-flow pressure or covenant risk.
- The outcome and potential cost of transaction-related litigation and any other material legal, tax or contingency developments.