GrafTech International Ltd. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. GrafTech manufactures graphite and carbon-based products through its Industrial Materials and Engineered Solutions segments.
Financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $260.5 million | $303.1 million | $825.4 million | $858.2 million |
| Gross profit / margin | $17.6 million / 6.8% | $36.6 million / 12.1% | $61.3 million / 7.4% | $134.1 million / 15.6% |
| Operating income (loss) | $(23.1) million | $(8.6) million | $(169.6) million | $23.1 million |
| Net income (loss) | $(34.9) million | $(7.6) million | $(201.9) million | $1.0 million |
| Diluted loss per share | $(0.26) | $(0.06) | $(1.48) | Income of $0.01 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $82.9 million | $65.2 million |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $69.3 million | $62.7 million |
Q3 sales fell 14% year over year. Industrial Materials sales declined 11% and Engineered Solutions sales declined 26%. For the first nine months, Industrial Materials sales were down 6%, while Engineered Solutions sales rose 4%. The nine-month operating loss includes a $121.6 million impairment charge.
Balance sheet and liquidity
- At September 30, cash was $10.9 million, total debt was approximately $540.7 million (including $1.1 million short-term debt), and stockholders’ equity was $1.11 billion. Cash less debt implies net debt of about $529.8 million.
- Unused revolving-credit capacity was $277 million after covenant restrictions and $5.7 million of letters of credit. The amended $470 million facility matures in April 2019; $53 million was drawn at period-end.
- The company reported compliance with credit covenants at September 30 and expected compliance through December 31, 2014. Covenants include minimum cash interest coverage of 2.50:1 and maximum senior secured leverage of 3.00:1.
- Nine-month cash from operations was $82.9 million; investing used $63.0 million and financing used $20.2 million. Cash ended at $10.9 million, down from $11.9 million at year-end 2013.
- Inventory decreased to $418.5 million from $490.4 million at year-end, contributing to working-capital cash generation. The supply-chain financing liability was zero at September 30.
Material changes and unusual items
- Management cited lower graphite-electrode pricing and weaker volumes, alongside weaker needle-coke pricing. Q3 electrode average selling prices, excluding currency effects, fell about 8%; the nine-month figure fell about 11%.
- Engineered Solutions faced lower pricing and volumes in thermal products for advanced consumer electronics. A customer bankruptcy led to $4.8 million of bad-debt expense and inventory write-downs in Q3. That customer had accounted for $17.5 million of new high-temperature furnace-system sales in the first nine months, creating uncertainty about future sales.
- GrafTech recorded $121.6 million of long-lived asset and related impairments in Engineered Solutions, including a $0.4 million goodwill impairment, after deciding to cease isomolded graphite production. Related inventory write-downs and other charges were also recorded.
- A $57.0 million non-cash tax charge in Q2 established a valuation allowance against U.S. deferred tax assets because recent losses weakened the evidence for their realization.
- Rationalization actions include closures of high-cost electrode plants in Brazil and South Africa and a Russian machine shop, reducing electrode capacity by about 60,000 metric tons and workforce by approximately 600, or 20%. Additional corporate and R&D actions include a planned 25% reduction in corporate functions and a smaller headquarters.
Outlook, risks, and contingencies
- Management reported that 5%–10% of expected graphite-electrode shipments for the second half of 2014 had been delayed into 2015, lowering production rates. It described the operating environment as challenging.
- Management targeted full-year 2014 EBITDA of $105 million–$115 million and net loss of $210.5 million–$217.5 million. These are company-defined non-GAAP EBITDA and GAAP net-loss targets, respectively.
- Corporate/R&D rationalization actions are expected to generate approximately $30 million in annualized recurring savings, mostly in 2015; the Engineered Solutions actions are expected to generate about $18 million in annual savings, with approximately $1 million in 2014. Management cautioned that savings may be delayed or not achieved.
- The Brazilian competition authority revived an investigation concerning alleged conduct in 1992–1998; no penalties had been assessed or asserted as of the filing. GrafTech stated it believes it has defenses. The company also reported EPA settlement discussions over alleged emissions-reporting deficiencies at its Seadrift subsidiary and did not expect material penalties.
- Key risks include further weakness in steel and graphite-electrode markets, pricing pressure and shipment delays, customer credit events, realization of restructuring savings, goodwill or asset impairment, currency and input-cost movements, and possible covenant or financing pressure if results deteriorate.
Key facts investors should verify
- Whether shipment deferrals, electrode pricing, and segment margins improve or worsen in subsequent filings.
- Whether the company remains within revolving-facility covenants and preserves adequate borrowing availability.
- Whether the announced cost savings are realized on schedule and whether further restructuring or impairment charges arise.
- The extent of revenue and receivable exposure to the bankrupt customer, and the effect on future Engineered Solutions sales.
- Developments in the Brazilian antitrust investigation and Seadrift EPA matter, including any penalties or material financial impact.