GRAFTECH INTERNATIONAL LTD quarterly report, Q1 FY2014

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GrafTech International Ltd. — Q1 2014 Form 10-Q

Business context and reporting period. Unaudited results cover the three months ended March 31, 2014, compared with the same period in 2013. GrafTech makes graphite and carbon products through Industrial Materials, serving primarily steel markets, and Engineered Solutions, serving industrial, electronics, energy, transportation and defense markets.

Financial performance

  • Revenue: $280.8 million, up 11% from $253.7 million. Industrial Materials sales rose 5% to $218.8 million; Engineered Solutions rose 38% to $62.0 million.
  • Profitability: Gross profit fell to $25.7 million from $48.6 million; gross margin declined to approximately 9.1% from 19.1%. Operating loss was $7.1 million versus operating income of $15.7 million. Net loss was $11.5 million, or $0.08 per share, compared with net income of $4.2 million, or $0.03 per share.
  • Segment results: Industrial Materials reported an operating loss of $9.4 million, versus income of $16.1 million. Engineered Solutions earned $2.4 million, versus a $0.3 million loss.
  • Cash flow: Operating cash flow was $22.1 million, compared with $18.0 million. Capital expenditures were $21.7 million versus $13.2 million; operating cash flow less capital expenditures was approximately $0.4 million. Investing activities used $17.1 million; financing activities provided $0.3 million.
  • Liquidity and debt: Cash was $17.3 million at quarter-end. Long-term debt was $554.5 million and short-term debt $0.2 million. The company reported $206 million of unused capacity under its then-current revolving facility, after covenant restrictions and letters of credit. Current assets were $795.6 million and current liabilities $201.7 million.
  • Other metrics: Research and development was $2.8 million; selling and administrative expense was $29.9 million. Interest expense was $9.0 million. The income tax benefit was $5.3 million, reflecting a 31.5% discrete-period effective rate.

Material changes versus Q1 2013

  • Sales growth did not translate into higher profit: cost of sales rose 24%, faster than the 11% increase in revenue. Results included $17.8 million of rationalization-related charges, chiefly accelerated depreciation.
  • Industrial Materials volumes increased, but pricing weakened: segment sales reflected a 22% volume increase, offset by an 18% negative price/mix effect. The weighted average graphite-electrode selling price, excluding currency, fell approximately 19% year over year.
  • Engineered Solutions benefited from higher volumes and new product sales, including high-temperature furnace systems, thermal solutions and advanced graphite materials.
  • Cash increased from $11.9 million at December 31, 2013 to $17.3 million at March 31, 2014. Long-term debt rose from $541.6 million to $554.5 million; the supply-chain-financing liability declined from $9.5 million to zero.

Outlook, commentary and risks

  • Management targeted 2014 EBITDA of $150–$180 million, overhead expense of $125–$130 million, interest expense of approximately $37 million, capital expenditures of $100–$110 million and depreciation and amortization of approximately $90 million. The forecast effective tax rate was revised to approximately 45% from 40%; operating cash flow guidance increased to $150–$180 million from $130–$160 million.
  • The EBITDA outlook reconciled to estimated 2014 net income ranging from a $14.3 million loss to $9.7 million of income. Management expected near break-even forecasted annual income and said it expected a return to overall profitability in the second half, after the rationalization plan was substantially complete.
  • The Industrial Materials initiative includes closing two high-cost graphite-electrode plants in Brazil and South Africa and a Russian machine shop, reducing capacity by approximately 60,000 metric tons and headcount by approximately 600. The plan was expected to incur about $95 million in pretax charges ($25 million cash and $70 million non-cash); $61.8 million was incurred in 2013. The plan was targeted for substantial completion by the end of Q2 2014. A separate Engineered Solutions initiative was expected to cost about $4.5 million, with the remainder expected in 2014 after $3.9 million of 2013 expense.
  • On April 23, 2014, the company amended and restated its revolving credit agreement. The new facility provides $470 million of borrowing capacity, matures in April 2019 and offered $332 million of unused capacity on a pro forma March 31 basis, compared with $206 million under the prior facility. The filing states the company was in compliance with existing covenants at quarter-end and expected compliance through December 31, 2014.
  • Key disclosed risks include graphite-electrode price and competitive pressure, steel-market demand, raw-material and energy costs and availability, currency and interest-rate movements, customer credit and order changes, restructuring execution, and liquidity or covenant pressure if operating results weaken. Management did not expect the cited legal matters to have a material adverse effect; the filing reported no material change to previously disclosed risk factors.

Investor verification priorities

  1. Track electrode pricing, price/mix, volumes and Industrial Materials margins; the large year-over-year price decline outweighed volume growth.
  2. Verify execution, cash costs, timing and expected savings from both rationalization programs, including the remaining plant closures and workforce reductions.
  3. Compare quarterly results and cash generation with the 2014 EBITDA, operating cash flow, capital expenditure and tax-rate outlook.
  4. Monitor revolving-facility availability, covenant headroom, debt levels and the terms and effects of the April 2014 refinancing.
  5. Assess whether Engineered Solutions growth and margins persist and whether working-capital needs absorb cash as sales increase.