GrafTech International Ltd. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. GrafTech manufactures graphite and carbon products, reporting in Industrial Materials and Engineered Solutions. Financial amounts below are in U.S. dollars; statements are unaudited.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $303.1 million | $320.7 million | $858.2 million | $877.3 million |
| Gross profit / margin | $36.6 million / 12.1% | $80.0 million / 24.9% | $134.1 million / 15.6% | $231.3 million / 26.4% |
| Operating income (loss) | $(8.6) million | $43.6 million | $23.1 million | $114.1 million |
| Net income (loss) | $(7.6) million | $29.6 million | $1.0 million | $89.0 million |
| Diluted EPS | $(0.06) | $0.22 | $0.01 | $0.63 |
- Q3 Industrial Materials sales fell 10% to $233.3 million; Engineered Solutions sales rose 15% to $69.8 million. Nine-month changes were down 6% and up 14%, respectively.
- Operating cash flow for the first nine months was $65.2 million, versus $13.6 million a year earlier. Investing cash outflow was $59.5 million, including $62.7 million of capital expenditures; financing cash outflow was $11.1 million. Cash declined to $11.5 million from $17.3 million at year-end 2012.
- At September 30, cash was $11.5 million; short- and long-term debt totaled $564.0 million, compared with $544.1 million at year-end 2012. Stockholders’ equity was $1.35 billion. The company reported $331.0 million of unused revolver capacity after covenant restrictions and letters of credit.
- Current assets were $805.3 million and current liabilities $215.3 million. Inventory was $519.0 million, including reserves of $11.6 million.
- Interest expense rose to $9.1 million in Q3 and $27.1 million for nine months, principally due to the $300 million 6.375% Senior Notes issued in November 2012. The revolving facility had $85 million drawn; the company reported compliance with its covenants.
Material changes and management commentary
- Gross profit fell 54% in Q3 and 42% for the nine-month period, chiefly reflecting lower electrode and needle-coke pricing and higher costs associated with greater electrode volumes. Electrode average selling prices, excluding currency effects, declined approximately 18% in Q3 and 14% for nine months year over year.
- Industrial Materials’ Q3 operating loss was $12.9 million, compared with $37.3 million of operating income a year earlier. Engineered Solutions operating income was $4.4 million, down from $6.3 million. For nine months, Industrial Materials operating income fell to $10.7 million from $104.1 million; Engineered Solutions increased to $12.5 million from $10.0 million.
- Management cited continued pressure from electrode capacity additions, weak steel-market conditions and customers’ efforts to reduce electrode consumption or use lower-cost products. Engineered Solutions growth included advanced consumer electronics; advanced graphite materials remained affected by weaker industrial and solar-related demand.
- Q3 included $14.6 million of rationalization expense, plus $1.3 million of accelerated depreciation and $1.6 million of inventory losses recorded in cost of sales. Other income included a $2.0 million gain from resolving a previously recorded loss contingency. The nine-month 2012 comparison included a $4.0 million insurance recovery.
- Management reported an interim goodwill impairment review with no impairment recorded; it cautioned that further economic deterioration or adverse changes in valuation assumptions could lead to impairment. A $2.7 million additional depreciation expense was recorded in the first nine months to correct prior-period errors; management said the adjustments were not material to prior or expected full-year 2013 statements.
Outlook, risks and contingencies
- Revised 2013 targets: EBITDA of $145–$155 million (previously $145–$165 million); overhead expense of about $130 million (previously $135 million); interest expense about $36 million; capital expenditures of $90–$100 million (previously $90–$110 million); depreciation and amortization of $95–$100 million; effective tax rate of 10%–20% (previously 35%–40%); and operating cash flow of $100–$120 million (previously $110–$130 million). EBITDA is a non-GAAP measure.
- The announced global restructuring plans to close two high-cost electrode plants and machine shops in Brazil and South Africa, and a machine shop in Russia, subject to workforce and union consultations. The plan would reduce capacity by about 60,000 metric tons and headcount by about 600, or 20% of the workforce. Estimated total pretax costs are $105 million—about $30 million cash and $75 million noncash—with approximately $51 million of additional expense expected in Q4 2013. Management targets completion by the end of Q2 2014 and estimates $75 million in annual savings, including about $35 million in 2014. Working-capital improvements are expected to help fund cash costs; management also expects inventory to decline about $100 million, with $75 million in 2014.
- Management expected covenant compliance through 2013 and 2014 based on forecast results, but warned that weaker results, liquidity needs or termination of supply-chain financing could require additional revolver borrowing and could pressure covenant compliance or access to financing. Revolver covenants include minimum cash interest coverage of 3.00:1 and maximum senior secured leverage of 2.25:1.
- Key operating risks include volatile steel and graphite-electrode demand and pricing, raw-material and energy costs, currency movements, customer credit and order patterns, labor consultations, execution and disruption risks from restructuring, and uncertain realization or timing of cost savings. Legal proceedings were described as not expected to have a material adverse effect, though outcomes are uncertain.
Important facts for investors to verify
- Whether electrode pricing and Industrial Materials margins stabilize, and whether higher volumes can offset price pressure.
- Progress on plant closures and workforce consultations; actual restructuring charges, cash payments, capacity reduction and savings versus the stated timetable and targets.
- Delivery of revised full-year EBITDA and operating cash-flow guidance, including the assumptions behind non-GAAP EBITDA.
- Working-capital and inventory reductions, cash generation, revolver availability and continued compliance with debt covenants.
- Debt-service burden, including the 2015 maturity of the Senior Subordinated Notes and the 2020 maturity of the 6.375% Senior Notes.
- Goodwill valuation assumptions and any further impairment indicators; also review the disclosed prior-period depreciation correction and its treatment.