GrafTech International Ltd. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. GrafTech manufactures graphite and carbon-based products through Industrial Materials, serving primarily steel markets, and Engineered Solutions, serving electronics, industrial, energy, transportation and defense markets. Financial statements are unaudited.
Financial performance
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q2 2012 | Q2 2013 | Six months 2012 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $315.6 | $301.4 | $556.5 | $555.1 |
| Gross profit / margin | $84.4 / 26.7% | $48.9 / 16.2% | $151.3 / 27.2% | $97.5 / 17.6% |
| Operating income / margin | $46.6 / 14.8% | $16.0 / 5.3% | $70.6 / 12.7% | $31.7 / 5.7% |
| Net income | $41.8 | $4.4 | $59.4 | $8.6 |
| Diluted earnings per share | $0.29 | $0.03 | $0.41 | $0.06 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $(31.5) | $11.6 |
| Capital expenditures | Not stated for quarter | Not stated for quarter | $61.6 | $38.5 |
- Revenue and segment mix: Q2 Industrial Materials sales fell 12% to $231.3 million; Engineered Solutions sales rose 31% to $70.0 million. For the first half, the segments changed by -3% and +14%, respectively.
- Debt and liquidity at June 30: Cash was $11.0 million; short-term debt $2.8 million; long-term debt $581.7 million. Total reported debt was therefore about $584.5 million. The company reported $371 million of unused revolver capacity after covenant restrictions and approximately $9.9 million of letters of credit. Current assets were $831.7 million and current liabilities $211.1 million.
- Cash movement: First-half cash increased from $17.3 million to $11.0 million after operating inflow of $11.6 million, investing outflow of $36.8 million and financing inflow of $19.4 million. Working capital used $51.0 million, including $33.4 million of inventory investment and $29.7 million of net outflows from payables and accruals.
- Other metrics: Comprehensive loss was $8.8 million in Q2 and $8.3 million for the first half, principally reflecting foreign-currency translation losses. First-half interest expense rose to $18.0 million from $9.9 million.
Changes versus comparable periods
- Q2 sales declined 5%, but cost of sales rose 9%; net income fell 90%. First-half sales were nearly flat, while cost of sales increased 13%, gross profit decreased 36%, operating income decreased 55%, and net income decreased 86%.
- Industrial Materials profitability weakened sharply. The company cited lower graphite-electrode prices, higher raw-material and overhead costs, and weaker needle-coke sales. Electrode average selling prices, excluding currency, fell approximately 15% in Q2 and 11% in the first half year over year. First-half electrode volumes increased, but did not offset price pressure.
- Engineered Solutions growth, notably advanced consumer electronics, partly offset Industrial Materials weakness. Segment sales rose 31% in Q2 and 14% in the first half; segment operating income was $8.4 million and $8.1 million, respectively, versus $4.7 million and $3.8 million in the comparable periods.
- Cost reductions lowered first-half selling and administrative expense by $13.7 million and research and development by $1.3 million. Higher interest expense largely reflected the $300 million 6.375% Senior Notes issued in November 2012.
- First-half 2012 results included a one-time $4.0 million insurance reimbursement for earlier flood damage. The 2012 tax comparison also benefited from a $10.5 million reduction in unrecognized tax benefits.
Outlook, management commentary and risks
- Management lowered 2013 EBITDA guidance to $145–$165 million from $165–$195 million, citing weaker-than-expected Industrial Materials demand and subdued steel-market conditions. Operating cash flow guidance fell to $110–$130 million from $150–$180 million, reflecting lower profitability and higher planned inventory.
- Other 2013 targets: overhead expense approximately $135 million (previously $140 million); interest expense approximately $37 million; capital expenditures $90–$110 million; depreciation and amortization approximately $95 million; and effective tax rate 35%–40% (previously 33%–36%). EBITDA is a company-defined non-GAAP measure.
- Management said it was in compliance with revolving-credit covenants at quarter-end and expected to remain compliant through year-end based on anticipated results and cash flows. It cautioned that it might need additional revolver borrowing if operating cash flow or supply-chain financing proved insufficient, and that a downturn could pressure cash flow, ratings, financing access and covenant compliance.
- Supply-chain financing for needle coke provides up to approximately $50 million of working-capital liquidity; the liability was $18.6 million at June 30. Inventory was $540.8 million, up from $513.1 million at year-end, partly due to contractual raw-material purchases and lower-than-anticipated sales.
- Risks highlighted include electrode pricing and competition, weak global steel demand, raw-material and energy costs or disruptions, customer credit and order changes, currency and interest-rate movements, and potential covenant constraints. The company reported various legal matters but did not believe their ultimate disposition would materially adversely affect its financial position, results or cash flows.
- The company recorded $2.9 million of additional Q2 depreciation expense ($1.9 million after tax) to correct prior-period errors, primarily releasing depreciation previously deferred in inventory. The first-half after-tax impact was $1.8 million; management said the adjustments were not material to previously issued or expected full-year 2013 financial statements.
- Management concluded disclosure controls were effective at the reasonable-assurance level; no material change in internal control over financial reporting was reported during the quarter.
Important facts for investors to verify
- Whether electrode pricing and Industrial Materials margins stabilize, given their central role in the earnings decline and reduced guidance.
- Whether inventory converts to sales and cash, and whether operating cash flow meets the revised $110–$130 million target.
- Debt-service capacity and covenant headroom under weaker operating results; confirm available revolver capacity and borrowing conditions.
- Progress against revised EBITDA, overhead, capital-spending and tax-rate targets, including the assumptions underlying non-GAAP EBITDA guidance.
- The effects of the depreciation correction, tax audits and $10.0 million of unrecognized tax benefits, as well as developments in disclosed legal matters.