GrafTech International Ltd. — 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; filed February 27, 2014. The filing is an annual report, not a standalone fourth-quarter filing. Unless otherwise noted, amounts below are U.S. dollars.
Business context and reporting period
GrafTech manufactures graphite and carbon products through two segments: Industrial Materials (graphite electrodes, refractories and needle coke) and Engineered Solutions (specialty graphite, composites, electronics and other advanced materials). Industrial Materials supplied 78% of 2013 sales; approximately 75% of sales were to customers outside the United States. The business is exposed to steelmaking, especially electric-arc-furnace steel production, as well as electronics, energy, transportation and other industrial markets.
Financial performance and liquidity
| Metric | FY 2013 | FY 2012 |
|---|---|---|
| Net sales | $1,166.7 million | $1,248.3 million |
| Gross profit / gross margin | $139.1 million / 11.9% | $315.8 million / 25.3% |
| Operating income (loss) / margin | $(2.6) million / (0.2)% | $156.5 million / 12.5% |
| Net income (loss) | $(27.3) million | $117.6 million |
| Diluted earnings (loss) per share | $(0.20) | $0.84 |
| Cash from operating activities | $116.8 million | $101.4 million |
| Capital expenditures | $86.3 million | $127.7 million |
Operating cash flow less capital expenditures was approximately $30.5 million in 2013, versus a use of approximately $26.3 million in 2012. Cash and cash equivalents were $11.9 million at year-end, compared with $17.3 million a year earlier. Current assets were $775.7 million and current liabilities $215.9 million; inventory was $490.4 million.
At year-end, long-term debt was $541.6 million and short-term debt $1.2 million. Long-term debt included $64.0 million drawn on the revolving facility, $300.0 million of 6.375% senior notes due 2020, and $175.7 million carrying value of non-interest-bearing senior subordinated notes with $200 million face value due in 2015. Unused revolver capacity was $246.1 million after covenant limitations and letters of credit. The company reported compliance with its debt covenants.
Material changes versus the prior comparable period
- Consolidated sales declined 7%. Industrial Materials sales fell 11% to $909.4 million, mainly as graphite electrode selling prices declined approximately 14%; electrode volumes increased. Engineered Solutions sales rose 16% to a record $257.2 million, led by advanced consumer electronics.
- Industrial Materials segment operating results moved from $143.3 million income to a $22.5 million loss. Engineered Solutions operating income increased from $13.2 million to $19.9 million.
- Cost of sales rose $95.1 million despite lower consolidated sales, reflecting rationalization-related charges, input costs and higher Industrial Materials volumes. Lower electrode and needle-coke prices compressed margins.
- Interest expense increased to $36.0 million from $23.2 million, primarily due to the $300 million senior notes issued in November 2012.
- Operating cash flow increased $15.4 million, principally as working capital provided $32.0 million of cash in 2013, versus using $106.2 million in 2012. Inventory declined $14.3 million and receivables declined $37.4 million, while accounts payable and accruals declined $38.2 million.
- Quarterly data show fourth-quarter sales of $308.5 million, gross profit of $5.0 million and net loss of $28.2 million. The quarter included $48.2 million of rationalization and related charges, including $27.0 million accelerated depreciation; a $14.4 million pension and postretirement mark-to-market gain partly offset charges.
Outlook, management commentary, risks and unusual items
- 2014 targets: Adjusted EBITDA of $150–$180 million; depreciation and amortization of approximately $90 million; selling, administrative and R&D overhead of $125–$130 million; interest expense of approximately $37 million; capital expenditures of $100–$110 million; effective tax rate of approximately 40%; and operating cash flow of $130–$160 million, including cash rationalization charges. EBITDA is a non-GAAP measure and the company cautions it is not a substitute for GAAP results or cash flow.
- Restructuring: The plan announced in October 2013 closes the two highest-cost graphite-electrode plants in Brazil and South Africa and a machine shop in Russia, alongside overhead reductions. It reduces electrode capacity by approximately 60,000 metric tons and is expected to be substantially complete by the end of Q2 2014. Management expects approximately $75 million in annual savings, including about $50 million in 2014, and approximately $150 million in working-capital improvements across 2014–2015. The Industrial Materials plan carries about $100 million of expected pretax charges, approximately $30 million cash; a separate Engineered Solutions initiative is expected to cost about $4.5 million.
- The ConocoPhillips/Phillips 66 needle-coke supply contracts expired at the end of 2013. GrafTech said it planned to source most 2014 requirements internally from Seadrift, supplemented by external purchases.
- Key operating risks include weak steel and electrode markets, industry overcapacity and price competition, further declines in electrode specific consumption, raw-material and energy price/supply volatility, foreign exchange exposure, and the successful execution and realization of restructuring savings.
- Financial risks include substantial debt, covenant restrictions, the 2015 subordinated-note maturity, variable-rate revolver exposure, and limited cash relative to obligations. Deferred tax assets are subject to valuation allowances; $20.4 million of gross deferred tax assets required an allowance at year-end, and $22.1 million of foreign tax credit carryforwards expire in 2016.
- GrafTech disclosed ongoing legal and environmental matters that it did not expect to have a material adverse effect based on information then available. A Brazilian wage-increase dispute could lead to substantial claims if a prior favorable Supreme Court ruling is reversed. Environmental remediation costs could exceed recorded accruals; the environmental remediation liability was $7.0 million at year-end. Goodwill was $496.8 million; management reported that estimated fair value exceeded carrying value but warned deterioration could trigger impairment.
- Other notable items: 2013 included $65.7 million of rationalization and related charges; a $14.4 million pension/OPEB mark-to-market gain; and a $2 million gain from resolution of a previously recorded contingency. The company recorded an additional $2.7 million depreciation correction relating to prior periods, which it said was not material to 2013 or prior statements. PwC issued unqualified opinions on the financial statements and internal control; management also concluded internal control was effective.
Most important facts for investors to verify
- Whether electrode pricing, demand and Industrial Materials margins stabilized, and whether the 2014 EBITDA and cash-flow targets were achieved.
- Whether plant closures and headcount actions were completed on schedule, with savings and working-capital benefits near management’s estimates and without material disruption.
- Whether internal and external needle-coke sourcing met production needs at competitive cost after the supply contracts expired.
- Liquidity and covenant headroom, particularly in light of the $200 million face-value subordinated notes due in 2015 and the company’s relatively low cash balance.
- Whether Engineered Solutions growth and margins continued, and whether demand in industrial and solar-related markets improved.
- Developments in the Brazilian labor dispute, environmental remediation obligations, deferred-tax-asset realizability and goodwill impairment assumptions.