GrafTech International Ltd. — 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010. This is an annual report, not a standalone fourth-quarter filing; quarterly figures below are unaudited. The company makes graphite and carbon products for steelmaking and other industrial markets, reported in Industrial Materials and Engineered Solutions.
Financial performance
| Metric | 2010 | 2009 | Change |
|---|---|---|---|
| Net sales | $1,007.0 million | $659.0 million | +53% |
| Gross profit | $289.4 million | $191.1 million | +51% |
| Operating income | $159.2 million | $98.6 million | +61% |
| Net income | $175.1 million | $12.6 million | Increased substantially |
| Diluted EPS | $1.42 | $0.10 | Up $1.32 |
| Operating cash flow | $144.9 million | $170.3 million | Down $25.4 million |
| Capital expenditures | $86.0 million | $56.2 million | Up $29.8 million |
- Gross margin was approximately 28.7% (2009: 29.0%); operating margin was approximately 15.8% (2009: 15.0%).
- Net income included a $30.3 million deferred-tax valuation allowance release related to the acquisitions, a $9.6 million non-cash gain on remeasurement of the prior Seadrift investment, and $15.2 million of acquisition costs. The reported effective tax rate was negative 0.2%, versus 65.8% in 2009; consequently, reported earnings are not a straightforward measure of underlying operating improvement.
- Cash flow from operations less capital expenditures was approximately $58.9 million, calculated from reported figures. Operating cash flow declined mainly as higher sales drove increases in receivables and inventory; working capital used $41.8 million.
- At year-end, cash was $13.1 million; long-term debt was $275.8 million, including $130.0 million drawn on the revolving facility and $143.4 million carrying value for subordinated notes. Revolver availability was $126.6 million. Total assets were $1.913 billion and stockholders’ equity was $1.230 billion.
Segments and fourth quarter
- Industrial Materials sales rose 55% to $833.9 million; segment operating income increased to $141.0 million from $88.8 million. Engineered Solutions sales rose 43% to $173.1 million; segment operating income increased to $18.2 million from $9.8 million.
- For the full year, sales growth reflected higher shipment volumes, partly offset by lower price/mix and currency effects. Industrial Materials volume increased 65%, while price/mix fell 6%; graphite electrode average selling prices declined about 7%, excluding currency effects.
- Fourth-quarter sales were $281.2 million, gross profit $71.5 million, and net income $77.6 million, or $0.60 diluted EPS. The quarter’s earnings included the $30.3 million tax benefit and acquisition-related items.
Material changes and transactions
- The company acquired the remaining 81.1% of Seadrift and all of C/G on November 30, 2010; their results are included only from December 1. Seadrift produces petroleum needle coke, a key electrode input; C/G makes large-diameter premium graphite electrodes. Management expects supply security, cost benefits, and improved North American customer service, but cautions that integration costs and benefits are uncertain.
- Acquisition consideration was reported at $936.7 million, including the fair value of the previously held Seadrift stake. Consideration to the sellers included approximately $249.4 million cash, 24.0 million shares valued at about $467.3 million, and $200 million face value of non-interest-bearing notes due 2015. The notes were recorded at $142.6 million fair value.
- Goodwill increased to $499.2 million, including $489.2 million from the acquisitions; acquired finite-lived intangible assets totaled $158.2 million. The purchase-price allocation was preliminary. Management reported no goodwill impairment in its 2010 annual test.
- Sales rebounded from the 2009 recessionary trough, but 2010 sales remained below 2008’s $1.190 billion. The reported 2010 increase also includes one month of acquired-company sales.
Liquidity, outlook, risks, and other matters
- The revolving facility was extended to April 2013, with a $260 million commitment and a conditional accordion up to $390 million. GrafTech reported compliance with its financial covenants at year-end; the facility requires at least 1.75x interest coverage and limits net senior secured leverage to 2.25x, subject to the agreement’s terms.
- Management’s 2011 targets: operating cash flow of $185–$215 million; capital expenditures of $135–$150 million; overhead expense of $145–$155 million; interest expense of $18–$20 million; depreciation and amortization of about $85 million; effective tax rate of 22%–24%; and diluted share count of about 146 million. It expected higher electrode volumes, partly offset by pricing pressure. These are targets, not guarantees.
- Needle-coke supply agreements with ConocoPhillips were terminated effective December 31, 2010 and replaced with three-year arrangements. Management said contracted quantities were expected to meet forecast requirements and that most 2011 needs had firm pricing; approximately 35% of 2011 requirements were expected from Seadrift.
- Key risks include cyclical steel and EAF demand, electrode price competition and capacity utilization, raw-material and energy costs and availability, acquisition integration and realization of expected benefits, foreign exchange exposure, restrictive debt covenants, and environmental or greenhouse-gas regulation.
- Contingencies include potential claims relating to historic Brazilian wage provisions, which could become substantial if an adverse legal outcome occurs, and environmental remediation obligations. Management did not expect the ultimate disposition of current legal matters to materially affect the company, but outcomes are uncertain.
- Management and the auditor concluded internal control over financial reporting was effective as of year-end. Seadrift and C/G, representing 50% of consolidated assets and 2% of sales, were excluded from the year-end controls assessment under the acquisition-year provision. The financial statements received an unqualified audit opinion.
Investor verification priorities
- Separate organic operating performance from the one-month consolidation of Seadrift and C/G, and evaluate the preliminary acquisition accounting, goodwill, and expected synergies.
- Assess whether cash generation can support the 2011 capital-spending plan while maintaining covenant headroom and managing the increased debt burden.
- Review electrode pricing, needle-coke contract terms and costs, and whether higher volumes can offset price pressure and input-cost inflation.
- Determine how much of 2010 earnings depended on the deferred-tax valuation allowance release and other acquisition-related or non-cash items.
- Monitor the Brazilian wage litigation, environmental exposures, and integration of the acquired businesses, including controls integration.