GrafTech International Ltd. — 2009 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2009; it also presents unaudited fourth-quarter results. GrafTech manufactures graphite electrodes and refractory products (Industrial Materials) and advanced graphite and natural graphite products (Engineered Solutions). Industrial Materials accounted for about 82% of 2009 sales. The global recession sharply reduced steel production, customer orders, and industry utilization.
Financial performance
| Metric | 2009 | 2008 |
|---|---|---|
| Net sales | $659.0 million | $1,190.2 million |
| Gross profit / margin | $191.1 million / 29.0% | $433.4 million / 36.4% |
| Operating income / margin | $98.6 million / 15.0% | $328.7 million / 27.6% |
| Net income | $12.6 million | $200.5 million |
| Diluted EPS | $0.10 | $1.74 |
| Operating cash flow | $170.3 million | $248.6 million |
| Capital expenditures | $56.2 million | $72.0 million |
Sales fell 45% year over year, primarily on lower volumes: Industrial Materials sales declined 47% to $538.1 million and Engineered Solutions sales declined 33% to $120.9 million. Segment operating income was $88.8 million and $9.8 million, respectively. Lower volumes and poor fixed-cost absorption compressed margins; price and mix partly offset the volume decline. Operating cash flow remained positive, supported in part by a $67.6 million working-capital cash source, including lower inventories.
Fourth quarter: Sales were $202.4 million, gross profit was $66.8 million, and net income was $34.3 million. Sales and gross profit improved sequentially as customers began replenishing depleted inventories. The quarter’s reported results included a $3.5 million gain from derecognizing a Brazilian excise-tax liability, a $0.6 million IT outsourcing termination expense, and a $4.1 million U.S. tax expense related to a currency gain on intercompany loan repayment.
Financial position and liquidity
At year-end, cash and cash equivalents were $50.2 million, total assets $892.6 million, and stockholders’ equity $577.1 million. Reported debt was $1.1 million short-term and $1.5 million long-term. GrafTech had no Revolving Facility borrowings and reported $209.2 million available after letters of credit; it also cited approximately $75 million of liquidity through factoring and supply-chain arrangements. The $215 million Revolving Facility was due to mature July 15, 2010, and the company was negotiating a replacement. It reported compliance with its financial covenants at year-end.
Operating cash flow less capital expenditures was approximately $114.1 million. Financing cash use included redemption of the remaining $19.9 million Senior Notes; all Senior Notes were redeemed in 2009. The company also had a $21.1 million incentive-compensation payout expected in the second quarter of 2010. No cash dividends were paid in 2008 or 2009.
Material changes, outlook, and risks
- Industry graphite-electrode utilization was estimated at approximately 50% for 2009, down sharply from prior levels. GrafTech said fourth-quarter customer restocking had begun, but demand remained below pre-crisis levels.
- GrafTech recorded a $52.8 million noncash impairment of its Seadrift affiliate investment in 2009, following a $34.5 million impairment in 2008. Further impairment was possible if forecast revenue, growth, or profitability assumptions were not achieved. The company also loaned Seadrift $6.0 million; the subordinated demand note bears 10% interest.
- Needle-coke costs were a significant 2010 risk: material purchased in late 2009 cost about 50% more per metric ton than 2008 material, and its use was expected to raise 2010 cost of goods sold. The negotiated 2010 purchase price was essentially flat with 2009; passing costs through to customers depended on market recovery.
- For 2010, management targeted first-quarter operating income of $30–$34 million, with marginal earnings improvement in later quarters. It expected higher electrode volumes, partly offset by higher raw-material costs, and Engineered Solutions recovery beginning in the second half. Targets included overhead of $105–$110 million, capital expenditures of $70–$75 million, depreciation of about $35 million, and an effective tax rate of 24%–27%. Management said limited visibility and shorter-term customer contracts constrained detailed full-year guidance.
- Other key risks included refinancing the July 2010 revolver on acceptable terms, restrictive debt covenants, weak steel and end-market demand, competition and pricing pressure, raw-material and energy supply/cost changes, foreign-exchange exposure, environmental and legal contingencies, and realization of deferred tax assets. At year-end, $106.8 million of gross deferred tax assets was covered by a valuation allowance; the filing reported $165.7 million of gross deferred tax assets and $69.3 million of gross deferred tax liabilities.
- Management concluded internal control over financial reporting was effective; the independent auditor gave an unqualified opinion on the financial statements and internal controls.
Important facts for investors to verify
- Whether the company refinanced the Revolving Facility before its July 2010 maturity, and the replacement facility’s size, cost, covenants, and availability.
- Whether volume recovery and price realization offset higher needle-coke costs, and whether 2010 operating results tracked management’s targets.
- Whether Seadrift’s operating performance and valuation assumptions support the remaining investment carrying value and $6.0 million loan.
- Whether U.S. taxable income supports use of deferred tax assets and whether tax audits or uncertain tax positions change the reported provision or valuation allowance.
- Whether customer restocking represented durable demand improvement, given the sharp 2009 sales decline and estimated industry utilization of about 50%.