Business context and reporting period
GrafTech International Ltd. filed this Form 10-K for the fiscal year ended December 31, 2012. The company makes graphite and carbon products through two segments: Industrial Materials, serving primarily steel and metals markets, and Engineered Solutions, serving electronics, energy, transportation, industrial, and defense markets. Results are audited; quarterly figures cited below are unaudited.
Financial results and liquidity
| Metric | FY 2012 | FY 2011 | Change |
|---|---|---|---|
| Net sales | $1,248.3 million | $1,320.2 million | Down 5% |
| Gross profit / margin | $315.8 million / 25.3% | $324.5 million / 24.6% | Profit down 3% |
| Operating income / margin | $156.5 million / 12.5% | $166.0 million / 12.6% | Down 6% |
| Net income | $117.6 million | $153.2 million | Down 23% |
| Diluted EPS | $0.84 | $1.05 | Down $0.21 |
| Cash from operating activities | $101.4 million | $76.6 million | Up $24.8 million |
FY 2012 capital expenditures were $127.7 million; operating cash flow less capital expenditures was approximately negative $26.3 million. Working capital consumed $106.2 million of cash, including $67.3 million for inventory. At year-end, cash was $17.3 million, total debt was approximately $544.1 million, and unused revolving capacity was approximately $468 million, subject to covenants. The company reported covenant compliance and expected to remain compliant through 2013.
Industrial Materials sales fell 9% to $1,025.6 million; segment operating income declined to $143.3 million from $158.5 million. Engineered Solutions sales rose 18% to a record $222.7 million; segment operating income increased to $13.2 million from $7.5 million.
In Q4 2012, sales were $371.0 million, gross profit $84.5 million, net income $28.6 million, and diluted EPS $0.21, compared with $348.0 million, $83.7 million, $57.1 million, and $0.39, respectively, in Q4 2011. The 2012 fourth-quarter pension and postretirement mark-to-market loss was $8.8 million.
Material changes versus the prior year
- Lower Industrial Materials volumes—particularly electrodes and needle coke—more than offset higher realized prices. Electrode average selling prices, excluding currency effects, rose about 10% year over year.
- Engineered Solutions growth, led by advanced consumer electronics and 2011 acquisitions, offset continued weakness in solar-related sales.
- Net income declined despite lower sales, reflecting higher interest expense ($23.2 million versus $18.3 million) and a swing from a $9.9 million income tax benefit in 2011 to $16.8 million of tax expense in 2012. The respective effective tax rates were negative 6.9% and 12.5%.
- Inventory increased to $513.1 million from $444.1 million, while total assets rose to $2.30 billion from $2.17 billion.
Outlook, risks, and unusual items
Management’s 2013 targets were $175–$205 million for its stated earnings measure (earnings before interest, taxes, depreciation, amortization, and other income or expense), $150–$180 million of operating cash flow, $90–$120 million of capital expenditures, and $35–$40 million of interest expense. It forecast a 33%–36% effective tax rate, approximately 23%–26% cash tax rate, and expected higher Industrial Materials volumes from restocking and improved steel production. Management cautioned that new electrode and needle-coke capacity, excess industry supply, and weak steel-market conditions were driving downward pricing pressure. It expected the first quarter to be the weakest and the second half to improve; Engineered Solutions was targeted for double-digit full-year revenue growth.
Management planned cost reductions and lower overhead, while directing growth investment toward Engineered Solutions. Its 2013 segment plans included approximately $60 million of Industrial Materials capital expenditures and $45 million for Engineered Solutions, of which $35 million was growth capital.
In November 2012, GrafTech issued $300 million of 6.375% senior unsecured notes due 2020. Proceeds principally supported repayment of revolving borrowings; the company’s reported debt mix shifted substantially toward fixed-rate or zero-interest obligations. Senior subordinated notes have a $200 million face amount due in 2015, versus a $164.2 million carrying value at year-end. The company repurchased approximately 10.1 million shares in 2012 for $103.5 million and authorized a replacement program for up to 10 million shares; no purchases under the replacement program had been made by year-end.
Key risks include cyclical steel demand, intensifying competition and capacity additions, raw-material and energy availability and cost, foreign exchange exposure, debt service and restrictive covenants, deferred-tax-asset realizability, environmental obligations, and potential goodwill impairment. A Brazilian wage-interpretation dispute could lead to substantial claims if a prior favorable court ruling is reversed. Environmental remediation accruals were $8.3 million; management noted actual costs could exceed accruals. The 2012 results also included $4.0 million of flood-damage insurance reimbursements and the $8.8 million pension and postretirement mark-to-market loss. Management reported effective internal controls; the independent auditor gave unqualified opinions on the financial statements and internal control.
Important facts for investors to verify
- Whether 2013 pricing pressure and added electrode and needle-coke capacity materially affect segment margins, volumes, and management’s earnings targets.
- Whether inventory is reduced as planned and working-capital needs permit the targeted operating cash flow and capital program.
- Debt maturities, the 2015 $200 million face-value subordinated-note obligation, revolving-facility availability, and ongoing covenant headroom.
- Progress on the expiring 2013 needle-coke supply contracts and access to suitable feedstocks for Seadrift.
- Realizability of deferred tax assets and foreign tax credits, along with developments in the Brazilian labor litigation and environmental matters.
- Whether share repurchases continue and how capital allocation balances buybacks, debt, maintenance, and growth investment.