GrafTech International Ltd. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual report, not a quarterly filing. GrafTech was acquired by Brookfield in August 2015; the 2015 results are divided into predecessor and successor periods under different accounting bases, so year-over-year comparisons require care. GrafTech was a voluntary filer and stated it was not subject to Exchange Act periodic filing requirements.
Business context
GrafTech’s continuing business was Industrial Materials, principally graphite electrodes used in electric-arc-furnace steelmaking and petroleum needle coke, a key electrode input. The company said it was focusing on graphite electrodes and pursuing divestiture of its Engineered Solutions businesses. Brookfield owned all common stock; the filing reports 100 shares outstanding.
Financial performance and liquidity
| Metric | FY 2016 | Context |
|---|---|---|
| Continuing-operations net sales | $438.0 million | Graphite electrode prices fell 27%; a 12% increase in sales volume partly offset the decline. |
| Gross profit (loss) | $(29.0) million | Included a $19.0 million lower-of-cost-or-market inventory charge; reported gross margin was approximately -6.6%. |
| Operating loss | $(92.1) million | Continuing operations. |
| Net loss from continuing operations | $(108.9) million | Income tax benefit was $7.6 million. |
| Net loss, including discontinued operations | $(235.8) million | Included $127.0 million loss from discontinued operations, substantially reflecting a $119.9 million impairment of Engineered Solutions assets held for sale. |
| Operating cash flow | $22.8 million | Working-capital changes provided $68.6 million, including $53.5 million from inventory reductions. |
| Capital expenditures | $27.9 million | Operating cash flow less capital expenditures was approximately $(5.0) million. |
| Cash and cash equivalents | $11.6 million | At December 31, 2016. |
| Debt | $365.4 million carrying amount | Included $274.1 million carrying value of Senior Notes, which have $300.0 million principal due in 2020, and $90.7 million under the credit agreement. |
The company had a $225 million revolving facility, subject to a $25 million minimum-liquidity requirement. At year-end, $61.2 million was borrowed and $12.3 million of letters of credit was outstanding. GrafTech reported compliance with applicable credit-facility covenants. Current assets were $330.9 million and current liabilities were $112.4 million; current assets include discontinued-operation assets.
Changes versus prior comparable period
- Continuing net sales were $438.0 million in 2016 versus $533.0 million for the combined 2015 predecessor and successor periods, a decline of about 18%. The filing attributes the 2016 revenue pressure primarily to lower electrode prices amid industry overcapacity and weak steel-market conditions; higher volume provided a partial offset.
- Gross results deteriorated to a $29.0 million loss, including the inventory valuation charge. GrafTech cited lower oil and decant-oil costs and prior rationalization initiatives as offsets to price pressure.
- Operating cash flow was $22.8 million in 2016, versus $51.4 million across the two 2015 periods. 2016 cash generation benefited materially from inventory reduction.
- Total net loss widened from $154.2 million across the two 2015 periods to $235.8 million in 2016, mainly due to the substantial discontinued-operations impairment. Comparisons are affected by the Brookfield acquisition accounting and the reclassification of Engineered Solutions as discontinued operations.
Outlook, commentary and risks
- Management described further electrode price declines in 2016 but noted indicators that the market might be bottoming. It said rising blast-furnace input costs and lower scrap costs were beginning to improve the relative economics of EAF steelmaking. No specific company revenue, earnings or cash-flow guidance was provided.
- The filing cited IMF global growth estimates of 3.1% for 2016 and 3.4% for 2017, and World Steel Association forecasts for global steel-demand growth of 0.5% in 2017. These are external forecasts, not company guidance.
- Management intended to sell the remaining Engineered Solutions businesses and use sale proceeds to repay revolving and term-loan borrowings. Fiber Materials Inc. was sold in November 2016 for $15.9 million, with up to $8.5 million of additional contingent proceeds tied to future earnings.
- Key risks include cyclical steel and EAF demand, electrode pricing and excess industry capacity, competition and imports (particularly from China), raw-material and energy availability and prices, foreign exchange, and dependence on successful asset sales and continued covenant compliance.
- Debt covenants restrict business and financing flexibility; a downturn could weaken cash flow and covenant headroom. Moody’s downgraded the Senior Notes to Caa1 in January 2016.
- GrafTech disclosed a Brazilian employee wage-claim lawsuit that could be material, as well as a Brazilian graphite-electrode antitrust investigation. It also faces environmental and other legal contingencies; the filing says outcomes and potential costs may be uncertain.
- Management reported effective internal control over financial reporting as of year-end; the auditor did not audit internal controls. Deloitte issued an unqualified opinion on the 2016 financial statements.
Investor verification priorities
- Verify the status, expected timing, proceeds and remaining impairment exposure for the Engineered Solutions divestitures, including contingent Fiber Materials consideration.
- Review debt maturities, the $25 million minimum-liquidity test, covenant thresholds and availability under the reduced $225 million revolving facility.
- Assess whether electrode pricing, volumes and EAF steel demand improved after year-end; distinguish management’s commentary from third-party forecasts.
- Examine the assumptions behind the $119.9 million discontinued-operations impairment and the $19.0 million inventory write-down.
- Track developments and potential exposure in the Brazilian wage litigation and antitrust investigation, and assess environmental accruals against possible future remediation costs.
- Use the audited statements and notes for precise comparisons: the 2015 acquisition created predecessor/successor accounting periods, while 2016 excludes Engineered Solutions from continuing operations.