GrafTech International Ltd. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods. GrafTech manufactures graphite and carbon products. Its Industrial Materials segment serves primarily the steel industry; Engineered Solutions serves electronics, industrial, energy, transportation and defense markets. Financial statements are unaudited.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $320.7 million | $345.8 million | $877.3 million | $972.2 million |
| Gross profit | $80.0 million | $92.7 million | $231.3 million | $240.8 million |
| Gross margin | 25.0% | 26.8% | 26.4% | 24.8% |
| Operating income | $43.6 million | $57.5 million | $114.1 million | $134.7 million |
| Net income | $29.6 million | $40.3 million | $89.0 million | $96.1 million |
| Diluted EPS | $0.22 | $0.28 | $0.63 | $0.66 |
- Q3 operating margin was 13.6%, versus 16.6% a year earlier; nine-month operating margin was 13.0%, versus 13.9%.
- Q3 Industrial Materials sales fell 14% to $260.2 million, chiefly on lower electrode and needle-coke volumes; higher realized prices partly offset the declines. Engineered Solutions sales rose 39% to $60.5 million, led by advanced consumer electronics and acquisition-related revenue.
- Nine-month Industrial Materials sales declined 14% to $715.5 million, while Engineered Solutions increased 18% to $161.8 million. Segment operating income declined in both segments year over year for the nine-month period.
- Nine-month operating cash flow was $13.6 million, down from $29.3 million. Investing cash outflow was $85.9 million, including $92.8 million of capital expenditures; financing cash inflow was $76.6 million. Working capital used $128.4 million, including a $96.3 million inventory cash outflow.
- At September 30, cash was $16.2 million; short-term debt was $0.2 million and long-term debt was $593.5 million. Revolver borrowings were $430 million, with $117 million available and $8 million of letters of credit outstanding. GrafTech reported compliance with its debt covenants.
- Inventories rose to $545.8 million from $444.1 million at year-end 2011. The company said it expected to reduce inventory significantly over the 18 months beginning in Q4 2012.
Changes, outlook and notable items
- Q3 sales fell 7%, operating income fell 24%, and net income fell 26% year over year. Lower Industrial Materials volumes and higher raw-material costs and overhead absorption weighed on margins. The company expected those cost pressures to continue through year-end.
- Nine-month sales declined 10% and operating income declined 15%. Lower Industrial Materials volumes drove the sales decline; Engineered Solutions growth partly offset it. Favorable currency and lower-cost year-end inventory benefited nine-month costs, with some benefit reversing in Q3 as higher-cost inventory flowed through.
- GrafTech completed a 10-million-share repurchase program for $101.7 million during the first nine months, largely funded by increased revolver borrowing. A new authorization for up to 10 million shares was approved in July 2012; the filing does not quantify future purchases.
- Management’s 2012 targets were EBITDA of $235–$245 million, overhead expense of about $155 million, interest expense of about $22 million, capital expenditures of $120–$130 million, an effective tax rate of 21%–23%, operating cash flow of $100–$120 million, and fully diluted shares of about 140 million. Engineered Solutions revenue was expected to reach about $220 million. Management said 2013 capital spending could be lower, depending on economic conditions.
- GrafTech announced needle-coke price increases of about 15% year over year and, in early October, an 8% increase for standard-size melter electrodes. It did not expect a material 2012 earnings impact because most 2012 business was booked; the increases were intended to support 2013 margins. Super-premium needle coke entered commercial production in 2012; management expected higher margins to offset somewhat reduced capacity, but no material 2012 impact.
- Nine-month tax expense benefited from a $9.2 million decrease in unrecognized tax benefits, primarily from resolution of prior-year positions. Q3 also benefited from research and development tax credits. The company received $4.0 million of insurance reimbursements for 2011 flood damage. Prior-period inventory-related cost adjustments of $2.8 million in Q3 and $0.3 million year to date were described as immaterial.
- Management cited uncertain global growth and steel demand, European debt concerns, competitive capacity and pricing, raw-material and energy costs, foreign exchange, customer order delays, and possible supply interruptions. It warned that pension mark-to-market adjustments in Q4 could materially affect costs and expenses. Legal matters were not expected to have a material adverse effect; no material changes to the prior annual report’s risk factors were reported.
Important facts for investors to verify
- Whether weaker steel-related volumes and the elevated inventory balance improve as management anticipated, and whether inventory reduction releases cash.
- Whether the announced price increases take effect and offset higher raw-material and overhead costs in 2013.
- Progress toward 2012 operating cash flow, EBITDA and capital-spending targets, given low year-to-date operating cash flow and substantial working-capital use.
- Debt, revolver availability, covenant headroom and the effect of further borrowing or share repurchases on interest expense and liquidity.
- Q4 pension mark-to-market effects, tax-position developments and the degree to which favorable tax items affected reported earnings.