GrafTech International Ltd. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Financial statements are unaudited. Unless otherwise stated, dollar amounts below are in millions.
Business context and reporting period
GrafTech makes graphite and carbon products. Industrial Materials serves steel and metals markets; Engineered Solutions serves transportation, solar, oil and gas, and electronics markets. Results include Seadrift and the St. Marys facility, acquired in November 2010, and Micron Research, acquired in February 2011; acquisition-related costs and purchase accounting make year-over-year comparisons less directly comparable.
Financial performance
| Metric | Q3 2010 | Q3 2011 | Nine months 2010 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $255.2 | $345.8 | $725.8 | $972.2 |
| Gross profit | $76.2 | $92.7 | $221.4 | $240.8 |
| Gross margin | 29.9% | 26.8% | 30.5% | 24.8% |
| Operating income | $42.5 | $57.5 | $127.9 | $134.7 |
| Operating margin | 16.6% | 16.6% | 17.6% | 13.9% |
| Net income | $26.0 | $40.3 | $101.7 | $96.1 |
| Diluted EPS | $0.21 | $0.28 | $0.84 | $0.66 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $54.0 | $29.3 |
| Capital expenditures | Not provided for quarter | Not provided for quarter | $51.5 | $102.0 |
Q3 sales rose 35%, led by a 45% increase in Industrial Materials; Engineered Solutions sales declined 7%. For the nine months, sales grew 34%, while operating income increased 5% and net income fell 6%. Industrial Materials operating income was $120.5 million for the nine months versus $114.0 million; Engineered Solutions operating income was $14.2 million versus $13.9 million.
Margins were pressured by higher needle coke and other production costs, foreign currency effects, and purchase-accounting adjustments. Purchase accounting increased cost of sales by $19.2 million in Q3 and $112.2 million for the nine months. The nine-month period also included $7.5 million of noncash amortization of the discount on acquisition-related notes.
Financial position and liquidity
- At September 30, cash was $11.3 million, total assets $2.075 billion, and stockholders’ equity $1.318 billion.
- Debt totaled $354.3 million: $18.2 million short-term and $336.1 million long-term. Including $22.0 million of supply-chain financing liability, total financing liabilities were $376.3 million.
- Reported current assets were $682.5 million and current liabilities $230.4 million. Cash declined from $13.1 million at December 31, 2010.
- Nine-month operating cash flow was $29.3 million, down from $54.0 million. Working capital used $139.8 million, including $54.9 million from receivables and $76.2 million from inventory growth. Investing activities used $100.3 million; financing activities provided $69.8 million. Cash ended at $11.3 million.
- At September 30, $65.2 million was available under the then-existing revolving facility, after letters of credit. The company reported covenant compliance.
- On October 7, 2011, the company amended and restated its revolving credit agreement: stated facility availability increased from $260 million to $570 million, maturity extended from April 2013 to October 2016, and borrowing margins and certain covenant terms changed. Management reported that the subsequent expansion raised availability to $310 million; investors should distinguish the facility commitment from immediately available borrowing capacity.
Changes, outlook, and risks
- Drivers and pressures: Management cited recovering graphite-electrode demand and higher volumes, including acquired businesses. However, average graphite-electrode selling prices declined approximately 4% in Q3 and 6% year to date, excluding currency effects. Management said increased needle coke costs could not be fully passed on to customers.
- Segment mix: Engineered Solutions had lower Q3 sales and operating income, reflecting weaker solar and oil-and-gas-related demand and unfavorable mix, partly offset by electronics demand. Nine-month sales increased, particularly in natural graphite products.
- 2011 outlook, conditional on economic forecasts: EBITDA of $275–$285 million; operating income of approximately $190–$200 million; depreciation and amortization of approximately $85 million; overhead expense of $145 million; capital expenditures of $145–$155 million; effective tax rate of 18%–20%; and operating cash flow of $140–$155 million. These are management expectations, not guarantees.
- Accounting change: GrafTech retrospectively changed pension and postretirement actuarial gain/loss recognition to accelerate recognition. Management estimated that, without the changes, Q3 net income would have been $39.1 million rather than $40.3 million and nine-month net income $92.5 million rather than $96.1 million.
- Other items: Q3 included $0.5 million of expense for damage at a manufacturing facility; insurance claims were being prepared. The company reported no belief that existing legal matters would materially harm its financial position, results, or cash flows. It had $13.2 million of unrecognized tax benefits and said $1.5–$2.0 million might be reduced within 12 months.
- Principal risks: Economic and steel-demand weakness, electrode pricing and competition, raw-material and energy costs and supply, currency and interest-rate movements, working-capital demands, acquisitions and integration, pension funding, and compliance with debt covenants. Management warned that downturns or disruptions to receivables factoring or supply-chain financing could increase revolver borrowings and pressure liquidity.
Important facts for investors to verify
- Whether the 2011 earnings and cash-flow outlook remained achievable, particularly given nine-month operating cash flow of $29.3 million against full-year guidance of $140–$155 million.
- How acquired operations, purchase-accounting charges, rising needle coke costs, and lower electrode prices affected sustainable margins and earnings.
- Actual borrowing availability under the amended credit agreement, covenant headroom, and the effect of incremental borrowing costs and debt amortization.
- Whether working-capital growth—especially receivables and inventory—converts to cash, and whether receivables factoring and supply-chain financing remain available on acceptable terms.
- The impact of the pension accounting change and future actuarial movements, pension contributions, tax settlements, and the facility-damage insurance recovery.