GrafTech International Ltd. — 2011 Form 10-K Summary
Business context and reporting period
Fiscal year ended December 31, 2011; this is an annual report, not a quarterly filing. GrafTech manufactures graphite electrodes, refractory and needle coke products, and advanced and natural graphite materials. Its Industrial Materials segment primarily serves steelmaking; Engineered Solutions serves electronics, industrial, energy, transportation, and defense markets. The year included acquisitions of Micron Research (February) and Fiber Materials (October); 2011 also reflects a full year of Seadrift and C/G operations, versus one month in 2010.
Financial performance and liquidity
| Metric | 2011 | 2010 |
|---|---|---|
| Net sales | $1,320.2 million | $1,007.0 million |
| Gross profit / gross margin | $324.5 million / 24.6% | $289.3 million / 28.7% |
| Operating income / operating margin | $166.0 million / 12.6% | $158.0 million / 15.7% |
| Net income | $153.2 million | $174.7 million |
| Diluted earnings per share | $1.05 | $1.41 |
| Operating cash flow | $76.6 million | $144.9 million |
| Capital expenditures | $156.6 million | $86.0 million |
Sales rose 31%, but cost of sales increased 39%, lowering gross margin. Industrial Materials sales increased 36% to $1,132.2 million, including about $198 million from the acquired businesses; Engineered Solutions sales rose 9% to $188.0 million. Segment operating income was $158.5 million for Industrial Materials, up from $140.2 million, and $7.5 million for Engineered Solutions, down from $17.8 million.
Net income fell 12% despite higher sales and operating income. Results included a $26.5 million income-tax benefit, primarily from releasing a valuation allowance on foreign tax credit carryforwards, and a $22.3 million pension and postretirement mark-to-market loss. Interest expense rose to $18.3 million, including $10.0 million of non-cash discount amortization on the acquisition-related subordinated notes.
Operating cash flow declined as working capital used $142.6 million, mainly from increases in receivables and inventories. At year-end, cash was $12.4 million; long-term debt was $387.6 million and short-term debt $14.2 million. Revolver borrowings were $232.0 million, with $322.1 million available. The company reported compliance with its credit covenants. Total assets were $2.17 billion and stockholders’ equity $1.34 billion.
Fourth-quarter 2011 sales were $348.0 million, gross profit $83.7 million, net income $57.1 million, and diluted EPS $0.39. Fourth-quarter 2010 figures were $281.2 million, $67.8 million, $72.9 million, and $0.56, respectively; the comparison is affected by significant tax and other unusual items in both periods.
Material changes versus prior period
- Acquisition-related consolidation, particularly the full-year contribution of Seadrift and C/G, was a major driver of Industrial Materials growth.
- Industrial Materials price and mix reduced sales growth: weighted-average graphite electrode selling prices declined about 2%, excluding currency effects. Price increases announced during 2011 were expected to support 2012 margins but had little effect on 2011 results.
- Higher volumes, production costs, currency effects, and acquired-intangible amortization contributed to higher expenses; acquired-intangible amortization was $23.0 million for the year.
- Engineered Solutions profitability weakened: segment operating income fell despite higher sales, partly due to costlier product mix and increased mark-to-market charges. Solar demand softened from the third quarter.
- Cash generation weakened as operating cash flow fell by $68.3 million year over year, while capital spending increased substantially.
Outlook, risks, and unusual items
For 2012, management targeted EBITDA of $250–$290 million, overhead expense of about $170 million, interest expense of $18–$22 million, capital expenditures of $140–$160 million, depreciation of about $95 million, an effective tax rate of 23%–25%, operating cash flow of $140–$170 million, and diluted shares of approximately 145 million. These are targets, not guarantees. Management expected modest growth in EAF steel production and graphite electrode demand, while noting that steel operating rates remained below pre-crisis levels and solar demand was expected to remain weak until 2013.
The October 2011 credit agreement increased revolving availability to $570 million, extended maturity to October 2016, and reduced borrowing costs; it also retains financial covenants and restrictions on debt, acquisitions, dividends, and repurchases. The company paid no dividends in 2010 or 2011 and authorized a new repurchase program for up to 10 million shares. It repurchased about 2.2 million shares during 2011 for $32.1 million.
Key risks include cyclical steel demand and pricing, competition and capacity additions, raw-material and energy availability and cost, foreign currency and international operating exposures, debt covenant compliance and access to financing, and the ability to realize deferred tax assets. Other exposures include environmental and health-and-safety requirements, litigation, pension assumptions, and possible disruption of manufacturing. A Brazil wage-claim dispute could lead to claims against the subsidiary if a prior favorable court ruling is reversed. Management did not expect existing legal matters or environmental obligations to have a material adverse effect, but outcomes are uncertain. Environmental protection expenses were $15.7 million in 2011.
The company reported effective internal control over financial reporting, and its auditor issued an unqualified opinion on the financial statements and internal controls.
Important facts for investors to verify
- How much of 2011 sales growth and future earnings depends on the acquired businesses, and whether their integration and expected synergies are being realized.
- Whether margins recover as announced price increases take effect and whether raw-material, energy, and production costs remain manageable.
- Whether operating cash flow improves after the substantial 2011 working-capital investment, and whether planned capital spending is funded without undue additional borrowing.
- Whether the 2012 EBITDA, cash-flow, tax-rate, and capital-expenditure targets are achieved; the filing does not provide a clear reconciliation of the EBITDA target to a GAAP measure.
- How the $26.5 million tax benefit, remaining deferred-tax valuation allowance, and foreign tax credit expirations affect recurring earnings and cash taxes.
- Debt, covenant headroom, pension funding needs, the Brazil labor litigation, and material environmental or other contingencies.