GrafTech International Ltd. — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009. GrafTech manufactures graphite electrodes and refractory products for steelmaking and advanced graphite and natural graphite products through its Industrial Materials and Engineered Solutions segments. Unless noted, financial amounts below are in millions of U.S. dollars.
Financial performance
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net sales | $164.9 | $315.7 | $456.7 | $925.3 |
| Gross profit | $46.7 | $114.0 | $124.4 | $336.4 |
| Gross margin | 28.3% | 36.1% | 27.2% | 36.4% |
| Operating income | $25.1 | $86.7 | $53.0 | $258.4 |
| Net income (loss) | $6.9 | $83.4 | $(21.8) | $165.9 |
| Basic EPS | $0.06 | $0.70 | $(0.18) | $1.52 |
- Q3 sales declined 47.8% year over year; nine-month sales fell 50.6%. Lower volumes, especially from steel-sector demand weakness and customer inventory destocking, drove the declines. Higher price/mix partly offset volume and currency effects.
- Q3 segment operating income was $23.8 million for Industrial Materials and $1.2 million for Engineered Solutions, versus $74.2 million and $12.5 million, respectively, a year earlier. Nine-month amounts were $47.0 million and $6.0 million, versus $228.5 million and $30.0 million.
- Operating cash flow was $121.7 million for the first nine months, down from $169.3 million. Investing activities used $47.0 million, including $40.5 million of capital expenditures and a $6.0 million loan to Seadrift; financing activities used $78.8 million. Cash ended at $8.7 million.
- At September 30, total assets were $849.6 million, stockholders’ equity was $546.9 million, short-term debt was $10.3 million, and long-term debt was $1.5 million. The company had redeemed its remaining $19.9 million of Senior Notes during September.
Material changes and unusual items
- A $52.8 million noncash impairment of the Seadrift investment, combined with other affiliate-related losses and charges, contributed to a $54.3 million nine-month expense. GrafTech cited lower expected volumes, growth, and profitability at Seadrift amid the economic downturn. The investment balance was $64.5 million at quarter-end; GrafTech also had a $6.0 million loan to the affiliate.
- Production below normal capacity resulted in $7.1 million of excess production overhead costs through September, including $6.3 million recorded in the first nine months.
- Nine-month other expense included $6.5 million of currency losses, compared with $5.8 million of currency gains in 2008. Q3 currency losses were $9.9 million versus gains of $18.5 million a year earlier.
- The nine-month 2009 tax expense was $8.3 million despite a pretax loss of $13.5 million; the reported effective tax rate was 61.5%. The company said the Seadrift impairment’s tax benefit was not fully realized because of U.S. valuation allowances.
- GrafTech retrospectively changed accounting for its previously converted Debentures. The adjustment reduced reported nine-month 2008 net income from $175.7 million to $165.9 million and diluted EPS from $1.50 to $1.45; Q3 2008 was unaffected.
Liquidity, outlook, and risks
- Management said liquidity was adequate. The $215 million revolving facility matures in July 2010; $5.0 million was drawn and $204.2 million was available at September 30, after letters of credit. The company reported compliance with its covenants and expected continued compliance over the next 12 months, but refinancing or extension was not assured.
- Additional working-capital liquidity of about $100 million was available through receivables sales and supply-chain financing, subject to receivables, customer credit quality, and purchasing levels. Cash flow from operations for the first nine months was below the full-year target.
- GrafTech raised its 2009 operating income target to $80–$85 million from $60–$70 million. It expected capital expenditures of $50–$55 million, depreciation of $32–$34 million, and operating cash flow of approximately $150 million. Management cited better-than-expected Q3 results, earlier-than-expected customer destocking completion in some regions, and anticipated Q4 restocking, while emphasizing that recovery remained fragile and slow.
- Key risks include weak steel and electrode demand, customer destocking, low utilization and pricing pressure, further Seadrift impairment, raw-material and energy costs, currency movements, customer credit and receivables-factoring availability, and the need to refinance the revolving facility. The company also disclosed a $6.8 million accrued Brazilian IPI tax liability; participation in a government payment program could reduce it by up to $3.0 million, but GrafTech had not decided whether to participate.
- Management stated that disclosure controls were effective at the reasonable-assurance level and that no material change in internal controls occurred during the quarter. The company did not expect the ultimate disposition of its disclosed legal matters to materially adversely affect its financial position, results, or cash flows.
Investor verification priorities
- Check subsequent results against the $80–$85 million operating-income and approximately $150 million operating-cash-flow targets, and assess whether customer restocking continued.
- Review the Seadrift investment valuation assumptions and whether further impairment or additional affiliate funding became necessary.
- Verify extension or refinancing of the revolving facility before its July 2010 maturity, covenant headroom, and actual borrowing availability.
- Track the Brazilian IPI tax-program decision and any change in the accrued liability.
- Reconcile reported cash generation with working-capital movements, receivables sales, supply-chain financing, and capital spending.