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GrafTech Reports Difficult Operating Environment in 2012

02/26/2013 - As it reported its 2012 results, GrafTech said the already oversupplied graphite electrode market has been further exacerbated by graphite electrode capacity expansions in excess of 100,000 tonnes.

As it reported its 2012 results, GrafTech said the already oversupplied graphite electrode market has been further exacerbated by graphite electrode capacity expansions in excess of 100,000 tonnes (see outlook below).

2012 Fourth Quarter Review
  • Net sales increased seven percent to US$371 million compared to net sales of $348 million in the fourth quarter of 2011.
  • EBITDA was $66 million, up 26 percent versus the same quarter last year. This includes a $9 million non-cash pension related charge; the fourth quarter of 2011 included a similar charge of $22 million. Excluding this charge for the fourth quarter of both years, adjusted EBITDA* was $75 million for the fourth quarter in 2012, or flat versus the same period in 2011.
  • Net income was $29 million, or $0.21 per diluted share, versus $57 million, or $0.39 per diluted share, in the fourth quarter of 2011. The fourth quarter of 2011 included a $26 million non-cash discrete tax benefit. Excluding this tax item and the pension related charges, fourth quarter 2012 adjusted net income* was $34 million, or $0.25 per diluted share, compared to fourth quarter 2011 adjusted net income* of $45 million, or $0.31 per diluted share.
2012 Full Year Financial Review
  • Net sales were $1,248 million, a five percent decline from our all-time record sales of $1,320 million in 2011.
    • Industrial Materials segment revenue was $1,026 million, a decrease of nine percent year-over-year.
    • Engineered Solutions segment revenue was $223 million, representing record revenue for the segment and an increase of 18 percent year-over-year.
  • 2012 EBITDA was $238 million, a decrease of four percent year-over-year. This includes a $9 million non-cash pension related charge**; 2011 included a similar charge of $22 million. Excluding this charge for both years, adjusted EBITDA* was $247 million in 2012, a decrease of eight percent from 2011.
  • Net income was $118 million, or $0.84 per diluted share. This includes a $10 million non-cash discrete tax benefit in the second quarter of 2012. There was a similar tax benefit of $26 million in 2011. Excluding the tax benefit and the pension related charges, 2012 adjusted net income* was $113 million, or $0.81 per diluted share, versus $141 million in 2011, or $0.96 per diluted share.
  • Net cash provided by operating activities was $101 million in 2012 versus $77 million in 2011 as a result of lower working capital investments.
  • Net debt* at year end 2012 was $554 million compared to $419 million at year end 2011. This increase is primarily attributed to higher borrowings related to a 10 million share repurchase program completed in 2012. Working capital investments and capital expenditures also contributed to the increase.
  • In November 2012, GrafTech executed a successful $300 million eight-year unsecured 6.375% Senior Notes offering, securing a strategic component of its balance sheet and creating strong financial flexibility. Proceeds were used to repay amounts previously outstanding under its revolving credit facility.
2012 Full Year Operational Review
  • GrafTech announced the development of a super-premium grade of Seadrift needle coke and successfully commercialized this breakthrough product in the second quarter of 2012. This represents a key development in expanding Seadrift’s ability to service the full range of customer needle coke needs.
    • This important strategic accomplishment marks a milestone in our ability to internally source our needle coke requirements, providing us with greater procurement flexibility and less dependence on external suppliers.
  • In August 2012, GrafTech celebrated the successful landing of NASA’s Mars Science Laboratory Curiosity rover mission. The thermal solutions used in the rover’s heat shield, which protected the Curiosity from the intense heat and friction generated during descent through the Martian atmosphere, were developed and manufactured by a subsidiary in our Engineered Solutions’ segment.
Craig Shular, chief executive officer of GrafTech, commented, “In 2012, GrafTech delivered its second best sales in Company history and record Engineered Solutions revenue despite difficult global economic conditions. Our Seadrift facility has been a very important part of our 2012 results, delivering quality advancements, commercializing super premium needle coke and contributing meaningfully to our Industrial Materials segment.”
Mr. Shular continued, “We responded quickly to the changing market dynamics in 2012, reducing our work force by nine percent, freezing merit increases for the global leadership team and reducing planned capital expenditures and overhead expense. We remain focused on managing costs, capitalizing on growth opportunities and maximizing profitability in a very competitive and challenging graphite electrode market in 2013.”
Industrial Materials Segment
The Industrial Materials segment’s net sales for the fourth quarter of 2012 were $310 million, as compared to $297 million in the fourth quarter of 2011. Net sales in the quarter increased primarily as a result of higher realized selling prices for both graphite electrodes and needle coke compared to the prior year quarter, offset in part by lower volumes in the electrode business.
Adjusted operating income for the Industrial Materials segment was $44 million in the fourth quarter of 2012, as compared to $49 million in the fourth quarter of 2011, excluding pension related charges. The decline in operating income was due to lower graphite electrode sales volume and higher costs, partially offset by higher selling prices across the segment.
It is important to note that 2013 marks the final year of a third party wind-down agreement triggered by the acquisition of Seadrift in which GrafTech is obliged to purchase minimum needle coke quantities. Going forward, this will provide us with increased flexibility to further optimize our vertical integration with Seadrift and manage inventories.
Engineered Solutions Segment
Net sales for the Engineered Solutions segment increased 19 percent to $61 million in the fourth quarter of 2012 as compared to $51 million in the fourth quarter of 2011. Adjusted operating income* was $7 million, or 11 percent of net sales, in the fourth quarter of 2012 as compared to $4 million, or 8 percent of net sales, in the fourth quarter of 2011, excluding the pension related charges in both periods. The increase in revenue and operating income was primarily driven by growth in our advanced consumer electronics products and a more favorable product mix as we continue to penetrate high-growth end markets with attractive margin profiles.
Mr. Shular commented, “Our Engineered Solutions business finished the year with record sales of $223 million, achieving a more than 20 percent annual growth rate for the past three years. The capital investments we made and new products we developed in our research and development center in recent years helped propel this growth. In 2013, we expect to build on this positive momentum with continued revenue growth and margin expansion.”
Corporate
Total company selling and administrative and research and development expenses were $42 million for the fourth quarter of 2012. This compares to $52 million in the same period last year. Excluding pension related charges in both years, the year-over-year decrease was $3 million driven by lower administrative expense as a result of right sizing and austerity initiatives taken throughout the year to proactively manage costs in a difficult operating environment.
Interest expense was $8 million in the fourth quarter of 2012 compared to $5 million in the same period of the prior year. The increase was driven by the issuance of the Senior Notes in November 2012 and higher borrowings associated with the share repurchase program.
Outlook
Based on current International Monetary Fund (IMF) projections, the estimate for global GDP growth in 2013 is 3.5 percent, a slight downward revision from IMF’s last projection in October 2012. The IMF notes that, although global economies are expected to recover at a gradual pace, downside risks remain significant. The IMF highlights that recessionary conditions in Europe persist and that the Euro region continues to pose the largest downside risk to the global outlook. Emerging markets and developing economies are forecast to grow 5.5 percent in 2013, a gradual improvement from 2012.
According to the World Steel Association and other published reports, global steel production is expected to increase 3.2 percent in 2013. However, steel customer confidence and profitability remains low due to the continued economic uncertainty, particularly in Europe. Overall, we expect higher volumes in our Industrial Materials segment in 2013 due to a restocking of inventory and an improvement in steel production levels across our global customer base.
The graphite electrode market has become increasingly competitive with the addition of approximately 100,000 metric tons of capacity coming on line over the past year, of which approximately 65,000 metric tons are located in China. An estimated 130,000 metric tons of additional graphite electrode capacity expansions have also been announced, of which approximately 100,000 metric tons are located in China, and are projected to be operational in 2013/2014, although several of these announced projects may be postponed. These new additions have further exacerbated a challenging global graphite electrode industry, which already had excess capacity.
In the needle coke market, additional supply has come on line with the restart of a major Asian producer whose operations had been suspended for several months in 2012. This producer appears to be currently fully operational, resulting in additional available capacity in 2013.
The graphite electrode and needle coke capacity additions described above are compounded further by a still recovering global economy and challenging steel market, in which many steel producers continue to struggle to achieve acceptable profitability levels. The modest improvement in the global economies and our steel end market, while encouraging, is not substantial enough to offset the negative impact of the graphite electrode and needle coke capacity additions. As a result, these factors are contributing to downward pricing pressure on both graphite electrodes and needle coke for 2013.
Looking forward, we believe that the excess graphite electrode capacity will be partially absorbed over time by growth in electric arc furnace (EAF) steel production. Based on CRU International (an independent market research firm) and other estimates, it is anticipated that approximately 100 million tonnes of new EAF capacity will come on line over the next five years.
In light of current economic conditions, we are further reducing overhead expense by means of additional rightsizing initiatives, hiring restrictions, suspension of 2013 salary merit increases and reductions in travel and other discretionary expenses. We have also reduced targeted capital expenditures from 2012 levels given the difficult operating environment. In our Industrial Materials segment, at the mid-point of our guidance range, capital expenditures are expected to be approximately $60 million, $5 million of which will be invested in product innovation to grow our competitive advantages. In our Engineered Solutions segment, we plan to invest approximately $45 million, of which $35 million will be growth capital to support increasing demand for products used in the advanced consumer electronics (OLED/LED/LCD displays, tablets, smartphones, eReaders) and energy (lithium ion batteries, LEDs, oil and gas) industries. These investments position our Company for future growth and support our target of double-digit revenue growth and operating income margin expansion for the segment in 2013. On a standalone basis (excluding shared corporate allocations, interest and taxes), we expect the Engineered Solutions business will generate sufficient cash to fund its capital and other business investments in 2013.
The diversification that our Engineered Solutions business provides is expected to partially mitigate the challenging cyclical steel environment that we face. We anticipate solid top line growth and an improved margin profile in this segment as our Engineered Solutions product portfolio shifts to higher margin businesses. The first quarter of 2013 however will be negatively impacted by seasonally slower advanced consumer electronics sales and startup costs associated with investments to support future growth. As a result, operating income for the segment is anticipated to be comparable to the first quarter of 2012. For this segment, we expect double-digit revenue growth for the full year and operating income margins to be in the range of 13 percent to 15 percent in the second half of 2013.
We are targeting full year EBITDA to be in the range of $175 million to $205 million. We expect that the first quarter will be our weakest, with EBITDA targeted to be in the range of $30 million to $40 million. The first quarter of 2013 will be negatively impacted by seasonally lower graphite electrode volumes and higher cost inventory due to the carryover of third party needle coke acquired in 2012 and higher fixed cost absorption associated with lower graphite electrode utilization rates in the fourth quarter of 2012.
In the second half of 2013, we expect improved profitability due to higher sales in both business segments and lower costs in our Industrial Materials segment as we work off higher cost inventory and reflect lower fixed cost per unit of production as operating rates improve. We expect to exit the year with fourth quarter 2013 EBITDA targeted to be in the range of $60 million to $70 million.
We are targeting cash flow from operations to be in the range of $150 million to $180 million in 2013, as we reduce inventory levels related to the third party wind-down agreement and further optimize our Seadrift facility. Finally, we are targeting the effective tax rate to be in the range of 33 percent to 36 percent in 2013 as the tax benefit inherent in our operating model is reduced due to a less favorable mix of jurisdictional profitability. It is important to note, however, that our cash tax rate is estimated to be approximately 10 percentage points lower, or 23 percent to 26 percent, as we effectively utilize foreign tax credits.
In summary, our expectations for 2013 are as follows:
  • EBITDA targeted in the range of $175 million to $205 million;
  • Overhead expense (selling and administrative, and research and development expenses) of approximately $140 million;
  • Interest expense in the range of $35 million to $40 million;
  • Capital expenditures in the range of $90 million to $120 million;
  • Depreciation expense in the range of $90 million to $95 million;
  • An effective tax rate in the range of 33 percent to 36 percent;
  • Cash flow from operations in the range of $150 million to $180 million; and
  • Fully diluted share count of approximately 136 million shares.
Mr. Shular concluded, “We have built an advantaged, backward integrated, low-cost business model supported by a solid capital structure, which we believe positions us well to capitalize on future growth opportunities. The advancements in graphite electrode and needle coke quality combined with our industry-leading customer technical service and global production platform position us to best serve our world-wide customers. In addition, our Engineered Solutions segment, which has produced double-digit revenue growth over the past three years, provides us with a sustainable base for further diversification.
“Our team has a proven track record of successfully managing through electrode industry cycles and will continue to leverage our business model and strategic advantages to drive long-term shareholder value.”