During the 2005 first quarter, we had three lines of business, as follows:
Our synthetic graphite line of business constitutes its own reportable segment, and our natural graphite and advanced carbon materials lines of business together constitute our Other reportable segment. See Note (5) to the Consolidated Financial Statements for certain information regarding our reportable segments.
Effective April 1, 2005, we realigned our synthetic graphite and advanced carbon materials lines of business into two new lines of business: a graphite electrode line of business and an advanced carbon solutions line of business. The graphite electrode line of business will focus exclusively on graphite electrodes. The advanced carbon solutions line of business will include cathodes, carbon electrodes and refractories, and advanced synthetic graphite products. Our natural graphite line of business will remain unchanged. The Company will begin reporting segment information consistent with the April management changes in the second quarter of 2005.
Reference is also made to the information under “Preliminary Notes – Businesses” in our other SEC filings for background information on our businesses, industry and related matters.
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Global Economic Conditions and Outlook
We are impacted in varying degrees, both positively and negatively, as global, regional or country economic conditions fluctuate.
Synthetic Graphite. Although we have noted instances of softening steel production in certain segments, including several mills opting to take extended or earlier than planned maintenance downtime, we remain cautiously optimistic about 2005 steel production levels, as previously rising steel inventories appear to be declining. We believe that underlying steel demand remains strong and should continue reducing the steel inventory overhang during the 2005 second quarter. Overall, we believe that global and regional economic conditions will continue to be strong in 2005, resulting in increased steel and aluminum production and increased graphite electrode and cathode demand.
In the 2004 fourth quarter, we initiated a base price adjustment (a “BPA”) on 2005 orders for melter graphite electrodes. The BPA was based on, among other things, graphite electrode demand, raw material availability and increasing production costs. As a result of this action and continued book building at higher prices, we expect average melter graphite electrode revenue per metric ton to be approximately $600, or 24%, higher in 2005 than in 2004.
In the non-melter graphite electrode segment, prices vary significantly due to the variety of end markets and performance requirements across those end markets and, to a lesser extent, higher availability of lower grade products. Average revenue per metric ton in this segment is expected to increase approximately $100 in 2005 as compared to 2004.
Based on these pricing actions, we expect 2005 average graphite electrode revenue per metric ton, including both melter and non-melter segments, to be between $2,900 and $3,000, approximately 15% to 20% higher than in 2004. We expect our graphite electrode sales volume in 2005 to be approximately 210,000 metric tons, or 6% lower than 2004.
We purchase our raw materials from a variety of sources. For 2005, we have secured virtually all of our needle coke volume requirements and have locked in price on the volume. We expect our graphite electrode production costs, including the impact on profitability from potentially lower utilization rates of our graphite electrode capacity, will increase by approximately 10% to 12% in 2005 as compared to 2004. Approximately half of the increase is expected from inflation in production costs, in particular coke, energy and freight. We have entered into firm price contracts for approximately 75% of our graphite electrode production costs, excluding the impact of changes in currency exchange rates. The balance of the increase is expected from the impact of changes in currency exchange rates, as virtually all of our graphite electrode production is outside the United States.
Our venture with Alcan, which is a 30% owner of our cathode business and which purchases cathodes from us under requirements contracts that remain in effect through 2006, continues to position us as the leading supplier of cathodes to the aluminum industry. We believe that, over the long term, demand for graphite cathodes will increase relative to semi-
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graphitic cathodes as new smelting furnaces are built, thereby reducing the current excess supply of graphite cathodes.
Other. We expect growing net sales of our electronic thermal management products and services. We have hired and are continuing to hire additional personnel in sales, marketing and research and development to support our growth. We have a formal targeted hiring plan to grow the advanced energy technology team to about 200 employees over the next 18 months. These resources will focus on the continued growth of the electronic thermal management business as we continue to leverage our successes to penetrate new customers and applications and identify new market opportunities. We estimate sales of these products to increase by at least 50% in 2005 as compared to 2004.
We expect continued strong demand for most of our other products, with incremental profitability due to product mix and prices. In particular, demand for advanced synthetic graphite products used in the transportation, oil and gas and metallurgical industries continues to be strong. Demand for our carbon refractories continues to be strong as a result of our increased penetration of various markets, particularly Europe and China, and increased blast furnace construction and refurbishment. We continue to seek to drive productivity and cost improvements in all of these businesses.
Overall. We expect our net sales to increase by over 10% in 2005 as compared to 2004. The 2005 cash tax rate is targeted to be less than 30%, whereas the effective tax rate is expected to be between 36% to 38%. Capital expenditures are estimated to be between $45 and $50 million and depreciation expense is estimated to be about $38 million in 2005.
Our outlook could be significantly impacted by, among other things, factors described under “Preliminary Notes – Forward Looking Statements and Risks” in this Report. For a more complete discussion of these and other factors, see “Risk Factors” in the Annual Report.
Results of Operations
Three Months Ended March 31, 2005 as Compared to Three Months Ended March 31, 2004.Net sales of $211 million in the 2005 first quarter represented a $14 million, or 7%, increase from net sales of $197 million in the 2004 first quarter, primarily due to higher net sales in our synthetic graphite line of business. Cost of sales of $162 million in the 2005 first quarter represented a $10 million, or 7%, increase from cost of sales of $152 million in the 2004 first quarter, primarily due to higher sales volumes. Gross profit of $49 million in the 2005 first quarter represented a $4 million, or 9%, increase from gross profit of $45 million in the 2004 first quarter. Gross margin was 23.0% in the 2005 first quarter as compared to gross margin of 22.8% in the 2004 first quarter. See below for further details regarding such changes.
Synthetic Graphite Segment. Net sales of $185 million in the 2005 first quarter represented an $11 million, or 7%, increase from net sales of $174 million in the 2004 first quarter. The increase was due primarily to higher average graphite electrode sales revenue per metric ton of $21 million, including a $2 million net favorable currency benefit, and higher sales
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volume of advanced synthetic graphite materials of $5 million, offset by lower sales volume of graphite electrodes of $8 million and an unfavorable product mix of cathodes and related products of $2 million. Average sales revenue per metric ton of graphite electrodes in the 2005 first quarter was $2,815 as compared to $2,485 in the 2004 first quarter. Volume of graphite electrodes sold was 47,300 metric tons in the 2005 first quarter as compared to 50,600 metric tons in the 2004 first quarter.
Cost of sales of $141 million in the 2005 first quarter represented an $8 million, or 6%, increase from cost of sales of $133 million in the 2004 first quarter. Cost of sales increased throughout the synthetic graphite segment primarily due to production cost increases associated with the unfavorable impact of currency exchange rates from the impact of the weaker U.S. dollar, primarily relative to the South African Rand, the Brazilian Real and the Euro, of $4 million, and to a lesser extent, increased coke, energy, freight and other costs of $4 million. As a result, gross profit in the 2005 first quarter was $44 million, 7% or $3 million higher than the 2004 first quarter. Gross margin was 23.7% of net sales in the 2005 first quarter as compared to the 23.5% of net sales in the 2004 first quarter.
Other Segment. Net sales of $26 million in the 2005 first quarter represented a $3 million, or 13%, increase from net sales of $23 million in the 2004 first quarter. This increase was primarily due to a $3 million increase in electronic thermal management sales (to $5 million), from $2 million in the 2004 first quarter, offset by a decrease of $1 million in sales of other natural graphite products. The balance of the increase was due primarily to higher sales volumes of carbon electrodes. Cost of sales of $21 million in the 2005 first quarter represented a $2 million, or 11%, increase from cost of sales of $19 million in the 2004 first quarter. The increase in cost of sales was primarily related to higher sales volumes of our carbon electrodes and various other costs. Gross profit in the 2005 first quarter was $5 million (a gross margin of 18.6% of net sales) as compared to gross profit in the 2004 first quarter of $4 million (a gross margin of 17.6% of net sales).
Items Affecting Us as a Whole. Selling, administrative and other expenses were $26 million in the 2005 first quarter and $21 million in the 2004 first quarter. The increase was due primarily to higher variable compensation expense of $2 million, higher selling expenses of $1 million associated with higher net sales, the negative impact of net changes on currency exchange rates of $1 million and $1 million of various other costs.
Other expense, net, was $6 million in the 2005 first quarter and consisted primarily of $7 million of currency exchange losses, primarily associated with Euro-denominated intercompany loans, a $2 million write-off of capitalized bank fees and $1 million of bank and other financing fees. These costs were partially offset by the favorable fair value adjustments on the Debenture redemption make-whole provision of $3 million.
Other expense, net, was $13 million in the 2004 first quarter and consisted primarily of a $6 million loss on reduction of Senior Notes outstanding, a $2 million fair value adjustment on interest rate caps, $2 million of currency exchange losses, primarily associated with Euro-
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denominated intercompany loans, a $2 million charge for legal, environmental and other related assets and $3 million of bank and other financing fees and various other costs. These expenses were partially offset by a curtailment gain from the termination of a defined benefit pension plan of $2 million.
In the 2005 first quarter, restructuring charges were nominal. In the 2004 first quarter, we recorded a $1 million charge primarily associated with changes in estimates related to U.S. voluntary and selective severance programs.
The following table summarizes activity relating to the accrued expense in connection with the restructuring charges. The restructuring accrual is included in other accrued liabilities and other long-term obligations on the Consolidated Balance Sheets.
| Severance
and Related
Costs
| Plant
Shutdown
and Related
Costs
| Total
|
|---|
| (Dollars in millions) |
|---|
Balance at December 31, 2004 | | | $ | 5 | | $ | 4 | | $ | 9 | |
| Restructuring charges | | | | - | | | - | | | - | |
| Change in estimate | | | | - | | | - | | | - | |
| Payments and settlements | | | | (2 | ) | | (1 | ) | | (3 | ) |
|
| |
| |
| |
| Balance at March 31, 2005 | | | $ | 3 | | $ | 3 | | $ | 6 | |
|
| |
| |
| |
The components of this balance at March 31, 2005 consist primarily of $2 million related to the closure of our graphite electrode manufacturing operations in Caserta, Italy, $2 million related primarily to remaining lease payments on our former corporate headquarters, $1 million related to the closure of our graphite electrode manufacturing operations in Welland, Canada and $1 million related to the closure of our advanced synthetic graphite machining operations in Sheffield, United Kingdom. We expect to make $3 million of these payments by the end of 2005, with the majority of the remaining payments to be paid by the end of 2007. It is also possible that we may, at any time, decide to permanently shut down certain remaining graphite electrode operations in Italy. In such event, we may record additional restructuring charges and incur additional exit costs.
In the 2004 first quarter, we recorded a $1 million charge for additional potential liabilities and expenses in connection with antitrust investigations and related lawsuits and claims.
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The following table presents an analysis of interest expense:
| For the Three
Months Ended
March 31,
|
|---|
| 2004
| 2005
|
|---|
| (Dollars in millions) |
|---|
| Interest incurred on debt | | | $ | 14 | | $ | 13 | |
| Interest rate swap benefit | | | | (4 | ) | | (1 | ) |
| Amortization of fair value adjustments for terminated hedge instruments | | | | (1 | ) | | (1 | ) |
| Accelerated amortization of fair value adjustments for terminated hedge instruments | | |
| due to reduction of Senior Notes | | | | (3 | ) | | - | |
| Amortization of debt issuance costs | | | | 1 | | | 1 | |
|
| |
| |
| Interest expense | | | $ | 7 | | $ | 12 | |
|
| |
| |
Average total debt outstanding was $679 million in the 2005 first quarter as compared to $668 million in the 2004 first quarter. The average annual interest rate was 6.5% in the 2005 first quarter as compared to 5.8% in the 2004 first quarter. These average annual rates include the benefits of our interest rate swaps, but exclude imputed interest on the DOJ antitrust fine for the 2004 first quarter and the acceleration of the amortization of gains realized from the sale of interest rate swaps due to the early extinguishment of debt from our exchanges of common stock for Senior Notes outstanding.
Interest income amounted to $1 million in the 2004 first quarter primarily due to interest earned on cash proceeds from the issuance and sale of the Debentures and interest earned on the provisional payment made to the EU Competition Authority in February 2004.
Provision for income taxes was a charge of $1 million in the 2005 first quarter and in the 2004 first quarter. The effective income tax rate was approximately 37% in the 2005 first quarter as compared to approximately 65% in the 2004 first quarter. The higher effective income tax rate in the 2004 first quarter was primarily due to nondeductible expenses associated with the restructuring charge. We estimate that we will have an effective income tax rate between 36% to 38% for 2005, excluding the effects of nondeductible restructuring expenses.
As a result of the matters described above, net income was $2 million in the 2005 first quarter as compared to a break-even position in the 2004 first quarter.
Effects of Inflation
We incur costs in the U.S. and each of the six non-U.S. countries in which we have a manufacturing facility. In general, our results of operations, cash flows and financial condition are affected by the effects of inflation on our costs incurred in each of these countries. See “–Currency Translation and Transactions” for a further discussion of highly inflationary countries.
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During the past three years, we experienced higher freight, energy and other raw material costs primarily due to substantial increases in regional and worldwide market prices of natural gas and other petroleum-based raw materials. We seek to mitigate the effects of those increases on our cost of sales through improved operating efficiencies, higher prices for our products and ongoing cost savings, and, in some cases, fixed price or derivative hedging contracts. We have in the past entered into, and may in the future enter into, natural gas hedge contracts to effectively fix our direct and indirect natural gas cost exposure in North America (45% of direct worldwide exposure). In addition, we have in the past entered into and may in the future enter into, short duration fixed rate purchase contracts with certain of our natural gas suppliers in order to mitigate seasonal increases in our natural gas costs. We currently do not have any natural gas derivative contracts. We cannot assure you that future increases in our costs will not occur or exceed the rate of inflation or the amounts, if any, by which we may be able to increase prices for our products.
Currency Translation and Transactions
We account for our non-U.S. subsidiaries under SFAS No. 52, “Foreign Currency Translation.” Accordingly, except for highly inflationary countries, the assets and liabilities of our non-U.S. subsidiaries are translated into dollars for consolidation and reporting purposes. Foreign currency translation adjustments are generally recorded as part of stockholders’ deficit and identified as part of accumulated other comprehensive loss on the Consolidated Balance Sheets until such time as their operations are sold or substantially or completely liquidated.
Highly inflationary economies are defined as having cumulative inflation of about 100% or more over a period of three calendar years. In general, the financial statements of foreign operations in highly inflationary economies are remeasured as if the functional currency of their economic environments were the dollar and translation gains and losses relating to these foreign operations are included in other (income) expense, net, on the Consolidated Statements of Operations rather than as part of stockholders’ deficit on the Consolidated Balance Sheets. We have subsidiaries in Russia, Mexico, Brazil and other countries which have had in the past, and may have in the future, highly inflationary economies.
We account for our Mexican and Russian subsidiaries using the dollar as its functional currency, as sales and purchases for each subsidiary are predominantly dollar-denominated. Our remaining subsidiaries use their local currency as their functional currency.
We also record foreign currency transaction gains and losses as part of other (income) expense, net.
Significant changes in currency exchange rates impacting us are described under “Effects of Changes in Currency Exchange Rates” and “Results of Operations – Items Affecting Us as a Whole.”
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Effects of Changes in Currency Exchange Rates
We incur costs in dollars and the currency of each of the six non-U.S. countries in which we have a manufacturing facility, and we sell our products in multiple currencies. In general, our results of operations, cash flows and financial condition are affected by changes in currency exchange rates affecting these currencies relative to the dollar and, to a limited extent, each other.
When the currencies of non-U.S. countries in which we have a manufacturing facility decline (or increase) in value relative to the dollar, this has the effect of reducing (or increasing) the dollar equivalent cost of sales and other expenses with respect to those facilities. This effect is, however, partially offset by the cost of petroleum coke, a principal raw material used by us, which is priced in dollars. In certain countries where we have manufacturing facilities, and in certain instances where we price our products for sale in export markets, we sell in currencies other than the dollar. Accordingly, when these currencies increase (or decline) in value relative to the dollar, this has the effect of increasing (or reducing) net sales. The result of these effects is to increase (or decrease) operating profit and net income.
Many of the non-U.S. countries in which we have a manufacturing facility have been subject to significant economic changes, which have significantly impacted currency exchange rates. We cannot predict changes in currency exchange rates in the future or whether those changes will have net positive or negative impacts on our net sales, cost of sales or net income. We cannot assure you that we would be able to mitigate any adverse effects of such changes.
During the 2005 first quarter, the average exchange rate of the Euro, the South African Rand and the Brazilian Real increased about 6%, 17% and 11%, respectively, when compared to the average exchange rate for the 2004 first quarter. During the 2005 first quarter, the average exchange rate for the Mexican Peso declined less than 1% when compared to the average exchange rate for the 2004 first quarter.
In the case of net sales of graphite electrodes, the impact of these events was an increase of about $2 million in the 2005 first quarter as compared to the 2004 first quarter. In the case of cost of sales of graphite electrodes, the impact of these events was an increase of about $4 million in the 2005 first quarter as compared to the 2004 first quarter.
The impact of these events on net sales of cathodes was an increase of about $2 million in the 2005 first quarter as compared to the 2004 first quarter. The impact of these events on cost of sales of cathodes was an increase of about $2 million in the 2005 first quarter as compared to the 2004 first quarter.
We have non-dollar denominated intercompany loans between GrafTech Finance and some of our foreign subsidiaries. At March 31, 2005, the aggregate principal amount of these loans was $449 million (based on currency exchange rates in effect at March 31, 2005). These loans are subject to remeasurement gains and losses due to changes in currency exchange rates. A portion of these loans are deemed to be essentially permanent and, as a result, remeasurement
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gains and losses on these loans are recorded in accumulated other comprehensive loss in the stockholders’ deficit section of the Consolidated Balance Sheets. The balance of these loans are deemed to be temporary and, as a result, remeasurement gains and losses on these loans are recorded in other (income) expense, net, on the Consolidated Statements of Operations. In the 2004 first quarter, we had a net total of $2 million in currency losses, including $5 million of exchange losses due to the remeasurement of intercompany loans and translation of financial statements of foreign subsidiaries which use the dollar as their functional currency. In the 2005 first quarter, we had a net total of $7 million in currency losses, including $8 million of exchange losses due to the remeasurement of intercompany loans and translation of financial statements of foreign subsidiaries which use the dollar as their functional currency. To manage certain exposures to specific financial market risks caused by changes in currency exchange rates, we use various financial instruments as described under “Item 3–Qualitative and Quantitative Disclosures about Market Risk.”
Liquidity and Capital Resources
Our sources of funds have consisted principally of invested capital, cash flow from operations and debt and equity financings. Our uses of those funds (other than for operations) have consisted principally of debt reduction, capital expenditures, payment of fines, liabilities and expenses in connection with antitrust investigations, lawsuits and claims, payment of restructuring costs and other obligations and operating costs.
We are highly leveraged and have other substantial obligations. At March 31, 2005, we had total debt of $686 million, cash and cash equivalents of $16 million and a stockholders’ deficit of $65 million. In addition, we have historically factored a portion of our accounts receivable and used the proceeds to reduce our debt. We have used a portion of the net proceeds from the issuance and sale of the Debentures in January 2004 to replace the cash previously provided by such factoring. As such, certain of our subsidiaries sold receivables totaling $7 million in 2004. No receivables were factored in the 2005 first quarter.
We use cash and cash equivalents, funds available under the Revolving Facility, subject to continued compliance with the financial covenants and representations under the Revolving Facility, as well as cash flow from operations as our primary sources of liquidity. The Revolving Facilities provides for maximum borrowings of up to $215 million. At March 31, 2005, $183 million was available (after consideration of outstanding letters of credit of $8 million). It is possible that our future ability to borrow under the Revolving Facility may effectively be less because of the impact of additional borrowings upon our compliance with the maximum net senior secured debt leverage ratio permitted or minimum interest coverage ratio required under the Revolving Facility.
At March 31, 2005, we were in compliance with all financial and other covenants contained in the Senior Notes, the Debentures and the Revolving Facility, as applicable. Based on expected operating results and expected cash flows, we expect to be in compliance with these covenants in 2005. If we were to believe that we would not continue to comply with these
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covenants, we would seek an appropriate waiver or amendment from the lenders thereunder. We cannot assure you that we would be able to obtain such waiver or amendment on acceptable terms or at all.
At March 31, 2005, 68% (or $461 million) of our total debt, excluding the fair value adjustments to debt and unamortized bond premium, had effectively been converted to variable rate obligations. At March 31, 2005, we had swaps for a notional amount of $435 million. We have interest rate swaps that effectively convert the fixed rate debt (represented by the Senior Notes) into variable rate debt. At March 31, 2005, variable interest was calculated based on the six month LIBOR rate as of the date of payment plus 5.7940%, calculated in arrears for $285 million aggregate notional amount, and based on the six month LIBOR plus 5.7967%, for the remaining $150 million aggregate notional amount. In the 2005 second quarter, we sold $20 million notional amount of swaps and paid a nominal fee. As a result of these transactions, we now hold $415 million notional amount of swaps for the remaining term of the Senior Notes.
At March 31, 2005, we also had interest rate caps for a total notional amount of $500 million through August 2007. These instruments effectively cap our interest rate exposure, represented by the net impact of our swaps on the Senior Notes, to no greater than 11.3% per annum.
At March 31, 2005, the Revolving Facility had an effective interest rate of 5.70%, our $435 million principal amount of Senior Notes had an effective rate of 9.19% (i.e., a fixed rate of 10.25%, effectively swapped to a variable rate of the LIBOR plus 5.7949%) and our $225 million principal amount of Debentures had a fixed rate of 1.625%. We estimate that we will have interest expense of approximately $49 million for 2005.
We continue to implement interest rate management initiatives to seek to minimize interest expense and optimize the risk in our portfolio of fixed and variable interest rate obligations as described under “Item 3–Quantitative and Qualitative Disclosures about Market Risk” in this Report.
Cash Flow and Plans to Manage Liquidity. We use cash and cash equivalents, funds available under the Revolving Facility and cash flow from operations as our primary sources of liquidity.
As a result of our significant leverage and other substantial obligations, our business strategies include efforts to enhance our capital structure by further reducing our gross obligations. Accordingly, we have placed the highest priority on accelerating the amount and speed of cash generated every day. Our efforts include leveraging our unique global manufacturing network by driving higher utilization rates and more productivity from our existing assets, accelerating commercialization initiatives across all of our businesses and realizing other global efficiencies.
As part of our cash management activities, we seek to manage accounts receivable credit risk and collections and payment of accounts payable to maximize our free cash at any given
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time and minimize accounts receivable losses. We may from time to time and at any time exchange or purchase Senior Notes in open market or privately negotiated transactions, opportunistically on terms that we believe to be favorable. We also continue to evaluate other opportunities to reduce our obligations, including the obligations associated with our U.S. defined benefit plan, which was frozen in 2003. We intend to continue to sell real estate, non-strategic businesses and certain other non-strategic assets. We cannot assure you if or when we will be able to complete these sales or that we will realize proceeds therefrom that meet our current expectations.
Our high leverage and other substantial obligations could have a material impact on our liquidity. Cash flow from operations services payment of our debt and other obligations, thereby reducing funds available to us for other purposes.
We believe that the long term fundamentals of our business continue to be sound. Accordingly, although we cannot assure you that such will be the case, we believe that, based on our expected cash flow from operations, our existing capital resources, and taking into account our working capital needs and our efforts to reduce costs, improve efficiencies and product quality, and accelerate commercialization of new products and cash flow, we will be able to manage our liquidity to permit us to service our debt and meet our obligations when due. Based on expected operating results and expected cash flows, we expect to be in compliance with all financial and other covenants in 2005.
Cash Flows. In general, during the 2004 first quarter and the 2005 first quarter, we used cash in operating activities (including payments related to restructurings and antitrust investigations, lawsuits and claims) as well as for capital expenditures. Financing for these uses was provided primarily by our incurrence of long-term and short-term debt.
Cash Flow Used in Operating Activities. Cash flow used in operating activities was $13 million in the 2005 first quarter as compared to $153 million in the 2004 first quarter, an improvement of $140 million.
Cash used in operating activities was $13 million in the 2005 first quarter. The primary uses consisted of $26 million for working capital and $3 million for other long-term assets and liabilities, offset by $16 million of cash from net income, after adding back the net effect from non-cash items. Working capital uses related primarily to a $22 million increase in inventories (due to an increase in work in process and finished inventory buffers positioned throughout our facility, necessary to enhance the reliability and stability of our graphite electrode production network, increase productivity and reduce distribution costs), a $24 million decrease in payables (due to timing of payment patterns, including our semi-annual interest payment on the Senior Notes), $3 million of restructuring payments and $3 million of payments of antitrust investigations and related lawsuits and claims, offset by a $26 million decrease in accounts and notes receivable. Other long-term assets and liabilities uses were primarily for pension, postretirement and other employee benefits. Non-cash items consisted primarily of $9 million of depreciation and amortization and $7 million of other net charges.
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Cash used in operating activities was $153 million in the 2004 first quarter. The primary uses consisted of $166 million for working capital and $16 million for other long-term assets and liabilities offset by a source of cash of $29 million from the net loss, after adding back the net effect from non-cash items. Working capital uses related primarily to a $71 million provisional payment against the EU antitrust fine, $13 million of restructuring payments, decreases in payables due to timing of payment patterns (including our semi-annual interest payment on the Senior Notes), and a reduction in factoring of accounts receivable of $41 million. Other long-term assets and liabilities uses were primarily for pension and postretirement benefits. Non-cash items consisted primarily of $12 million related to deferred income taxes, $9 million of depreciation and amortization and $5 million of loss on exchange of common stock for Senior Notes.
Cash Flow Used in Investing Activities.Cash flow used in investing activities was $11 million in the 2005 first quarter and $9 million in the 2004 first quarter. Virtually all of such investing activities consisted of capital expenditures.
Capital expenditures amounted to $11 million for the 2005 first quarter and related primarily to graphite electrode productivity and production stability initiatives and other essential capital maintenance.
Capital expenditures of $9 million in the 2004 first quarter related primarily to the expansion of graphite electrode manufacturing capacity, implementation of People Soft Enterprise One (formerly known as J.D. Edwards) information systems and essential capital maintenance.
Cash Flow Provided by Financing Activities. Cash flow provided by financing activities was $17 million in the 2005 first quarter as compared to $194 million during 2004 first quarter.
During the 2005 first quarter, we borrowed $24 million under the Revolving Facility. We used these borrowings primarily to pay our semi-annual interest payment on the Senior Notes. In the 2005 first quarter, we also paid $4 million of financing costs in conjunction with the refinancing of the Revolving Facility and $3 million in connection with interest rate swaps.
During the 2004 first quarter, we received gross proceeds of $225 million (less issuance costs of $7 million) from the sale of the Debentures. We used these proceeds primarily to repay term loans of $21 million outstanding under the Senior Facilities. We also used these proceeds to make a provisional payment of $71 million to the EU Competition Authority against the EU antitrust fine and to replace cash previously provided by factoring of accounts receivable. In January 2004, we also purchased $8 million aggregate principal amount of Senior Notes, plus accrued interest, for $9 million in cash.
Restrictions on Dividends and Stock Repurchases
A description of the restrictions on our ability to pay dividends and our ability to repurchase common stock is set forth under “Item 5 – Dividend Policies and Restrictions” in the
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Annual Report. Such description contains all of the information required with respect thereto.
Recent Accounting Pronouncements
A description of recent accounting pronouncements is set forth under “New Accounting Standards” in Note 2 to the Notes to the Consolidated Financial Statements contained in this Report, and such description is incorporated herein by reference. Such description contains all of the information required with respect thereto.
Description of Our Financing Structure
The description of the Revolving Facility, the Senior Notes and the Debentures set forth under “Long-Term Debt and Liquidity” and “Subsequent Events” in the Annual Report is incorporated by reference, subject to the additional or different information set forth in this Report.
Revolving Facility
On February 8, 2005, we entered into an Amended and Restated Credit Agreement, dated as of February 8, 2005, among GTI, GrafTech Finance, GrafTech Global, the LC Subsidiaries from time to time party thereto, the lenders from time to time party thereto and JPMorgan Chase Bank, N.A., as Administrative Agent, Collateral Agent and Issuing Bank.
As amended and restated, the Credit Agreement provides for, among other things, an extension until July 15, 2010 of the maturity of the Revolving Facility, lower interest rates, less restrictive financial covenants, additional flexibility for investments and acquisitions and, subject to certain conditions (including a maximum senior secured leverage ratio test), an accordion feature that permits GrafTech Finance to establish additional credit facilities thereunder in an aggregate amount, together with the Revolving Facility, of up to $425 million.
The Revolving Facility provides for revolving and swingline loans to GrafTech Finance and issuance of letters of credit for the account of GrafTech Finance and other designated subsidiaries from time to time in an aggregate principal and stated amount at any time not to exceed $215 million. Loans and letters of credit may be denominated in dollars, euros and certain other currencies and are available for working capital and other general corporate purposes.
The interest rate applicable to the Revolving Facility is, at our option, either LIBOR plus a margin ranging from 1.25% to 2.25% (depending on our leverage ratio or our senior unsecured (or corporate or implied issuer) rating) or, in the case of dollar denominated loans, the alternate base rate plus a margin ranging from 0.25% to 1.25% (depending on such ratio or rating). The alternate base rate is the higher of (i) the prime rate announced by JP Morgan Chase Bank, N.A. or (ii) the federal fund effective rate plus 0.50%. GrafTech Finance pays a per annum fee ranging from 0.250% to 0.500% (depending on such ratio or rating) on the undrawn portion of the commitments under the Revolving Facility.
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PART I (CONT’D)
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Senior Notes
GrafTech Finance currently has $435 million aggregate principal amount of Senior Notes outstanding. Interest on the Senior Notes is payable semi-annually on February 15 and August 15 of each year at the rate of 10.25% per annum. The Senior Notes mature on February 15, 2012.
Unsecured intercompany term notes in an aggregate principal amount, at March 31, 2005, equal to $541 million (based on currency exchange rates in effect at March 31, 2005) issued by our operating subsidiaries in Mexico, South Africa and Switzerland and our holding company subsidiary in France and guarantees of those unsecured intercompany term notes by our principal foreign subsidiaries have been pledged by GrafTech Finance to secure the Senior Notes, subject to the limitation that at no time will the combined value of the pledged portion of any foreign subsidiary’s unsecured intercompany term note and unsecured guarantee of unsecured intercompany term notes issued by other foreign subsidiaries exceed 19.99% of the principal amount of the then outstanding Senior Notes. As a result of this limitation, the principal amount of unsecured intercompany term notes pledged to secure the Senior Notes at March 31, 2005 equals $334 million (based on currency exchange rates in effect at March 31, 2005), or about 77% of the principal amount of the outstanding Senior Notes. The remaining unsecured intercompany term notes held by GrafTech Finance in an aggregate principal amount at March 31, 2005 of $207 million (based on currency exchange rates in effect at March 31, 2005) and any pledged unsecured intercompany term notes that cease to be pledged due to a reduction in the principal amount of the then outstanding Senior Notes due to redemption, repurchase or other events, will not be subject to any pledge and will be available to satisfy the claims of creditors of GrafTech Finance (including the lenders under the Revolving Facility, the holders of the Senior Notes and the holders of the Debentures) as their interests may appear. The Senior Notes prohibit the pledge of these unsecured intercompany term notes or related guarantees to secure any other debt or obligation.
Our operating subsidiary in Russia, Carbone Savoie, AET and certain immaterial domestic and foreign operating and holding companies are neither guarantors of the secured intercompany revolving note of our Swiss subsidiary that is pledged to secure the Revolving Facility nor guarantors of the Senior Notes or the unsecured intercompany term notes pledged to secure the Senior Notes, nor guarantors of the Debentures. At December 31, 2004 and March 31, 2005, the aggregate combined book value of their assets was about $185 million and $189 million, respectively, and their debt and liabilities totaled $74 million (excluding intercompany trade and other miscellaneous liabilities of $19 million) and $82 million (excluding intercompany trade and other miscellaneous liabilities of $9 million), respectively. For the 2005 first quarter their aggregate combined net income was nil and for the 2004 first quarter their aggregate combined net income was about $1 million. For the 2005 first quarter and 2004 first quarter, their aggregate combined net source of cash from operations was about $3 million and $13 million, respectively (excluding the impact of payments and borrowings under a short-term unsecured intercompany cash flow note issued by Carbone Savoie).
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PART I (CONT’D)
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Debentures
GTI currently has $225 million aggregate principal amount of Debentures outstanding. Interest on the Debentures is payable semi-annually on January 15 and July 15 of each year, commencing July 15, 2004, at the rate of 1.625% per annum. The Debentures mature on January 15, 2024, unless earlier converted, redeemed or required to be repurchased.
Litigation Initiated By Us Against Our Former Parents
In February 2000, we commenced a lawsuit against our former parents, Mitsubishi Corporation and Union Carbide Corporation, to recover certain payments made to them in connection with our leveraged equity recapitalization in January 1995 as well as certain unjust receipts by them from their investments in us and damages for aiding and abetting breaches of fiduciary duties owed to us by our former senior management in connection with illegal graphite electrode price fixing activities. We were seeking to recover more than $1.5 billion, including interest. In November 2002, the SDNY District Court granted Union Carbide Corporation’s motion to disqualify certain of our counsel. In January 2004, the SDNY District Court granted the defendants’ motion to dismiss this lawsuit. We appealed the grant of both motions to the Circuit Court of Appeals, which affirmed the decisions of the SDNY District Court. We sought a rehearing before the Circuit Court of Appeals, which was denied in March 2005. After a thorough review of our appeal options, we have determined to not seek any further appeals in this matter. Through March 31, 2005, we had incurred about $7 million of legal expenses in connection with this lawsuit.
Antitrust Litigation Against Us
In 1997, the DOJ and the EU Competition Authority commenced investigations into alleged violations of the antitrust laws in connection with the sale of graphite electrodes. The antitrust authorities in Canada, Japan and Korea subsequently began similar investigations. The EU Competition Authority also commenced an investigation into alleged antitrust violations in connection with the sale of specialty graphite. These antitrust investigations have been finally resolved. Several of the investigations resulted in the imposition of fines against us. These fines, or payments in accordance with a payment schedule, in the case of the DOJ antitrust fine, have been timely paid.
We have settled virtually all of the civil antitrust lawsuits (including class action lawsuits) previously pending against us, certain civil antitrust lawsuits threatened against us and certain possible civil antitrust claims against us arising out of alleged antitrust violations occurring prior to the date of the relevant settlement in connection with the sale of graphite electrodes, carbon electrodes and bulk graphite products. All settlement payments due have been timely paid. There remain, however, certain pending claims as well as pending lawsuits in the U.S. relating to the sale of graphite electrodes sold to foreign customers. It is also possible that additional antitrust lawsuits and claims could be asserted against us in the U.S. or other jurisdictions. We are currently not reserved for such matters.
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Other Proceedings Against Us
We are involved in various other investigations, lawsuits, claims and other legal proceedings incidental to the conduct of our business. While it is not possible to determine the ultimate disposition of each of them, we do not believe that their ultimate disposition will have a material adverse effect on our financial position, results of operations or cash flows.
Product Warranties
We generally sell products with a limited warranty. We accrue for known warranty claims if a loss is probable and can be reasonably estimated. At December 31, 2004 and March 31, 2005, claims accrued but not yet paid amounted to $1 million. The following table presents the activity in this accrual for the 2005 first quarter:
| |
|---|
| Balance at December 31, 2004 | | | $ | 1 | |
| Product warranty charges | | | | - | |
| Payments and settlements | | | | - | |
|
| |
| Balance at March 31, 2005 | | | $ | 1 | |
|
| |
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PART I (CONT’D)
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risks primarily from changes in interest rates, currency exchange rates, commercial energy rates, and changes to the fair value of the redemption option and related make-whole provision under the Debentures. We routinely enter into various transactions that have been authorized according to documented policies and procedures to manage these well-defined risks. These transactions relate primarily to financial instruments described below. Since the counterparties to these financial instruments are large commercial banks and similar financial institutions, we do not believe that we are exposed to material counterparty credit risk. We do not use financial instruments for trading purposes.
Our exposure to changes in interest rates results primarily from floating rate long-term debt tied to LIBOR or euro LIBOR. Our exposure to changes in currency exchange rates results primarily from:
| o | sales made by our subsidiaries in currencies other than local currencies; |
| o | raw material purchases made by our foreign subsidiaries in currencies other than local currencies; and |
| o | investments in and intercompany loans to our foreign subsidiaries and our share of the earnings of those subsidiaries, to the extent denominated in currencies other than the dollar. |
Our exposure to changes in energy costs results primarily from the purchase of natural gas and electricity for use in our manufacturing operations. Our exposure to changes in the fair value of the redemption make-whole option results primarily from changes in the closing price of our common stock during each quarterly period.
Interest Rate Risk Management.We implement interest rate management initiatives to seek to minimize our interest expense and optimize the risk in our portfolio of fixed and variable interest rate obligations. Use of these initiatives is allowed under the Senior Notes and the Revolving Facility. We have interest rate swaps that effectively convert fixed rate debt (represented by the Senior Notes) into variable rate debt.
At December 31, 2004, we had swaps for a notional amount of $450 million. At December 31, 2004, $435 million (out of our total outstanding $450 million notional amount) of interest rate swaps were designated as hedging the exposure to changes in the fair value of the related debt (called a fair value hedge). The related debt for those swaps is the Senior Notes, of which $435 million aggregate principal amount was outstanding at December 31, 2004.
In the 2005 first quarter, we sold $15 million notional amount of undesignated swaps and paid a nominal fee. Additionally, we sold $150 million notional amount of our fair value hedge swaps and paid $3 million in cash. Immediately thereafter, we repurchased $150 million notional amount of fair value hedge swaps with a different counterparty. As a result of these transactions, at March 31, 2005, we held $435 million notional amount of swaps. In the 2005
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second quarter, we sold $20 million notional amount of swaps and paid a nominal fee. As a result of these transactions, we now hold $415 million notional amount of swaps for the remaining term of the Senior Notes.
At December 31, 2004 and March 31, 2005 (excluding the offsetting value of our interest rate caps), the principal value of our debt was reduced by $10 million and $17 million, respectively, as a result of our fair value hedges. The market values of those interest rate swaps, excluding changes in value resulting from accrued interest payable or receivable from the counterparty, are currently recorded as part of other long-term obligations on the Consolidated Balance Sheets. Accrued interest receivable from or payable to the counterparty is recorded as a component of interest expense on the Consolidated Statement of Operations.
Such interest rate swaps have effectively converted our fixed rate debt (represented by the Senior Notes) into variable rate debt. At December 31, 2004, such variable interest was calculated based on the six month LIBOR rate as of the date of payment plus 5.7940%, calculated in arrears. At March 31, 2005, variable interest was calculated based on the six month LIBOR rate as of the date of payment plus 5.7940%, calculated in arrears for $285 million aggregate principal amount of our Senior Notes outstanding, and based on the six month LIBOR plus 5.7967% for the remaining $150 million aggregate principal amount of our Senior Notes outstanding.
All of our swaps are valued monthly, and we are required to provide cash collateral to the counterparty to the extent that the fair market value of the swap liability, net of the fair market value of our interest rate caps, exceeds a specific threshold. At December 31, 2004, all of our swaps were with one counterparty and this threshold was $15 million. At March 31, 2005, this threshold for posting cash collateral was $30 million ($15 million pertaining to the newly purchased $150 million of fair value swaps and $15 million for the remaining $285 million). We were not required to provide any cash collateral at December 31, 2004 or March 31, 2005.
When we sell a fair value hedge swap, the gain or loss is amortized as a credit or charge to interest expense over the remaining term of the Senior Notes. When we effectively reduce the outstanding principal amount of the Senior Notes (through debt-for-equity exchanges, repurchases or otherwise), the related portion of such credit or charge is accelerated and recorded in the period in which such reduction occurs. At December 31, 2004 and March 31, 2005, the principal value of our debt was increased by $25 million and $21 million, respectively, as a result of gains realized from previously sold swaps. The net impact of current and terminated hedge instruments was a $15 million and a $4 million increase in the fair value of our debt at December 31, 2004 and March 31, 2005, respectively, and was recorded on the Consolidated Balance Sheets on the line entitled “fair value adjustments for hedge instruments.”
Interest rate swaps reduced our interest expense by approximately $8 million in the 2004 first quarter. The reduction was due to the benefit from current interest rate swaps in the amount of $4 million, $1 million of amortization of fair value adjustments for previously sold interest
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PART I (CONT’D)
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rate swaps and $3 million due to the acceleration of the amortization of fair value adjustments for previously sold interest rate swaps due to a reduction of Senior Notes.
Interest rate swaps reduced our interest expense by $2 million in the 2005 first quarter. The reduction was due to the benefit from current interest rate swaps in the amount of $1 million and the amortization of fair value adjustments for previously sold interest rate swaps of $1 million.
We enter into agreements with financial institutions that are intended to limit, or cap, our exposure to incurrence of additional interest expense due to increases in variable interest rates. These instruments effectively cap our interest rate exposure, represented by the net impact of our swaps on the Senior Notes, to no greater than 11.3% per annum. At December 31, 2004 and March 31, 2005, we had interest rate caps for a notional amount of $500 million. All of our interest rate caps are marked-to-market monthly. Gains and losses are recorded in other (income) expense, net, on the Consolidated Statements of Operations. The mark-to-market adjustment on caps was a $2 million loss for the 2004 first quarter and a nominal gain for the 2005 first quarter.
Currency Rate Management. We enter into foreign currency instruments to attempt to manage exposure to changes in currency exchange rates. These foreign currency instruments, which include, but are not limited to, forward exchange contracts and purchased currency options, attempt to hedge global currency exposures, net, relating to euro-denominated debt and identifiable foreign currency receivables, payables and commitments held by our foreign and domestic subsidiaries. Forward exchange contracts are agreements to exchange different currencies at a specified future date and at a specified rate. Purchased foreign currency options are instruments which give the holder the right, but not the obligation, to exchange different currencies at a specified rate at a specified date or over a range of specified dates. The result is the creation of a range in which a best and worst price is defined, while minimizing option cost. Forward exchange contracts and purchased currency options are carried at market value.
The notional amount of open foreign exchange contracts used by us to minimize foreign currency exposure against euro depreciation was $54 million at December 31, 2004 and $39 million at March 31, 2005. These contracts are marked-to-market monthly and gains and losses are recorded in other (income) expense, net, on the Consolidated Statements of Operations. We recorded a nominal gain with respect to contracts held during the 2005 first quarter. There were no contracts outstanding during the 2004 first quarter.
Commercial Energy Rate Management. We currently do not have any natural gas derivative or other commercial energy rate contracts. We have in the past entered, and may in the future enter, into short duration fixed rate purchase contracts with certain of our natural gas suppliers in order to mitigate seasonal increases in our natural gas costs. We currently have such contracts with certain of our natural gas suppliers.
Derivative Liability Associated with the Debentures. The redemption make-whole option is accounted for separately from the underlying debt and recorded as a derivative financial
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instrument. The embedded derivative financial instrument was classified as a derivative liability upon issuance and is included in the other long-term obligations in the Consolidated Balance Sheet. At each balance sheet date, we adjust the redemption make-whole option to its estimated fair value. Upon issuance at January 22, 2004, the estimated fair value of our derivative liability was $6 million. At December 31, 2004, the estimated fair value of our derivative liability was $4 million. At March 31, 2005, the estimated fair value of our derivative liability was $1 million. We estimate the fair value of the redemption make-whole option using a financial model that uses several assumptions, including historical stock price volatility, risk-free interest rates, remaining maturity and the closing price of our common stock. We believe that the assumption that has the greatest impact on the determination of fair value is the closing price of our common stock during each quarterly period.
Sensitivity Analysis. We used a sensitivity analysis to assess the potential effect of changes in currency exchange rates, interest rates and the Debenture redemption make-whole option on results of operations for the 2005 first quarter. Based on this analysis, a hypothetical 10% weakening or strengthening in the dollar across all other currencies would have changed our reported gross margin for the 2005 first quarter by about $4 million. Based on this analysis, a hypothetical increase in interest rates of 100 basis points (including the impact of such increase on current interest rate swaps) would have increased our interest expense by about $1 million for the 2005 first quarter. Based on this analysis, a hypothetical 10% increase or decrease in the more relevant variables (particularly our current stock price, historical stock price volatility and borrowing costs) would have a nominal effect on the redemption make-whole option.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Report, and, based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that these controls and procedures are effective at the reasonable assurance level.
Disclosure controls and procedures are our controls that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
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Changes in Internal Controls Over Financial Reporting
Management's evaluation of disclosure controls and procedures did not identify any change in our internal controls over financial reporting that occurred during the quarter ended March 31, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
Item 1. Legal Proceedings
This information required in response to this Item is set forth in Note 11 to the Notes to Consolidated Financial Statements contained in this Report, and such information is hereby incorporated herein by reference. Such description contains all of the information required with respect thereto.
Item 6. Exhibits
The exhibits listed in the following table have been filed as part of this Report.
Exhibit
Number | | Description of Exhibit |
| 31.1 | | Certification pursuant to Rule 13a-14(a) under the Exchange Act by Craig S. Shular, Chief Executive Officer & President. |
| 31.2 | | Certification pursuant to Rule 13a-14(a) under the Exchange Act by Corrado F. De Gasperis, Vice President, Chief Financial Officer & Chief Information Officer. |
| 32.1 | | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Craig S. Shular, Chief Executive Officer & President. |
| 32.2 | | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Corrado F. De Gasperis, Vice President, Chief Financial Officer & Chief Information Officer. |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
| | GRAFTECH INTERNATIONAL LTD. |
| Date: May 10, 2005 | | By:/s/ Corrado F. De Gasperis
Corrado F. De Gasperis
Vice President, Chief Financial Officer,
& Chief Information Officer (Principal
Accounting Officer) |
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EXHIBIT INDEX
Exhibit
Number | | Description of Exhibit |
| 31.1 | | Certification pursuant to Rule 13a-14(a) under the Exchange Act by Craig S. Shular, Chief Executive Officer & President. |
| 31.2 | | Certification pursuant to Rule 13a-14(a) under the Exchange Act by Corrado F. De Gasperis, Vice President, Chief Financial Officer & Chief Information Officer. |
| 32.1 | | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Craig S. Shular, Chief Executive Officer & President. |
| 32.2 | | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 by Corrado F. De Gasperis, Vice President, Chief Financial Officer & Chief Information Officer. |
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