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| GTI > SEC Filings for GTI > Form 10-K on 27-Feb-2009 | All Recent SEC Filings |
27-Feb-2009
Annual Report
GENERAL
We have four major product categories: graphite electrodes, refractory products, advanced graphite materials, and natural graphite products.
Reportable Segments. Our businesses are reported in the following categories:
† Industrial materials, which consists of graphite electrodes and refractory products.
† Engineered solutions, which includes advanced graphite materials and natural graphite products.
Reference is made to the information under "Part I" for background information on our businesses, industry and related matters.
GLOBAL ECONOMIC CONDITIONS AND OUTLOOK
We are impacted in varying degrees, both positively and negatively, as global, regional or country conditions fluctuate. Our discussions about market data and global economic conditions below are based on or derived from published industry accounts and statistics.
2006 and 2007. Overall, global and regional economic conditions remained relatively stable in 2006 and 2007. We estimate that worldwide steel production was about 1.24 billion metric tons in 2006 and 1.325 billion metric tons in 2007, about a 10% and 7% increase, respectively, over the prior year. In 2006, China's production grew almost 20% and represented the single largest contributor to the growth in global steel demand. Chinese steel production was approximately 88% basic oxygen furnace related for 2006. However, China also was the growth leader for new EAF steel production. Overall, EAF steel production capacity grew, primarily driven by new EAF furnaces in China, and to a lesser extent, in Russia, the Middle East and North America. In 2007, China's production grew almost 16% and represented the single largest contributor to the growth in global steel demand. Chinese steel production was 87% basic oxygen furnace related in 2007. China remained the growth leader for new EAF steel production. Overall, EAF steel production capacity continued to grow in 2007, primarily driven by new EAF furnaces in China, and to a lesser extent, in Russia, the Middle East and North America. This contributed to a more favorable global pricing environment in 2007.
Demand for our engineered solutions products increased significantly in 2006 and 2007, as compared to prior years. The increases were mainly in the energy related markets, including solar, oil and gas exploration, transportation industries and markets for our natural graphite products.
2008. Global and regional economic conditions remained relatively stable in the first half of 2008. In September 2008 it became apparent that the global economy was entering into difficult times due to the financial industry crisis. Credit markets became frozen, liquidity diminished, business activity slowed at an extreme pace leading the global economy into its worst crisis in 60 years.
Due to the negative global economic situation and falling steel demand from key steel end-markets (automotive, construction, and appliances), a significant number of global steel producers reduced their operating rates in the fourth quarter.
Based on preliminary figures, worldwide steel production was about 1.304 billion metric tons in 2008, about a 1.6% decrease as compared to 2007. China's steel production grew at a much lower rate than in recent years due to a slowdown in economic growth and falling steel demand. In 2008, China's steel production grew by about 1.5%, a significant decline compared to China's recent double-digit annual growth rates. Steel production in the rest of the world declined by 3.5% in 2008.
The percent of EAF to total steel production remained at approximately 31% in 2008. EAF steel production was estimated to have been 405 million metric tons in 2008, about a 2% decrease compared to 2007. For the first nine months of the year, EAF production grew by over 3%, however, EAF production experienced a decline of 18% in the fourth quarter. China's EAF steel production increased 2% compared to the prior year. The rest of the world's EAF production declined by 3%, as a result of lower operating rates in the fourth quarter.
Demand for our engineered solutions segment increased in 2008 as compared to 2007. The increases were mainly in the energy related markets, including solar, oil and gas exploration, transportation industries, and ETM markets.
Outlook. Consensus among economists is that the global economic crisis is deepening, with slowdowns in major advanced economies now spreading into major emerging markets. A decline in growth rates is expected for advanced economies such as the United States and Europe. While in emerging countries such as China, India, and Brazil, economists expect very low growth compared with recent historical trends.
The challenging environment of the fourth quarter for our Industrial Materials business segment continues and we expect a similar scenario for at least the first half of 2009.
It is expected due to the financial crisis and global economic slowdown that much of the new EAF capacity projected to be started or completed in the 2009-2011 timeframe will be postponed. Longer term, it is expected that EAF will continue to grow as a percent of total steel driven primarily by new EAF furnaces in China, Russia, the Middle East and North America.
Because our engineered solutions business crosses many markets, the negative global economy will impact each market in varying degrees. However, we believe our engineered solutions products will be faced with reduced demand in 2009.
Economic conditions and the market environment continue to be extremely volatile and uncertain. As a result, we are not able to predict at this time an outlook for the full year 2009. However, we do expect:
† Capital expenditures to be approximately $55 million
† Depreciation expense to be approximately $35 million
Our outlook could be significantly impacted by, among other things, factors described under "Item 1A - Risk Factors" and "Item 1A - Forward Looking Statements" in this Report.
FINANCING TRANSACTIONS
On February 8, 2005, we completed a substantial amendment and restatement of the Credit Agreement to effect a refinancing of the Revolving Facility. We believe the refinancing enhanced liquidity. The Revolving Facility now provides for loans and letters of credit in a maximum amount outstanding at any time of up to $215.0 million and matures in July 2010. We have approximately $100 million of working capital liquidity available to use through our factoring and supply chain arrangements currently in place.
During 2008, we redeemed $180.0 million of the outstanding principal amount of the 10 1/4% Senior Notes due 2012, at 103.417% of the principal amount, plus accrued interest. During 2008, we also converted to equity the $225.0 million principal amount of our 1 5/8% Convertible Senior Debentures for 13,559,629 shares of our common stock and $9.2 million in cash, $9.0 million of which represented the present value of all remaining scheduled interest payments from the date of conversion until January 15, 2011.
During 2008, we entered into a supply chain financing arrangement, as discussed in more detail under "Liquidity and Capital Resources," below. During 2008, we purchased approximately $60.4 million of inventory under this arrangement.
During 2008, we sold $150.0 million of receivables at a cost lower than the cost to borrow a comparable amount for a comparable period under the Revolving Facility. See "Liquidity and Capital Resources" below for further discussion.
PROCEEDINGS AGAINST US
We are involved in various other investigations, lawsuits, claims, demands, environmental compliance programs, and other legal proceedings arising out of or incidental to the conduct of our business. While it is not possible to determine the ultimate disposition of each of these matters and proceedings, we do not believe that their ultimate disposition will have a material adverse effect on our financial position, results of operations or cash flows.
REALIZABILITY OF NET DEFERRED TAX ASSETS AND VALUATION ALLOWANCES
At December 31, 2008 we had $146.4 million of gross deferred income tax assets, of which $42.9 million required a valuation allowance. In addition, we had $123.4 million of gross deferred income tax liabilities. Our valuation allowance means that we do not believe that these assets are more likely than not to be realized. Until we determine that it is more likely than not that we will generate sufficient taxable income to realize our deferred income tax assets, income tax benefits in each current period will be fully reserved.
Our valuation allowance does not affect our ability and intent to utilize the deferred income tax assets as we generate sufficient future profitability. We are executing current strategies and developing future strategies, to improve sales, reduce costs and improve our capital structure in order to improve U.S. taxable income of the appropriate character to a level sufficient to fully realize these benefits in future years. The current U.S. tax attributes, if utilized, will allow us to significantly reduce our cash tax obligations in the U.S.
CUSTOMER BASE
We are a global company and serve all major geographic markets. Sales of our products to customers outside the U.S. accounted for about 77% of our net sales in 2006, 83% of our net sales in 2007, and 85% of our net sales in 2008. In 2008, seven of our ten largest customers were based in Europe, one in India, one in South America and one in the Middle East.
In 2008, our ten largest customers were purchasers of industrial materials products. No single customer or group of affiliated customers accounted for more than 10% of our net sales in 2008.
RESULTS OF OPERATIONS
Financial information discussed below excludes our cathodes business that was sold in December 2006 and has been accounted for as discontinued operations.
2007 Compared to 2006.
Consolidated. Net sales of $1,004.8 million in 2007 represented a $149.4 million or 17.5% increase from net sales of $855.4 million in 2006. Net sales for our industrial materials segment increased $136.0 million, or 18.8%, primarily due to favorable price/mix increases and favorable currency impacts in 2007 compared to 2006. Engineered solutions net sales increased $13.4 million, or 10.3%, due to price/mix increases and favorable currency impacts in 2007 compared to 2006.
Cost of sales of $677.5 million in 2007 represented a $61.9 million, or 10.1%, increase from cost of sales of $615.6 million in 2006. Cost of sales increased due to higher sales volumes, higher raw material and operating costs, and unfavorable currency impacts. These increases were offset by a decrease due to reduced period costs associated with the exit of the carbon electrode business and productivity savings realized from the sale of our Vyazma, Russia facility.
Gross profit of $327.3 million in 2007 represented an $87.5 million, or 36.5%, increase from gross profit of $239.8 million in 2006. Gross margin increased to 32.6% of net sales in 2007 from 28.0% of net sales in 2006.
Research and development expenses decreased $2.0 million, or 18.9%, from $10.6 million in 2006 to $8.6 million in 2007, with the decrease primarily due to salary reductions related to administration and support for our research and development function.
Selling and administrative expenses decreased $9.8 million, or 9.6 %, from $101.9 million in 2006 to $92.1 million in 2007. The decrease was due to a $3.2 million decrease in selling expenses, a $5.7 million decrease in administrative expenses, and a $0.9 million decrease in other overhead. These decreases in selling expenses were caused by decreased traveling and discretionary expenses as a result of our global cost-cutting initiative. Administrative expenses and other overhead also decreased due to this initiative and also due to cost savings realized by insourcing our accounting function in Parma, Ohio.
Beginning in 1997, the United States Department of Justice ("DOJ") and certain foreign antitrust authorities commenced investigations into alleged violations of the antitrust laws in connection with the sale of graphite electrodes. These antitrust investigations and related lawsuits and claims have been resolved. Several of the investigations resulted in the
imposition of fines against us which have been timely paid. In January 2007, we paid the last scheduled installment of the fine imposed by the DOJ.
Other income was $13.4 million in 2007 compared to $10.3 million in 2006. This increase was caused primarily by an increase in the gain on sale of assets. The gain on sale of assets increased by $20.3 million in 2007, caused primarily by the gain on the sale of our Caserta, Italy facility of $23.7 million and the $1.3 million gain from the sale of our Vyazma, Russia facility. This was offset by a $13.0 million charge incurred in 2007 related to the buy back of our Senior Notes. Currency fluctuations and intercompany loan translation provided income of $8.3 million in 2006, compared to $0.3 million in 2007, driven mainly by fluctuations in the Euro. In 2006, we received a $1.5 million benefit related to our Brazilian sales tax provision which did not recur in 2007 and legal, environmental and other expenses decreased $0.7 million year over year. During 2007, we also had income of $1.2 million received from the sale of litigation rights, and income of $0.6 million from the sale of investments. Expenses related to other items decreased an additional $2.8 million.
In 2006, we recorded a net restructuring charge of $10.0 million, pertaining primarily to a $3.7 million charge associated with the rationalization of our graphite electrode facilities, including those in France and the United States, a $1.8 million charge associated with the closure of our graphite electrodes manufacturing operations in Caserta, Italy, a $1.4 million charge primarily associated with the relocation of our corporate headquarters from Wilmington, Delaware to Parma, Ohio and a $2.7 million charge associated with severance and other costs for the shutdown of our carbon electrode production operations in Columbia, Tennessee.
In 2007, we recorded a net restructuring charge of $1.4 million, pertaining primarily to $0.7 million associated with the phase out of our graphite electrode machining and warehousing operations in Clarksville, Tennessee, $0.5 million associated with the closure of our graphite electrode manufacturing operations in Caserta, Italy, $0.1 million associated with severance and related costs related to our former Etoy, Switzerland facility and $0.1 million of severance and related costs for the shutdown of our carbon electrode production operations in Columbia, Tennessee.
The restructuring accrual is included in other accrued liabilities and other long-term obligations on the Consolidated Balance Sheets. The following table summarizes activity relating to the accrual:
Severance Plant
and Related Shutdown and
Costs Related Costs Total
------------- --------------- ---------
(Dollars in thousands)
Balance at January 1, 2006 $ 10,733 $ 794 $ 11,527
-- ---------- - -- ------------ - - ------- -
Restructuring charges 7,097 2,385 9,482
Change in estimates 474 - 474
Payments and settlements (12,089 ) (2,752 ) (14,841 )
Effect of change in currency exchange rates 1,200 31 1,231
-- ---------- - -- ------------ - - ------- -
Balance at December 31, 2006 7,415 458 7,873
-- ---------- - -- ------------ - - ------- -
Restructuring charges 1,018 534 1,552
Change in estimates 26 (209 ) (183 )
Payments and settlements (6,288 ) (596 ) (6,884 )
Effect of change in currency exchange rates 222 50 272
-- ---------- - -- ------------ - - ------- -
Balance at December 31, 2007 $ 2,393 $ 237 $ 2,630
-- ---------- - -- ------------ - - ------- -
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The components of the balance at December 31, 2007 consisted primarily of:
Industrial Materials:
† $0.8 million related to the rationalization of our graphite electrode facilities in France;
† $1.5 million related to the closure of our graphite electrode manufacturing operations in Caserta, Italy; and
† $0.3 million related to severance and related costs associated with our former Etoy, Switzerland facility.
In the first quarter of 2006, we abandoned long-lived fixed assets associated with costs capitalized for our enterprise resource planning system implementations due to an indefinite delay in the implementation of the remaining facilities. As a result, we recorded a $6.6 million impairment loss, including the write off of capitalized interest, in accordance with SFAS No. 144. Additionally, we recorded a $1.4 million impairment loss to adjust the carrying value of the assets in Switzerland to the estimated fair value less estimated selling costs. In the third quarter of 2006, we sold the long-lived assets at our Etoy, Switzerland facility for $7.1 million.
In the second quarter of 2006, we abandoned certain long-lived fixed assets associated with the accelerated closing of our carbon electrode facility in Columbia, Tennessee due to changes in our initial plan of restructuring the facility. As a result, we recorded a $0.6 million impairment loss in accordance with SFAS No. 144. Also in the second quarter, management established a plan to sell our subsidiary in Vyazma, Russia. We classified those assets as held for sale in the Consolidated Balance Sheet in accordance with SFAS No. 144.
In the fourth quarter of 2006, we abandoned certain fixed assets related to our graphite electrode operations. As a result, we recorded a $1.7 million loss in association with SFAS No. 144.
Interest expense is set forth in the following table:
For the Year Ended
December 31,
-----------------------------
2006 2007
------------- ---------
(Dollars in thousands)
Interest incurred on debt $ 42,518 $ 32,394
Amortization of fair value adjustments for terminated
hedge instruments (982 ) (605 )
Amortization of debt issuance costs 3,705 3,222
Interest on DOJ antitrust fine 222 5
Amortization of premium on Senior Notes (211 ) (116 )
Amortization of discount on Debentures 654 670
Interest incurred on other items 618 379
--- --------- - -- ------ -
Interest expense from continuing operations 46,524 35,949
Interest allocated to discontinued operations 9,736 -
--- --------- - -- ------ -
Total interest expense $ 56,260 $ 35,949
--- --------- - -- ------ -
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Average total debt outstanding was approximately $722.4 million in 2006 as compared to $505.2 million in 2007. The average annual interest rate was 7.2% in 2006 as compared to 6.3% in 2007. These average rates represent the average rates on total debt outstanding and include the gain or loss, if any, of our interest rate swaps.
Provision for income taxes was $48.3 million in 2007 as compared to $27.1 million in 2006. The income tax rate was 23.6% in 2007. The lower effective income tax rate is primarily due to a benefit resulting from a net decrease in the total valuation allowance for 2007 of $93.3 million, a net decrease in tax reserves and the mix of income in lower tax jurisdictions. Excluding the change in valuation allowances related to the discontinued operations, the impact of restructuring charges, asset impairments and the tax expense resulting from the cathode sale, the 2007 effective tax rate was approximately 25.3%.
The effective income tax rate was approximately 39.1% in 2006. Excluding the change in valuation allowances related to the discontinued operations, impact of restructuring charges, asset impairments and the tax expense resulting from the cathode sale, the 2006 effective tax rate was approximately 33%.
Subsequent to December 31, 2007, the 2004 "check the box" election that was made for our Swiss subsidiary was determined to be invalid. Our South Africa, U.K. and French subsidiaries remain "check the box" entities. However, the earnings of all of these subsidiaries from 2004-2007 are still considered to be repatriated to the U.S. under the principles of APB 23. We have established a deferred tax liability of $41.7 million associated with this repatriation. Foreign tax credit carryforwards and related valuation allowances were adjusted by a corresponding net amount, resulting in no overall federal impact. As of December 31, 2007, net U.S. deferred tax assets decreased by a cumulative $1.5 million as a result of this event, and are not significant to our overall financial position. The $1.5 million relates to a deferred tax asset for our state net operating loss carryforwards which decreased as a result of our post-event assessment of the likelihood that such deferred tax asset would be realized.
As a result of the matters described above, net income was $153.7 million in 2007, compared to $91.3 million in 2006.
Segment net sales. The following table represents our net sales by segment for the years ended December 31, 2006 and 2007:
For the Year Ended
December 31,
--------------------------
2006 2007
------------ -----------
(Dollars in thousands)
Industrial materials $ 725,202 $ 861,192
Engineered solutions 130,231 143,626
-- --------- - ---------
Total net sales $ 855,433 $ 1,004,818
-- --------- - ---------
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Our analysis of the percentage change in net sales for industrial materials and engineered solutions is set forth in the following table:
Net
Volume Price/Mix Currency Change
------ --------- -------- ------
Industrial materials 0 % 15 % 4 % 19 %
Engineered solutions 2 % 5 % 3 % 10 %
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Net sales for the industrial materials segment increased primarily due to favorable price/mix increases, and favorable currency impacts in 2007 compared to 2006. Volume increases in this segment for graphite electrodes and refractory products were offset by a decrease in volumes for carbon electrodes due to the exiting of this business in 2007. Engineered solutions net sales increased based on price/mix increases and favorable currency impacts during the year, coupled with increased volumes for our natural graphite products.
Segment operating net income. Corporate expenses are allocated to segments based on each segment's percentage of consolidated sales. The following table represents our operating income by segment for the years ended December 31, 2006 and 2007:
For the Year Ended
December 31,
--------------------------
2006 2007
------------- ---------
(Dollars in thousands)
Industrial materials $ 104,766 $ 212,363
Engineered solutions 2,189 12,896
--- --------- - -------
Total segment operating income $ 106,955 $ 225,259
--- --------- - -------
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Our analysis of the percentage change in segment operating expenses, including restructuring and impairment charges for industrial materials and engineered solutions is set forth in the following table:
Operating Expenses
---------------------------
2006 2007 Change
----- ---- ------
(Percentage of sales)
Industrial materials 86 % 75 % (11 %)
Engineered solutions 98 % 91 % (7 %)
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Segment operating expenses as a percentage of sales for industrial materials decreased 11% points to 75% in 2007. However, total operating expenses for 2007 increased $28.4 million compared to 2006, due primarily as a result of increased raw material costs of $51.8 million, related to our graphite electrode products, and unfavorable currency impacts of $22.5 million, caused primarily by the . . .
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