UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
_______________
FORM 10-Q
(Mark One)
[ X ]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended March 31, 2006
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ___________________ to ___________________
Commission file number: 1-13888
GRAFTECH INTERNATIONAL LTD.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
06-1385548
(I.R.S. Employer
Identification Number)
12900 Snow Road
Parma, OH
(Address of principal executive offices)
44130
(Zip code)
Registrant’s telephone number, including area code: (216) 676-2000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer |X| Accelerated Filer |_| Non-Accelerated Filer |_|
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).
Yes |_| No |X|
As of April 30, 2006, 98,444,163 shares of common stock, par value $.01 per share, were outstanding.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements:
Consolidated Balance Sheets at December 31, 2005 and March 31, 2006 (unaudited)
Page 3
Consolidated Statements of Operations for the Three Months ended March 31, 2005 and 2006 (unaudited)
Page 4
Consolidated Statements of Cash Flows for the Three Months ended March 31, 2005 and 2006 (unaudited)
Page 5
Notes to Consolidated Financial Statements (unaudited)
Page 7
Introduction to Part I, Item 2, and Part II, Item 1
Page 29
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Page 34
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Page 46
Item 4. Controls and Procedures
Page 48
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings
Page 50
Item 6. Exhibits
SIGNATURE
Page 51
EXHIBIT INDEX
Page 52
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
(Unaudited)
See accompanying Notes to Consolidated Financial Statements
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PART I (CONT’D)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
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CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
These interim Consolidated Financial Statements are unaudited; however, in the opinion of management, they have been prepared in accordance with Rule 10-01 of Regulation S-X adopted by the SEC and reflect all adjustments (all of which are of a normal and recurring nature) which management considers necessary for a fair statement of financial position, results of operations and cash flows for the periods presented. These interim Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements, including the accompanying Notes, contained in our Annual Report on Form 10-K for the year ended December 31, 2005 (the “Annual Report”). The year-end Consolidated Balance Sheet was derived from audited Consolidated Financial Statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. Results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results of operations that may be expected for any other interim period or for the entire year ending December 31, 2006.
We have revised our consolidated statements of cash flows to attribute payments made in connection with sales of interest rate swap derivatives as cash flows from investing activities. Previously, we reported these cash flows as part of cash flows from financing activities.
On November 24, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 151, “Inventory Costs — an amendment of APB No. 43,” Chapter 4, which is the result of its efforts to converge U.S. accounting standards for inventories with International Accounting Standards. SFAS No. 151 requires abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) to be recognized as current-period charges. It also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 did not have a significant impact on our consolidated results of operations or financial position.
On December 16, 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS No. 123(R) revises SFAS No. 123, “Accounting for Stock-Based Compensation,” and requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. Under SFAS No. 123(R), companies are to (1) use fair value to measure stock-based compensation awards and (2) cease using the “intrinsic value” method of accounting, which APB Opinion No. 25 allowed and resulted in no expense for many awards of stock options for which the exercise price of the option equaled the price of the underlying stock at the grant date. In addition, SFAS No. 123(R) retains the modified grant date model from SFAS No. 123. Under that model, compensation cost is measured at the grant date and adjusted to reflect actual forfeitures and the outcome of certain conditions. The fair value of an award is not remeasured after its initial estimation on the grant date (except in the case of a liability award or if the award is modified).
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We have adopted SFAS No. 123(R) in the first quarter of 2006 using the modified prospective transition method. Stock-based compensation recognized in our consolidated results of operations and financial position for the three months ended March 31, 2006 included compensation cost for stock-based awards granted prior to, but not fully vested as of January 1, 2006 and stock-based awards granted subsequent to January 1, 2006. Based on the current stock-based compensation plans in effect and awards issued and outstanding, our expense for the three months ended 2006 for stock-based compensation is $1.1 million of which $1.0 million relates to unvested restricted stock grants and $0.1 million to unvested stock options.
On November 10, 2005, the FASB Staff issued FSP No. SFAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” This FSP provides a practical transition election related to accounting for the tax effects of share-based payment awards to employees. SFAS No. 123(R), paragraph 81, indicates that, for purposes of calculating the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R) (an “APIC pool”), an entity shall include the net excess tax benefits that would have qualified as such had the entity adopted SFAS No. 123for recognition purposes. This FSP provides an elective alternative transition method. An entity may follow either the transition guidance for the APIC pool in paragraph 81 of SFAS No. 123(R) or the alternative transition method described in this FSP. We may take up to one year from the initial adoption of SFAS No. 123(R) to evaluate our available transition alternatives and make our one time election.
In May 2005, FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3,”which changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. This Statement defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. This Statement also redefines restatement as the revising of previously issued financial statements to reflect the correction of an error. This Statement shall be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We have adopted this Statement effective January 1, 2006. The adoption of SFAS No. 154 did not have a significant impact on our consolidated results of operations or financial position.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statement Nos. 133 and 140.”This Statement (1) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (2) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; (3) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an
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embedded derivative requiring bifurcation; and (4) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of our first fiscal year that begins after September 15, 2006. The fair value election of SFAS No. 155 may also be applied upon adoption of SFAS No. 155 for hybrid financial instruments that had been bifurcated under paragraph 12 of SFAS No. 133, prior to the adoption of this Statement. We will be required to adopt SFAS No. 155 in the first quarter of 2007. We are currently in the process of assessing the impact of the adoption of SFAS No. 155 on our consolidated results of operations and financial position.
We have historically maintained several stock incentive plans. The plans permitted options, restricted stock and other awards to be granted to employees and, in certain cases, also to non-employee directors. The aggregate number of shares authorized under the plans since their initial adoption was 19,300,000 at December 31, 2005.
Effective January 1, 2006, we adopted SFAS No. 123(R), which establishes accounting for stock-based awards exchanged for employee services, using the modified prospective application transition method. Accordingly, stock-based compensation cost is measured at the grant date, based on the fair market value of the award, over the requisite service period. Also, in accordance with the modified prospective transition method, our condensed consolidated financial statements for the periods prior to the first quarter of 2006 have not been restated to reflect this adoption.
Stock based compensation under SFAS 123(R)
In the first quarter of 2006, we recognized $1.1 million in stock-based compensation expense. A majority of the expense, $1.0 million, was recorded as selling, administrative, and other expenses in the Consolidated Statement of Operations, with the remaining expenses incurred as cost of sales and research and development.
As of March 31, 2006, the total compensation cost related to the non-vested restricted stock and stock options not yet recognized was $4.6 million and will be recognized over the weighted average life of 3.4 years.
Accounting for stock-based compensation
Restricted Stock. The fair value of restricted stock is based on the trading price of our common stock on the date of grant, less required adjustments to reflect dividends paid and expected forfeitures or cancellations of awards throughout the vesting period, which ranges between one and three years. The weighted average grant date fair value of restricted stock granted for the three months ended March 31, 2005 and 2006 was approximately $8.49 and $6.52, respectively.
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Restricted stock activity under the plans for the three months ended March 31, 2006 was as follows:
In the three months ended March 31, 2006, we granted 72,000 shares of restricted stock to certain directors, officers and employees at prices ranging from $4.71 to $7.82. Of these shares, 35,000 shares vest one year from the date of grant and 37,000 shares vest over a three-year period, with one-third of the shares vesting on the anniversary date of the grant in each of the next three years.
Stock Options. Our stock option compensation cost calculated under the fair value method is recognized over the vesting period of 5.0 years. The weighted-average fair value of options granted per share was $8.12 and $7.31 for the three months ended March 31, 2005 and 2006, respectively. The fair values of options granted are estimated on the date of grant using the Black-Scholes option-pricing model. We did not issue stock option awards in the first quarter of 2006. The weighted-average assumptions used in our Black-Scholes option-pricing model for awards issued during the three months ended March 31, 2005 are as follows:
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Stock options outstanding under the plans at March 31, 2006 are as follows:
Options granted, exercised, canceled and expired under our plans are summarized as follows:
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Pro Forma Information
Previously, we applied APB Opinion No. 25 and related Interpretations, as permitted by SFAS 123. Compensation expense associated with our restricted stock and stock options granted to non-employees was recorded in the Consolidated Statements of Operation and in the stockholders’ deficit section of the Consolidated Balance Sheets based on the fair market value. However, no compensation expense was recognized for our time vesting options granted. If compensation expense for each of our stock-based compensation plans was determined by the fair value method prescribed by SFAS No. 123, our net income (loss) and net income (loss) per share would have been reduced to the pro forma amounts indicated below:
Basic and diluted EPS are calculated based upon the provisions of SFAS No. 128,“Earnings Per Share”, and EITF No. 04-08, “Accounting Issues Related to Certain Features of
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Contingently Convertible Debt and the Effects on Diluted Earnings Per Share”, using the following share data:
Basic earnings (loss) per common share are calculated by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted earnings (loss) per share are calculated by dividing net income (loss), as adjusted, by the sum of the weighted average number of common shares outstanding plus the additional common shares that would have been outstanding if potentially dilutive securities, including those underlying the Debentures, had been issued.
The calculation of weighted average common shares outstanding for the diluted calculation excludes consideration of stock options covering 6,805,784 and 9,451,763 shares in the 2005 first quarter and 2006 first quarter, respectively, because the exercise of these options would not have been dilutive for those periods due to the fact that the exercise prices were greater than the weighted average market price of our common stock for each of those periods.
The calculation of weighted average common shares outstanding for the diluted calculation also excludes the 13,570,560 shares underlying the Debentures for the three months ended March 31, 2005 and 2006, and the effect of 428,743 stock options and restricted shares at March 31, 2006, as the effect would have been anti-dilutive.
Our businesses are reported in the following reportable segments: synthetic graphite, which consists of graphite electrodes, cathodes and advanced graphite materials and related services, and other, which consists of natural graphite, carbon electrodes and refractories and related services.
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We evaluate the performance of our segments based on gross profit. Intersegment sales and transfers are not material. The accounting policies of the reportable segments are the same as those for our Consolidated Financial Statements as a whole.
The following tables summarize financial information concerning our reportable segments.
At March 31, 2006, the outstanding balance of our restructuring reserve was $13.8 million. We expect the majority of the remaining payments to be paid by the end of 2007. The balance at March 31, 2006 consisted primarily of the following:
Synthetic Graphite Segment:
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Other Segment and Corporate:
In the first quarter of 2006, we recorded a net restructuring charge of $2.9 million. A majority of the net charge was comprised of the following:
The following table summarizes activity relating to the restructuring liability at March 31, 2006:
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 loss, including the write off of capitalized interest, in accordance with SFAS No. 144, “Accounting For the Impairment and Disposal of Long-Lived Assets”.
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Also, in the first quarter of 2006, management announced its intention to sell certain long-lived assets from our Etoy, Switzerland and Caserta, Italy facilities. As a result, we have classified these assets as held for sale in the Consolidated Balance Sheet in accordance with SFAS No. 144. In addition, we have recorded a $1.4 million impairment loss that adjusts the carrying value of the assets in Switzerland to the estimated fair value less estimated selling costs.
The following table presents an analysis of other (income) expense, net:
We have non-dollar-denominated intercompany loans between GrafTech Finance and some of our foreign subsidiaries. At December 31, 2005 and March 31, 2006, the aggregate principal amount of these loans was $414.6 million and $425.6 million, respectively (based on currency exchange rates in effect at such date). 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 gains and losses on these loans are recorded as a component of accumulated other comprehensive loss in the stockholders’ deficit section of the Consolidated Balance Sheets. The balance of these loans is deemed to be temporary and, as a result, remeasurement gains and losses on these loans are recorded as currency (gains) losses in other expense, net, on the Consolidated Statements of Operations. In the 2005 first quarter, we had a net total of $6.6 million of currency losses, including $6.2 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 2006 first quarter, we had a net total of $2.6 million of currency gains, including $4.2 million of exchange gains due to the remeasurement of intercompany loans and translation of financial statements of foreign subsidiaries that use the dollar as their functional currency.
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The components of our consolidated net pension and postretirement cost (benefit) are set forth in the following table:
The following table presents our long-term debt:
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Inventories are comprised of the following:
The following table presents an analysis of interest expense:
Comprehensive loss consisted of the following:
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Antitrust Matters
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 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. At December 31, 2005 and March 31, 2006, $26.0 million and $21.5 million remained in the reserve for liabilities and expenses in connection with antitrust investigations and related lawsuits and claims, respectively. The reserve is unfunded and represents the remaining DOJ antitrust fine obligation, with quarterly payments scheduled through January 2007.
Through March 31, 2006, except for certain foreign customer lawsuits discussed in Note 14 of the Annual Report, we have settled or obtained dismissal of 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 settlements in connection with the sale of graphite electrodes, carbon electrodes and bulk graphite products. All payments due have been timely paid.
We have been vigorously defending, and intend to continue to vigorously defend, against the foreign customer lawsuits. We may at any time, however, settle these lawsuits. It is possible that additional antitrust investigations, lawsuits or claims could be commenced or asserted against us in the U.S. and in other jurisdictions. We are currently not reserved for such matters.
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.
On March 1, 2006, we were served with a complaint commencing a securities class action in the United States District Court for the District of Delaware (Civil Action No. 06-133). The complaint alleged that GTI and certain officers violated federal securities law by making false statements or failing to disclose adverse facts, in or in relation to press releases issued by us on November 3, 2005, about our graphite electrode pricing power, our cost-cutting measures, the market for our non-graphite product lines, our forecasting ability, our internal controls and corporate compliance, and our restructuring activities and charges. The proposed class consists of all persons who purchased our securities during the period from November 3, 2005 until February 8, 2006. The complaint seeks, among other things, to recover damages resulting from
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such alleged violations. On March 21, 2006, the complaint was voluntarily withdrawn by the plaintiffs.
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. The following table presents the activity in this accrual for the 2006 first quarter (dollars in thousands):
On February 15, 2002, GrafTech Finance (“Finco”), a direct subsidiary of GTI (the “Parent”), issued $400 million aggregate principal amount of Senior Notes and, on May 6, 2002, $150 million aggregate principal amount of additional Senior Notes. All of the Senior Notes have been issued under a single Indenture and constitute a single class of debt securities. The Senior Notes mature on February 15, 2012. The Senior Notes have been guaranteed on a senior basis by the Parent and the following wholly-owned direct and indirect subsidiaries of the Parent: GrafTech Global, UCAR Carbon, UCAR International Trading Inc., UCAR Carbon Technology LLC, and UCAR Holdings V Inc. (“Holdings V”). The Parent, Finco and these subsidiaries together hold a substantial majority of our U.S. assets. Holdings V has no material assets or operations, and has been dissolved.
On January 22, 2004, the Parent issued $225 million aggregate principal amount of Debentures. The guarantors of the Debentures are the same as the guarantors of the Senior Notes, except for Parent (which is the issuer of the Debentures but a guarantor of the Senior Notes) and Finco (which is a guarantor of the Debentures but the issuer of the Senior Notes). The Parent and Finco are both obligors on the Senior Notes and the Debentures, although in different capacities.
The guarantors of the Senior Notes and the Debentures, solely in their respective capacities as such, are collectively called the “U.S. Guarantors.” Our other subsidiaries, which are not guarantors of either the Senior Notes or the Debentures, are called the “Non-Guarantors.”
All of the guarantees are unsecured, except that the guarantee of the Senior Notes by UCAR Carbon has been secured by a junior pledge of all of the shares of capital stock (constituting 97.5% of the outstanding shares of capital stock) of AET held by UCAR Carbon
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(called the “AET Pledged Stock”), subject to the limitation that in no event will the value of the pledged portion of the AET Pledged Stock exceed 19.99% of the principal amount of the then outstanding Senior Notes. All of the guarantees are full, unconditional and joint and several. Finco and each of the other U.S. Guarantors (other than the Parent) are 100% owned, directly or indirectly, by the Parent. All of the guarantees of the Senior Notes continue until the Senior Notes have been paid in full, and payment under such guarantees could be required immediately upon the occurrence of an event of default under the Senior Notes. All of the guarantees of the Debentures continue until the Debentures have been paid in full, and payment under such guarantees could be required immediately upon the occurrence of an event of default under the Debentures. If a guarantor makes a payment under its guarantee of the Senior Notes or the Debentures, it would have the right under certain circumstances to seek contribution from the other guarantors of the Senior Notes or the Debentures, respectively.
Provisions in the Revolving Facility restrict the payment of dividends by our subsidiaries to the Parent. At March 31, 2006, retained earnings of our subsidiaries subject to such restrictions were approximately $749.4 million. Investments in subsidiaries are recorded on the equity basis.
The following table sets forth condensed consolidating balance sheets at December 31, 2005 and March 31, 2006, condensed consolidating statements of operations for the 2005 and 2006 first quarters, and condensed consolidating statements of cash flows for the 2005 and 2006 first quarters of the Parent, Finco, all other U.S. Guarantors and the Non-Guarantors.
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PART I (CONT’D)GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)Condensed Consolidating Balance Sheetat December 31, 2005
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PART I (CONT’D)GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)Condensed Consolidating Balance Sheetat March 31, 2006
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PART I (CONT'D)GRAFTECH INTERNATIONAL LTD. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)
Condensed Consolidating Statements of Operationsfor the Three Months Ended March 31, 2005
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Condensed Consolidating Statements of Operationsfor the Three Months Ended March 31, 2006
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Condensed Consolidating Statements of Cash Flowsfor the Three Months Ended March 31, 2005
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Condensed Consolidating Statements of Cash Flowsfor the Three Months Ended March 31, 2006
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In the fourth quarter of 2005, we entered into natural gas derivative contracts to mitigate the impact of changes in natural gas prices. The contracts are not being accounted for as hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and, therefore, are recorded at fair value on the consolidated balance sheet. Changes in fair value are recorded in the consolidated statement of operations in cost of goods sold. During the first quarter of 2006, losses for these contracts were $0.7 million.
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Important Terms. We use various terms to simplify the presentation of information in this Report. These terms are defined in the Annual Report, which are incorporated herein by reference.
Presentation of Financial, Market and Legal Data. We present our financial information on a consolidated basis. As a result, the financial information for Carbone Savoie and AET is consolidated on each line of the Consolidated Financial Statements and the equity of the other owners in those subsidiaries is reflected on the lines entitled “minority stockholders’ equity in consolidated entities” and “minority stockholders’ share of income.” We use the equity method to account for 50% or less owned interests.
Unless otherwise noted, when we refer to dollars, we mean U.S. dollars.
Unless otherwise specifically noted, market and market share data in this Report are our own estimates or derived from sources described in “Part I – Preliminary Notes – Presentation of Financial, Market and Legal Data” in the Annual Report, which description is incorporated herein by reference. Our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under “Forward Looking Statements and Risks” in this Report and “Forward Looking Statements” and “Risk Factors” in the Annual Report. We cannot guarantee the accuracy or completeness of this market and market share data and have not independently verified it. None of the sources has consented to the disclosure or use of data in this Report.
The GRAFTECH logo, GRAFCELL®, EGRAF®, GRAFOIL®, and SpreaderShield™ are our trademarks and trade names used in this Report. This Report also contains trademarks and trade names belonging to other parties.
We make available, free of charge, on or through our web site, copies of our proxy statements, our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. We maintain our website athttp://www.graftech.com. The information contained on our web site is not part of this Report.
We have a code of ethics (which we call our Code of Conduct and Ethics) that applies to our principal executive officer, principal financial officer, principal accounting officers and controller, and persons performing similar functions, as well as our other employees, and which is intended to comply, at a minimum, with the listing standards of the NYSE as well as the Sarbanes-Oxley Act of 2002 and the SEC rules adopted thereunder. A copy of our Code of Conduct and Ethics is available on our web site.
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We also have corporate governance guidelines (which we call the Charter of the Board of Directors) which is available on our website athttp://www.graftech.com/GrafTech/About+Our+Company/Corporate+Governance/Corporate+Governance+Guidelines.htmas required by the NYSE. You may request a copy of the Charter of the Board of Directors, at no cost, by oral or written request to: GrafTech International Ltd., 12900 Snow Road, Parma, Ohio, 44130, Attention: Michael A. Carr, Manager of Investor Relations, Telephone (216) 676-2345.
Reference is made to the Annual Report for background information on various risks and contingencies and other matters related to circumstances affecting us and our industry.
Neither any statement made in this Report nor any charge taken by us relating to any legal proceedings constitutes an admission as to any wrongdoing.
Forward Looking Statements and Risk Factors. This Report contains forward looking statements. In addition, we or our representatives have made or may make forward looking statements on telephone or conference calls, by webcasts or emails, in person, in presentations or written materials, or otherwise. These include statements about such matters as: future production and sales of steel, aluminum, electronic devices, fuel cells and other products that incorporate or that are produced using our products; future prices and sales of and demand for such products; future operational and financial performance of our businesses; strategic plans and business projects; impacts of regional and global economic conditions; interest rate management activities; deleveraging activities; rationalization, restructuring, realignment, strategic alliance, raw material and supply chain, technology development and collaboration, investment, acquisition, venture, operational, tax, financial and capital projects; legal and litigation matters; consulting projects; potential offerings, sales and other actions regarding debt or equity securities of us or our subsidiaries; and future asset sales, costs, working capital, revenues, business opportunities, debt levels, cash flows, cost savings and reductions, margins, earnings and growth. The words “will,” “may,” “plan,” “estimate,” “project,” “believe,” “anticipate,” “expect,” “intend,” “should,” “would,” “could,” “target,” “goal” and similar expressions identify some of these statements.
Actual future events and circumstances (including future results and trends) could differ materially from those set forth in these statements due to various factors. These factors include:
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Occurrence of any of the events or circumstances described above could also have a material adverse effect on our business, financial condition, results of operations, cash flows or the market price of our common stock, the Senior Notes or the Debentures.
No assurance can be given that any future transaction about which forward looking statements may be made will be completed or as to the timing or terms of any such transaction.
All subsequent written and oral forward looking statements by or attributable to us or persons acting on our behalf are expressly qualified in their entirety by these factors. Except as otherwise required to be disclosed in periodic reports required to be filed by public companies with the SEC pursuant to the SEC’s rules, we have no duty to update these statements.
For a more complete discussion of these and other factors, see “Risk Factors” in the Annual Report.
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We are impacted in varying degrees, both positively and negatively, as global, regional or country conditions fluctuate.
Synthetic Graphite. Graphite electrode demand is primarily linked with the global production of steel in an electric arc furnace and, to a lesser extent, with the total production of steel and certain other metals. During the first quarter of 2006, global steel production and operating rates, excluding China, were comparable to the same period last year. However, due to China’s steel production growth of 17.6% during the 2006 first quarter as compared to the same period in 2005, global steel production increased by about 5.4%. Overall, EAF steel production capacity continues to expand, with estimates that production will increase by 3% during 2006.
We expect graphite electrode sales volume to be approximately 210,000 to 215,000 metric tons in 2006, depending on market conditions. We expect graphite electrode revenue to increase 15% in 2006 as compared to 2005, with a majority of the increase projected in the second half of the year.
The global graphite electrode pricing environment continues to improve as global demand for high quality, reliable graphite electrodes continues to grow. 2006 is expected to be one of the strongest years in over a decade for EAF new start-ups. These new furnaces are projected to add over 5% of EAF steel capacity over the course of 2006, primarily in China and Russia.
We have secured 100% of our anticipated 2006 premium needle coke requirements, our most significant and critical raw material. Premium needle coke represents the largest single component of graphite electrode production costs. Although raw material pricing pressures remain persistently high, we have identified productivity initiatives to help mitigate these rising 2006 production costs. These initiatives include the implementation of rationalization and productivity opportunities in our synthetic graphite facilities and continued streamlining, centralization and consolidation of our administrative activities. We believe these productivity and consolidation initiatives will contain our 2006 graphite electrode production cost increases to a range of 10% to 12%.
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 other cathodes as new smelting furnaces are built, thereby reducing the current excess supply of graphite cathodes.
Other Segment. We expect increased blast furnace construction and refurbishment to lead to continuing strong demand for our carbon refractories in the various geographic markets
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through 2006. We believe that overall long-term demand for our refractories continues to increase with strong global economic growth. We continue to seek to drive productivity and cost improvements in these product lines.
We expect continued growth of net sales of our ETM products and services. We have hired and are continuing to hire additional personnel in sales, marketing and research and development to support our growth. These resources will focus on the continued growth of our ETM business as we continue to leverage our successes to penetrate new customers and applications and identify new market opportunities including recent approvals for ETM solutions in liquid crystal display (LCD) panels. We believe the LCD flat panel display segment, when coupled with the plasma display television segment, is expected to grow from about eight million units in 2004 to sixty million units by 2008. Net sales for ETM products were $5.0 million as compared to $4.5 million in the 2005 first quarter. We expect ETM sales of approximately $30 million in 2006, representing an almost 60% increase over 2005.
Overall. The 2006 effective tax rate is expected to be in the range of 37% to 40%. Capital expenditures are estimated to be approximately $45 million and depreciation expense is estimated to be about $40 million in 2006.
Our outlook could be significantly impacted by, among other things, factors described under “Preliminary Notes — Forward Looking Statements and Risk Factors” in this Report. For a more complete discussion of these and other factors, see “Risk Factors” in the Annual Report.
Three Months Ended March 31, 2006 as Compared to Three Months Ended March 31, 2005.Net sales of $208.6 million in the 2006 first quarter represented a $2.5 million, or 1.2%, decrease from net sales of $211.1 million in the 2005 first quarter, primarily due to lower net sales of $5.7 million in our other segment that were partially offset by an increase of $3.2 million in the synthetic graphite segment. Cost of sales of $152.7 million in the 2006 first quarter represented a $9.7 million, or 6.0%, decrease from cost of sales of $162.4 million in the 2005 first quarter, primarily due to lower sales volumes, partially offset by increases in raw material and energy costs. Gross profit of $55.9 million in the 2006 first quarter represented a $7.2 million, or 14.8% increase from gross profit of $48.7 million in the 2005 first quarter. Gross margin was 26.8% in the 2006 first quarter as compared to gross margin of 23.0% in the 2005 first quarter. See below for further details regarding such changes.
Synthetic Graphite Segment. Net sales of $188.2 million in the 2006 first quarter represented a $3.2 million, or 1.7%, increase from net sales of $185.0 million in the 2005 first quarter. The increase was primarily due to a $7.3 million increase in cathodes and a $2.5 million increase in advanced synthetic graphite materials. The net sales increases in cathodes and advanced synthetic graphite materials were due primarily to increases in volumes and to a lesser extent pricing increases that were partially offset by net unfavorable currency impacts. The increases in net sales of cathodes and advanced synthetic graphite material were partially offset by a $6.7 million decrease in graphite electrode net sales due primarily to lower sales volumes of $13.8 million, net unfavorable currency impact of $3.5 million, unfavorable product mix of
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$3.0 million offset by $13.6 million due to higher realized pricing per metric ton. Volume of graphite electrodes sold was 42,400 metric tons in the 2006 first quarter as compared to 47,300 metric tons in the 2005 first quarter.
Cost of sales of $134.6 million in the 2006 first quarter represented a $6.6 million, or 4.7%, decrease from cost of sales of $141.2 million in the 2005 first quarter. Cost of sales decreased throughout the synthetic graphite segment primarily due to lower volumes sold in graphite electrodes. As a result, gross profit in the 2006 first quarter was $53.7 million, 22.5% more than the 2005 first quarter. Gross margin was 28.5% of net sales in the 2006 first quarter as compared to the 23.7% of net sales in the 2005 first quarter.
Other Segment. Net sales of $20.3 million in the 2006 first quarter represented a $5.7 million, or 21.9%, decrease from net sales of $26.0 million in the 2005 first quarter. This decrease was primarily due to a $3.8 million decrease in sales of carbon refractories due to the timing of product shipments that will occur in the second quarter of 2006 as a result of customer scheduling and a decrease of $1.7 million in carbon electrodes related to lower volumes. Cost of sales of $18.1 million in the 2006 first quarter represented a $3.1 million, or 14.6% decrease from cost of sales of $21.2 million in the 2005 first quarter. The decrease in cost of sales was primarily related to lower sales volumes. Gross profit in the 2006 first quarter was $2.3 million (a gross margin of 11.2% of net sales) as compared to gross profit in the 2005 first quarter of $4.8 million (a gross margin of 18.6% of net sales). The decrease in the gross margin percentage was due to the decrease in net sales.
Items Affecting Us as a Whole. Selling, administrative and other expenses of $28.0 million in the 2006 first quarter represented a $1.8 million, or 6.9%, increase from $26.2 million in the 2005 first quarter. This increase in the 2006 first quarter consisted of $0.7 million of non-recurring costs related to the transition and overlap of certain accounting and finance functions, $0.3 million of external consulting fees and $0.8 million of other corporate administration costs.
Other expense, net, was $0.6 million in the 2006 first quarter and consisted primarily of $0.5 million of bank and other financing fees, $0.8 million of relocation costs, $1.0 million of legal, environmental and other related costs, and $0.8 million of other costs. These expenses were partially offset by $2.5 million of currency exchange gains, primarily associated with Euro-denominated intercompany loans.
Other expense, net, was $5.9 million in the 2005 first quarter and consisted primarily of $6.6 million of currency exchange losses, primarily associated with Euro-denominated intercompany loans, a $1.5 million write-off of capitalized bank fees and $0.6 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 $2.8 million.
In the 2006 first quarter, restructuring charges were $2.9 million. In the 2005 first quarter, restructuring charges were nominal. The following table summarizes activity relating to the accrued expense in connection with the restructuring charges. The restructuring accrual is
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included in other accrued liabilities and other long-term obligations on the Consolidated Balance Sheets.
At March 31, 2006, the outstanding balance of our restructuring reserve was $13.8 million. We expect to make $13 million of these payments by the end of 2006, with the majority of the remaining payments to be paid by the end of 2007. The components of the balance at March 31, 2006 consisted primarily of:
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 projected resource constraints. As a result, we recorded a $6.6 million loss, including the write-off of
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capitalized interest, in accordance with SFAS No. 144, “Accounting For the Impairment and Disposal of Long-Lived Assets”.
Also, in the first quarter of 2006, management announced its intention to sell certain long-lived assets from the Etoy, Switzerland and Caserta, Italy locations. As a result, we have classified these assets as held for sale in the consolidated balance sheet in accordance with SFAS No. 144. In addition, we have recorded a $1.4 million impairment loss that adjusts the carrying value of the assets in Switzerland to the estimated fair value less selling costs.
Average total debt outstanding was $741.9 million in the 2006 first quarter as compared to $678.5 million in the 2005 first quarter. The average annual interest rate was 7.2% in the 2006 first quarter as compared to 6.5% in the 2005 first quarter. For the first quarter of 2005, the average annual rate includes the benefits of our interest rate swaps.
Provision for income taxes was a charge of $3.5 million in the 2006 first quarter and $0.8 million in the 2005 first quarter. The effective income tax rate was approximately (365)% in the 2006 first quarter as compared to approximately 38% in the 2005 first quarter. The effective income tax rate in the 2006 first quarter is negative due to jurisdictional profitability mix. We estimate that we will have an effective income tax rate between 37% to 40% for 2006, excluding the effects of nondeductible restructuring expenses and other items of income and expense.
As a result of the matters described above, net loss was $4.6 million in the 2006 first quarter as compared to net income of $1.5 million in the 2005 first quarter.
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
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exchange rates affecting these currencies relative to the dollar and, to a limited extent, each other.
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 2006 first quarter, the average exchange rate of the Brazilian Real and Mexican Peso increased about 19% and 6%, respectively, when compared to the average exchange rate for the 2005 first quarter. During the 2006 first quarter, the average exchange rate for the Euro and South African Rand decreased 10% and 7%, respectively, when compared to the average exchange rate for the 2005 first quarter.
In the case of net sales of synthetic graphite, the impact of these events was a decrease of about $6.3 million in the 2006 first quarter as compared to the 2005 first quarter. In the case of cost of sales of synthetic graphite, the impact of these events was a decrease of about $3.7 million in the 2006 first quarter as compared to the 2005 first quarter.
We have non-dollar denominated intercompany loans between GrafTech Finance and some of our foreign subsidiaries. At March 31, 2006, the aggregate principal amount of these loans was $425.6 million. 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 gains and losses on these loans are recorded as a component of accumulated other comprehensive loss in the stockholders’ deficit section of the Consolidated Balance Sheets. The balance of these loans is deemed to be temporary and, as a result, remeasurement gains and losses on these loans are recorded as currency (gains) losses in other expense, net, on the Consolidated Statements of Operations. In the 2005 first quarter, we had a net total of $6.6 million in currency losses, including $6.2 million of exchange losses due to the remeasurement of intercompany loans and translation of financial statements of foreign subsidiaries that use the dollar as their functional currency. In the 2006 first quarter, we had a net total of $2.6 million in currency gains, including $4.2 million of exchange gains 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–Quantitative and Qualitative Disclosures about Market Risk.”
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 capital expenditures, payment of fines, liabilities and expenses in
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connection with antitrust investigations, lawsuits and claims, payment of restructuring costs, pension and post-retirement contributions, debt reduction payments and other obligations.
We are highly leveraged and have other substantial obligations. At March 31, 2006, we had total debt of $763.1 million, cash and cash equivalents of $21.3 million and a stockholders’ deficit of $202.9 million.
As part of our cash management activities, we periodically factor or discount (by selling) certain accounts receivable to third parties. In the 2006 first quarter, certain subsidiaries sold receivables at a cost lower than the cost to borrow a comparable amount for a comparable period under the Revolving Facility. Proceeds of the sale of receivables were used to reduce debt. If we had not sold receivables, our accounts receivable and our debt would have been about $13.1 million higher at December 31, 2005 and about $15.3 million higher at March 31, 2006. All receivables sold during 2005 and the 2006 first quarter were sold without recourse, and no amount of accounts receivable sold remained on the Consolidated Balance Sheet at December 31, 2005 and March 31, 2006.
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 Facility provides for maximum borrowings of up to $215 million. At March 31, 2006, $124.1 million was available (after consideration of outstanding revolving and swingline loans of $83.1 million and outstanding letters of credit of $7.8 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, 2006, 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 for the next twelve months. If we were to believe that we would not continue to comply with these 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, 2006, 13% (or $98.2 million) of our total debt consists of variable rate obligations. As of March 31, 2006, there were no outstanding interest rate swaps or caps.
At March 31, 2006, the Revolving Facility had an effective interest rate of 7.3%, our $434.6 million principal amount of Senior Notes had a fixed rate of 10.25% and our $225 million principal amount of Debentures had a fixed coupon rate of 1.625%. We estimate that we will have interest expense of approximately $58.3 million for 2006.
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We expect to continue to implement interest rate management initiatives in the future 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. 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. 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.
Typically, the first quarter of each year results in neutral or negative cash flow from operations due to various factors. These factors include customer order patterns, fluctuations in working capital requirements and other factors. The third quarter tends to produce relatively less positive cash flow from operations primarily as a result of scheduled plant shutdowns by our customers for vacations. Our cash flow from operations in the first and third quarters typically is adversely impacted by the semi-annual interest payments on the Senior Notes and the Debentures. The second and fourth quarters correspondingly benefit from the absence of such interest payments.
As part of our cash management activities, we seek to manage accounts receivable credit risk and collections, and accounts payable and payment thereof to maximize our free cash at any given time and minimize accounts receivable losses. In order to seek to minimize our credit risks, we periodically reduce our sales of, or refuse to sell (except for cash on delivery), graphite electrodes to some customers and potential customers in the U.S. and, to a limited extent, elsewhere. Our unrecovered trade receivables worldwide were only 0.1% of global net sales during the last 3 years. We cannot assure you that we will not be materially adversely affected by accounts receivable losses in the future.
We use cash and cash equivalents, funds available under the Revolving Facility and cash flow from operations as our primary sources of liquidity. We believe that our business strategies will continue to improve the amount and speed of cash generated from operations under current economic conditions. Improvements in cash flow from operations resulting from these strategies are being partially offset by associated cash implementation costs while they are being implemented. We also believe that our planned asset sales together with these improvements in cash flow from operations should allow us to reduce our debt and other obligations over the long term.
We may from time to time and at any time repurchase Senior Notes or Debentures in open market or privately negotiated transactions, opportunistically on terms that we believe to be
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favorable. These purchases may be effected for cash (from cash and cash equivalents, borrowings under the Revolving Facility or new credit facilities, or proceeds from sale of debt or equity securities or assets), in exchange for common stock or other equity or debt securities, or a combination thereof. We will evaluate any such transaction in light of then prevailing market conditions and our then current and prospective liquidity and capital resources, including projected and potential needs and prospects for access to capital markets. Any such transactions may, individually or in the aggregate, be material.
We have in the past entered into, and may in the future enter into, natural gas derivative contracts and short duration fixed rate purchase contracts to effectively fix some or all of our natural gas cost exposure, as described under “Quantitative and Qualitative Disclosure about Market Risks” in this Report.
We are required to provide cash collateral to certain counterparties to the extent that the fair market value of the natural gas derivative contracts exceeds a specific threshold. At March 31, 2006, we were not required to provide any cash collateral.
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. Our leverage and these obligations make us more vulnerable to economic downturns in the event that these obligations are greater or timing of payment is sooner than expected.
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.
Cash Flow Provided by Operating Activities. Cash flow used in operating activities was $33.4 million in the 2006 first quarter as compared to $13.8 million in the 2005 first quarter, an increase of $19.6 million. The primary uses consisted of $40.2 million for working capital and $6.6 million for other long-term assets and liabilities offset by $13.4 million from the net loss, after adding back the net effect from non-cash items. Working capital uses related primarily to a $29.3 million increase in inventories to allow for transition of facilities and to position us to meet expected customer demand, a $4.5 million payment against the DOJ antitrust fine, $0.9 million of restructuring payments, and decreases in payables and accruals due to timing of payment patterns (including our semi-annual interest payment on the Senior Notes) of $31.2 million, offset by a $25.8 million decrease in accounts and notes receivable (including $2.4 million related to the factoring of accounts receivable). Other long-term assets and liabilities uses were primarily for pension and postretirement benefits. Other items that affected operating cash flow consisted primarily of $8.2 million related to impairments of long-term assets, $2.9 million
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related to restructuring charges, $9.2 million of depreciation, amortization and $2.3 million of other net uses of cash.
Cash used in operating activities was $13.8 million in the 2005 first quarter. The primary uses consisted of $26.5 million for working capital and $2.6 million for other long-term assets and liabilities, offset by $15.4 million of cash from net income, after adding back the net effect from non-cash items. Working capital uses related primarily to a $22.4 million increase in inventories to allow for transition of facilities and position to meet expected customer demand, a $23.6 million decrease in payables and accruals (due to timing of payment patterns, including our semi-annual interest payment on the Senior Notes), $3 million of restructuring payments and $3.4 million of payments in connection with antitrust investigations and related lawsuits and claims, offset by a $25.9 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 $8.6 million of depreciation and amortization and $5.2 million of other net charges.
Cash Flow Used in Investing Activities. Cash flow used in investing activities was $10.9 million in the 2006 first quarter and $13.8 million in the 2005 first quarter. Capital expenditures amounted to $10.9 million for the 2006 first quarter and $10.8 million of the 2005 first quarter and related primarily to graphite electrode productivity and production stability initiatives and other essential capital maintenance.
Cash Flow Provided by Financing Activities. Cash flow provided by financing activities was $59.6 million in the 2006 first quarter and $20.5 million during 2005 first quarter.
During the 2006 first quarter, we borrowed $44.1 million under the Revolving Facility. We used these borrowings primarily to pay our semi-annual interest payment on the Senior Notes, our scheduled payments to the DOJ, and to fund increases in working capital and capital expenditures. We also made contributions to certain pension plans.
During the 2005 first quarter, we borrowed $25 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 $3.8 million of financing costs in conjunction with the refinancing of the Revolving Facility.
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 Annual Report and such description is incorporated herein by reference. Such description contains all of the information required with respect thereto.
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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.
A description of the Revolving Facility, the Senior Notes and the Debentures is set forth under “Long-Term Debt and Liquidity” in the Annual Report, and such description is incorporated herein by reference.
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.
Through March 31, 2006, except for certain foreign customer lawsuits discussed in Note 14 of the Annual Report, we have settled or obtained dismissal of 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 payments due have been timely paid.
We have been vigorously defending, and intend to continue to vigorously defend, against the foreign customer lawsuits. We may at any time, however, settle these lawsuits. It is possible that additional antitrust investigations, lawsuits and claims could be commenced or asserted in the U.S. or other jurisdictions. We are currently not reserved for such matters.
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On March 1, 2006, we were served with a complaint commencing a securities class action in the United States District Court for the District of Delaware (Civil Action No. 06-133). The complaint alleged that GTI and certain officers violated federal securities law by making false statements or failing to disclose adverse facts, in or in relation to press releases issued by us on November 3, 2005, about our graphite electrode pricing power, our cost-cutting measures, the market for our non-graphite product lines, our forecasting ability, our internal controls and corporate compliance, and our restructuring activities and charges. The proposed class consists of all persons who purchased our securities during the period from November 3, 2005 until February 8, 2006. The complaint seeks, among other things, to recover damages resulting from such alleged violations. On March 21, 2006, the complaint was voluntarily withdrawn by the plaintiffs.
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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, and commercial energy rates. 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:
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. At December 31, 2005 and March 31, 2006, we had no interest rate swaps outstanding.
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.
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. At December 31, 2005 and March 31, 2006, we had no outstanding interest rate caps. 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 resulted in a nominal gain for the 2005 first quarter.
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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. As of December 31, 2005 and March 31, 2006, there were no outstanding contracts. In the 2005 first quarter, we recorded a nominal gain with respect to contracts held during the quarter.
Commercial Energy Rate Management. We have in the past entered into, and may in the future enter into, natural gas derivative contracts and short duration fixed rate purchase contracts to effectively fix some or all of our natural gas cost exposure. As of March 31, 2006, we had fixed about 35% of our worldwide natural gas exposure through such contracts. The outstanding contracts at December 31, 2005 were a nominal receivable. The loss and associated liability on outstanding contracts at March 31, 2006 amounted to $0.7 million.
Sensitivity Analysis. We used a sensitivity analysis to assess the potential effect of changes in currency exchange rates, interest rates, and commercial energy rates on results of operations for the 2006 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 2006 first quarter by $2.1 million. Based on this analysis, a hypothetical increase in interest rates of 100 basis points would have increased our interest expense by about $0.2 million for the 2006 first quarter.
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Evaluation of Disclosure Controls and Procedures. Management is responsible for establishing and maintaining adequate disclosure controls and procedures at the reasonable assurance level. Disclosure controls and procedures are designed to ensure that information required to be disclosed by a reporting company in the reports that it files or submits under the Exchange Act 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 it in the reports that it files under the Exchange Act is accumulated and communicated to management, including the chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of our management, including our Chief Executive Officer and interim Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2006. Based on that evaluation, our Chief Executive Officer and interim Chief Financial Officer has concluded that these controls and procedures are effective at the reasonable assurance level as of March 31, 2006.
Changes in Internal Controls over Financial Reporting. In our 2005 Annual Report on Form 10-K, we announced the relocation of our principal executive office from Wilmington, Delaware to Parma, Ohio, the relocation of various business transaction processing and accounting functions from our offices in Clarkesville, Tennessee to Parma, and the relocation of certain management, accounting and treasury functions from our offices in Etoy, Switzerland to Parma. During the first quarter of 2006, a significant number of our corporate employees (including employees involved in our control environment) have elected not to relocate and have left employment with us following a period during which their functions were transitioned to other employees hired in Parma.
In 2005, we also announced the termination of our business process services (“BPS”) agreement with CGI. Under this agreement, CGI managed certain of our accounting and finance functions and played a role in performing certain internal control functions. We no longer rely on the provider to perform these functions. The agreement’s effective termination date was February 28, 2006.
During the 2005 fourth quarter, we also announced the resignation of our Chief Financial Officer. Our Chief Financial Officer was also our principal accounting officer and was a key component of our overall control environment. In conjunction with his resignation, we named our Chief Executive Officer as our interim Chief Financial Officer. We have hired a new Chief Financial Officer who is also our principal accounting officer who began employment with us on May 8, 2006. Our Chief Executive Officer nonetheless continued to be responsible for the functions of the Chief Financial Officer through the filing of this Report with the SEC.
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Beginning in the 2005 fourth quarter and continuing in the 2006 first quarter, we have engaged in activities designed to ensure a smooth transition in connection with, and mitigate any material disruption to our business or our internal control over financial reporting resulting from these events. Among other things, as of March 31, 2006:
Except as described above, there has been no change in our internal controls over financial reporting that occurred during the 2006 first quarter that materially affected or is reasonably likely to materially affect our internal controls over financial reporting.
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This information required in response to this Item is set forth under “Contingencies” in Note 13 to the Notes to Consolidated Financial Statements contained in this Report, and such description is incorporated herein by reference.
The exhibits listed in the following table have been filed as part of this Report.
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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.
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